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COMMISSIONER V. BANKS (03-892)
Web-accessible at: http://supct.law.cornell.edu/supct/html/03-892.ZS.html
Argued November 1, 2004 -- Decided January 24, 2005**
Opinion author: Kennedy
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Respondent Banks settled his federal employment discrimination suit
against a California state agency and respondent Banaitis settled his
Oregon state case against his former employer, but neither included
fees paid to their attorneys under contingent-fee agreements as gross
income on their federal income tax returns. In each case petitioner
Commissioner of Internal Revenue issued a notice of deficiency, which
the Tax Court upheld. In Banks' case, the Sixth Circuit reversed in
part, finding that the amount Banks paid to his attorney was not
includable as gross income. In Banaitis' case, the Ninth Circuit found
that because Oregon law grants attorneys a superior lien in the
contingent-fee portion of any recovery, that part of Banaitis' settlement
was not includable as gross income.
Held: When a litigant's recovery constitutes income, the litigant's
income includes the portion of the recovery paid to the attorney as a
contingent fee. Pp. 5-12.
(a) Two preliminary observations help clarify why this issue is
of consequence. First, taking the legal expenses as miscellaneous
itemized deductions would have been of no help to respondents
because the Alternative Minimum Tax establishes a tax liability floor
and does not allow such deductions. Second, the American Jobs
Creation Act of 2004--which amended the Internal Revenue Code to
allow a taxpayer, in computing adjusted gross income, to deduct
attorney's fees such as those at issue--does not apply here because
it was passed after these cases arose and is not retroactive. Pp. 5-6.
(b) The Code defines "gross income" broadly to include all
economic gains not otherwise exempted.Under the anticipatory
assignment of income doctrine, a taxpayer cannot exclude an
economic gain from gross income by assigning the gain in advance to
another party, e.g., Lucas v. Earl, 281 U.S. 111, because gains
should be taxed "to those who earn them," id., at 114. The doctrine is
meant to prevent taxpayers from avoiding taxation through
arrangements and contracts devised to prevent income from vesting in
the one who earned it.Id., at 115. Because the rule is
preventative and motivated by administrative and substantive
concerns, this Court does not inquire whether any particular assignment
has a discernible tax avoidance purpose. Pp. 6-7.
(c) The Court agrees with the Commissioner that a contingent-
fee agreement should be viewed as an anticipatory assignment to the
attorney of a portion of the client's income from any litigation recovery.
In an ordinary case attribution of income is resolved by asking whether
a taxpayer exercises complete dominion over the income in question.
However, in the context of anticipatory assignments, where the
assignor may not have dominion over the income at the moment of
receipt, the question is whether the assignor retains dominion over the
income-generating asset. Looking to such control preserves the
principle that income should be taxed to the party who earns the
income and enjoys the consequent benefits.In the case of a
litigation recovery the income-generating asset is the cause of action
derived from the plaintiff's legal injury. The plaintiff retains dominion
over this asset throughout the litigation. Respondents'
counterarguments are rejected. The legal claim's value may be
speculative at the moment of the assignment, but the anticipatory
assignment doctrine is not limited to instances when the precise dollar
value of the assigned income is known in advance. In these cases, the
taxpayer retained control over the asset, diverted some of the income
produced to another party, and realized a benefit by doing so. Also
rejected is respondents' suggestion that the attorney-client relationship
be treated as a sort of business partnership or joint venture for tax
purposes. In fact, that relationship is a quintessential principal-agent
relationship, for the client retains ultimate dominion and control over the
underlying claim. The attorney can make tactical decisions without
consulting the client, but the client still must determine whether to settle
or proceed to judgment and make, as well, other critical decisions. The
attorney is an agent who is duty bound to act in the principal's
interests, and so it is appropriate to treat the full recovery amount as
income to the principal. This rule applies regardless of whether the
attorney-client contract or state law confers any special rights or
protections on the attorney, so long as such protections do not alter
the relationship's fundamental principal-agent character. The Court
declines to comment on other theories proposed by respondents and
their amici, which were not advanced in earlier stages of the litigation or
examined by the Courts of Appeals. Pp. 7-10.
(d) This Court need not address Banks' contention that
application of the anticipatory assignment principle would be
inconsistent with the purpose of statutory fee-shifting provisions, such
as those applicable in his case brought under 42 U.S.C. sect. 1981
1983, and 2000(e) et seq.He settled his case, and the fee paid to
his attorney was calculated based solely on the contingent-fee
contract. There was no court-ordered fee award or any indication in his
contract with his attorney or the settlement that the contingent fee paid
was in lieu of statutory fees that might otherwise have been
recovered. Also, the American Jobs Creation Act redresses the
concern for many, perhaps most, claims governed by fee-shifting
statutes. P. 11.
No. 03-892, 345 F.3d 373; No. 03-907, 340 F.3d 1074, reversed
and remanded.
Kennedy, J.,
delivered the opinion of the Court, in which all other Members joined,
except Rehnquist, C. J., who took no part in the decision of the cases.
Notes
*. Together with No. 03-907, Commissioner of Internal Revenue v.
Banaitis, on certiorari to the United States Court of Appeals for the
Ninth Circuit.
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