Section of Taxation Publications
  VOL. 57
NO. 3
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 Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
Are Attorneys' Fees Income to the Taxpayer? The Inequitable and Inconsistent Result of the Ninth Circuit's State Attorney Lien Law Approach: Banaitis v. Commissioner
Chris Staton Spicer


Whether attorneys’ fees paid out of a damage recovery are included in gross income has a profound effect on a plaintiff’s after-tax recovery in a litigation settlement. Different circuits apply different legal frameworks and doctrines and, as a result, arrive at divergent conclusions. In Banaitis v. Commissioner, the United States Court of Appeals for the Ninth Circuit held that because of certain distinctive features of Oregon state law, contingent fees paid directly to the taxpayer’s attorney did not have to be included in the taxpayer’s gross income. Reversing the Tax Court’s decision in part, the appellate court ruled that because Oregon law gives attorneys strongly enforceable property interests in litigation settlements, a taxpayer recovering in that state can exclude from gross income any fees paid directly to an attorney. Oddly, however, a taxpayer who resides in other states within the Ninth Circuit, Alaska or California for example, would not be able to exclude similar fees from gross income because the state law property interest for attorneys collecting fees in Oregon is much stronger than in Alaska or California. With this interpretation, the Ninth Circuit created a legal framework whereby the amount of the plaintiff’s recovery in a litigation settlement will vary according to state attorney lien law. Such variability is seemingly inconsistent with the policy of uniform application of the tax law to similarly situated taxpayers.

This Note discusses the Ninth Circuit’s reasoning regarding whether attorneys’ fees are includable in gross income and suggests that the method adopted in the Fifth and Sixth Circuits provides a fairer and more consistent result. In contrast to the Ninth Circuit’s state attorney lien law approach, the Fifth and Sixth Circuits follow a partnership approach in which attorneys’ fees are only includable in gross income to the lawyer receiving them, and not to the plaintiff. Part I of this Note briefly explains the facts of the case and the applicable Code provisions, the Tax Court’s holding, and the respective parties’ theories on appeal. Part II describes the Ninth Circuit’s holding and reasoning. Part III analyzes the decision of the court and advocates that an alternative method employed by both the Fifth and Sixth Circuits is more appropriate. Part IV concludes that the Ninth Circuit did not provide a fair result for all future taxpayers.


Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


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