Commissioner of Internal Revenue v. Banks

PETITIONER: Commissioner of Internal Revenue
RESPONDENT: Sigitas J. Banaitis
LOCATION: City of New London Town Hall

DOCKET NO.: 03-892
DECIDED BY: Rehnquist Court (1986-2005)
LOWER COURT: United States Court of Appeals for the Sixth Circuit

CITATION: 543 US 426 (2005)
GRANTED: Mar 29, 2004
ARGUED: Nov 01, 2004
DECIDED: Jan 24, 2005

David B. Salmons - argued the cause for Petitioner
James R. Carty - argued the cause for Respondent Banks
Philip N. Jones - argued the cause for Respondent Banaitis

Facts of the case

Sigitas Banaitis and John Banks separately argued to the U.S. Tax Court that contingency fees paid to lawyers could be deducted from taxable gross income. The court disagreed and ruled for the Internal Revenue Service. The IRS said Banaitis and Banks owed taxes on contingency fees. Banaitis appealed to the Ninth Circuit Court of Appeals, which ruled that under Oregon law contingency fees could not be taxed as income. Banks appealed to the Sixth Circuit Court of Appeals, which ruled contingency fees were never taxable income. Other federal appeals courts ruled to the contrary. The U.S. Supreme Court consolidated Banaitis' and Banks' cases.


Does a taxpayer's gross income from litigation proceeds include contingency fees paid to lawyers?

Media for Commissioner of Internal Revenue v. Banks

Audio Transcription for Oral Argument - November 01, 2004 in Commissioner of Internal Revenue v. Banks

Audio Transcription for Opinion Announcement - January 24, 2005 in Commissioner of Internal Revenue v. Banks

Sandra Day O'Connor:

I have an opinion to announce in two consolidated cases in numbers 03-892 and 03-907, Commission of Internal Revenue versus Banks, Commissioner of Internal Revenue versus Banaitis.

They are authored by Justice Kennedy.

These consolidated cases require us to interpret the Internal Revenue Code.

The respondent taxpayers were plaintiffs and civil suits where the sums recovered must be treated as income.

Part of each plaintiff’s recovery was paid to his attorney pursuant to a contingent fee arrangement.

The question is whether for purposes of determining the taxpayer’s gross income.

The whole amount of the recovery must be deemed income to the taxpayer or on the other hand whether the moneys paid to the attorneys are excluded from the taxpayer’s gross income.

The resolution of this question is important because for the years in question the alternative minimum tax prevented the taxpayer’s from deducting their legal expenses.

The government maintains that under Settle Tax Principles the whole of the litigation recovery including the portion paid to the attorney must be counted as income to the taxpayer.

In an opinion to the Court filed today written by Justice Kennedy, we agree with the position of the government.

We have long held that the taxpayer cannot exclude an economic gain from gross income by assigning the gain in advance to another party even if the taxpayer does not actually received the income, the incomes is attributed to the taxpayer if he or she retains dominion over the income generating asset.

In the case of a litigation recovery, the income generating asset is the cause of action that derives from the plaintiff’s legal injury.

The plaintiff retains dominion over this asset throughout the litigation, although the attorney contributes a skill and effort to their recovery, the attorney-client relationship remains a principal agent relationship not a business partnership or joint venture.

The client retains ultimate control over critical decisions such as to whether to settle the litigation.

Even where the attorney exercises independent judgment on tactical decisions, the attorney remains an agent who is duty-bound to act for the exclusive benefit of the client.

The fact that the attorney is the client’s agent means it is appropriate to treat the full amount of any recovery as income to the client.

The rule applies whether or not the contingent fee contract or State law confers any special rights or protections on the attorney so long as those protections do not alter the fundamental principal agent character of the relationship.

The judgments of the Court of Appeals for the Sixth and the Ninth Circuits are reversed.

The cases are remanded for further proceedings consistent with this opinion.

The opinion is unanimous.

The Chief Justice did not participate in the decision of these cases.