Commissioner of Internal Revenue v. Banks & Commissioner of Internal Revenue v. Banaitis (consolidated)
Both Banks and Banaitis alleged they were unfairly terminated by their employers and sought legal recourse. Prior to litigation, Banks and Banaitis retained council who agreed to represent them pursuant to a contingency fee agreement. At trial, a jury awarded Banks $8,728,559, approximately half of which was paid, pursuant to the terms of the contingency fee agreement, to his attorney. Banaitis received a settlement of $464,000, over a third of which was paid to his attorney. Later, both men deducted the contingency fee amounts from their gross income on their federal income tax returns. They claimed the contingency fee amounts paid to their attorneys were never part of their gross income because they never actually had control of the money. The Internal Revenue Service (IRS) disagreed with the deductions and issued Notices of Deficiency, alerting the men that they still owed taxes on the contingency fee amounts.
Banks and Banaitis filed petitions with the United States Tax Court seeking review of their tax deficiencies. In both cases, the Tax Court found in favor of the IRS, holding that contingency fee amounts are part of gross income and, therefore, subject to taxation. Banaitis appealed the Tax Court decision to the Ninth Circuit Court of Appeals and Banks appealed to the Sixth Circuit Court of Appeals. Both courts sided with the petitioners, finding that contingency fees are not part of gross income. The Ninth Circuit held that Oregon law “affords attorneys generous property interests in judgments and settlements” to the extent that contingency fees paid directly to plaintiff’s attorneys are never part of the plaintiff’s gross income. The Sixth Circuit held that contingency fees are never part of a plaintiff’s gross income, regardless of the state law. In justifying its holding, the Sixth Circuit noted that the contingency fee never passed through the taxpayer’s hands and was never controlled by the taxpayer. Both circuits, however, noted that there is a great deal of confusion among the circuits regarding the treatment of contingency fees. The cases were consolidated for hearing before the Supreme Court.
Question Presented:
Whether, under Section 61(a) of the Internal Revenue Code, 26 U.S.C. ยง 61(a), a taxpayer's gross income from the proceeds of litigation includes the portion of his damages recovery that is paid to
his attorneys pursuant to a contingent fee agreement.
Decisions under Review:
Commissioner of Internal Revenue v. Banaitis
Commissioner of Internal Revenue v. Banks
