A Capital Gains Anomaly: Commissioner v. Banks and the Proceeds from Lawsuits

74 Pages Posted: 7 Jun 2011 Last revised: 28 Jan 2012

See all articles by Steve Black

Steve Black

Texas Tech University School of Law

Katherine D. Black

Utah Valley University

Michael D. Black

Parr Waddoups Brown Gee & Loveless

Date Written: January 6, 2011

Abstract

When a litigant receives an award of damages or agrees to a settlement of a lawsuit for which the litigant and her attorney have agreed to a contingent fee, a portion of those damages or the settlement is paid to the attorney. For income tax purposes, there is a question of whether the litigant should include the portion paid to her attorney as her own income.

The question is not merely academic. In a tax system that does not always allow the litigant to deduct her attorney's fees, the litigant may end up paying tax on money that she never sees. In some cases, that tax can exceed the amount of money she gets from the lawsuit – making the litigant poorer by having pursued the suit at all.

The U.S. Supreme Court heard two cases regarding inclusion in income of contingent attorney’s fees, Commissioner v. Banks and Commissioner v. Banaitas. Although the cases seemed to resolve the question of including the fee paid to the attorney, the Court created an anomaly when they stated that the "income-generating asset is the cause of action that derives from the plaintiff's legal injury." Taking their words at face value, it appears the Supreme Court has made it possible to characterize all income from lawsuits or settlements as capital gain.

Keywords: attorneys fees, capital gains, taxation, income, damages

JEL Classification: H2, H24, H25, K34

Suggested Citation

Black, Steve and Black, Katherine D. and Black, Michael D., A Capital Gains Anomaly: Commissioner v. Banks and the Proceeds from Lawsuits (January 6, 2011). St. Mary's Law Journal, Vol. 43, p. 113, 2011. Available at SSRN: https://ssrn.com/abstract=1858776

Steve Black (Contact Author)

Texas Tech University School of Law ( email )

1802 Hartford
Lubbock, TX 79409
United States

Katherine D. Black

Utah Valley University ( email )

800 West University Parkway
Orem, UT 84058-5999
United States

Michael D. Black

Parr Waddoups Brown Gee & Loveless ( email )

Suite 1300, 185 South State Street
Salt Lake City, UT 84111
United States

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