The Netting of Costs Against Income Receipts (Including Damage Recoveries) Produced By Such Costs, Without Barring Congress from Disallowing Such Costs

54 Pages Posted: 22 Sep 2007 Last revised: 16 Nov 2007

See all articles by Joseph M. Dodge

Joseph M. Dodge

Florida State University - College of Law


The principal thesis is that, under the federal income tax, costs of obtaining specific sums of money should be capitalized (as opposed to being treated as expenses), just as costs of obtaining property should be so capitalized. Since this article deals with costs of obtaining or receiving specific 'cash amounts', it propounds what can be referred to as a netting or offset rule, principle, or thesis. The netting thesis is a straightforward application of the capitalization principle that would operate (notwithstanding perceived current tax accounting conventions) without regard to the arbitrary confines of the taxable year.

The netting thesis is opposed by the IRS, most conspicuously in the case of legal fees incurred by successful litigation plaintiffs (typically under contingency-fee arrangements) in obtaining non-excludible damages and settlement awards. The Service claims that such litigation costs are deductible under section 212(1) as expenses for the production or collection of income, but it turns out that such expenses are strongly disfavored as miscellaneous itemized deductions. The 2005 case of 'Commissioner v. Banks', which rejected an assignment-of-income theory for excluding from a plaintiff's income amounts paid to attorneys, declined to entertain the netting thesis on the ground that the issue wasn't ripe. Plaintiffs in certain situations have obtained tax relief under section 62(a)(20), enacted in late 2004.

This article argues that the netting thesis should be adopted by the courts and/or Treasury. After laying out the deep theory of capitalization, various doctrinal strands (pro and con) are examined. It is concluded that adoption of the netting thesis can be done within existing doctrine and without rendering section 212(1) without relevance. It is also argued that there is no difference in 'constitutional' status between basis recovery and expenses, with the consequence that Congress has the power to disallow them equally.

Suggested Citation

Dodge, Joseph M., The Netting of Costs Against Income Receipts (Including Damage Recoveries) Produced By Such Costs, Without Barring Congress from Disallowing Such Costs. Virginia Tax Review, Vol. 27, 2007, FSU College of Law, Law and Economics Paper No. 07-22, FSU College of Law, Public Law Research Paper No. 277, Available at SSRN:

Joseph M. Dodge (Contact Author)

Florida State University - College of Law ( email )

425 W. Jefferson Street
Tallahassee, FL 32306
United States
850-644-4590 (Phone)

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