Metropolitan News-Enterprise


Monday, December 15, 2003


Page 3


Pre-Tax Deduction of Wrongful Discharge Attorney Fees Disallowed


By DAVID WATSON, Staff Writer


A taxpayer is not entitled to deduct from his income, as an adjustment attributable to a reimbursed employee expense, fees paid to his lawyer by his former employer in settling a wrongful termination claim, the Ninth U.S. Circuit Court of Appeals ruled Friday.

Writing for himself and two colleagues, Judge Stephen S. Trott said the U.S. Tax Court correctly disallowed the deduction sought by Frank Biehl and his wife, Barbara, on their 1996 tax return. Biehl sued North Coast Medical, Inc. for wrongful termination in 1994 and reached a $1.2 million settlement in 1996 after a jury found in his favor.

At Biehl’s request, NCMI issued a $401,000 check to the lawyer who represented him and a separate check for $799,000 to Biehl. The Biehls reported only the latter amount as taxable income.

The Internal Revenue Service issued a deficiency notice. The agency ruled the Biehls could deduct the attorney’s fees as a miscellaneous trade or business expense under Internal Revenue Code Sec. 162, but Trott noted that such a deduction would not have benefited them since no miscellaneous deductions are permitted in calculating the alternative minimum tax.

The Biehls challenged the determination, seeking an “above-the-line” deduction under Sec. 62(a)(2)(A), which permits such deductions for “expenses paid or incurred by the taxpayer, in connection with the performance by him of services as an employee, under a reimbursement or other expense allowance arrangement with his employer.”

Neither the language of the statute, its history, nor the implementing regulations supported applying it to the fees paid by NCMI to Biehl’s lawyer, Trott explained.

Trott noted that IRS regulations require a “business connection” to support a deduction under Sec. 62(a)(2)(A), and that the Tax Court found that no such connection could be present where a payment occurred after the employment relationship had ended.

“Although it may be true, as the Biehls contend, that the lawsuit arose out of Mr. Biehl’s former employment, that determination is not sufficient to qualify attorneys’ fees for a deduction under [Sec.] 62(a)(2)(A),” Trott wrote.

He went on to say:

“Whereas [Sec.] 62(a)(1) only requires the expense be ‘attributable to a trade or business,’ the language in [Sec.] 62(a)(2)(A) is much more definite. For a reimbursable employee expense to qualify for an above the line deduction, not only must it be attributable to a trade or business, but it must also have been incurred during the course of ‘performance—of services as an employee.’—Had Congress intended to open the flood-gates to all expenses incurred in connection with employment it could have done so. A straightforward reading of Sec. 62(a)(2)(A), especially when compared with Sec. 61(a)(1), does not support such an expansive approach.”

While the issue was not one previously confronted by the Ninth Circuit, Trott said, the Biehls’ appellate counsel and Georgetown University law professor Stephen Bruce Cohen—who supported the Biehls’ position in the litigation as an amicus—“conceded during oral argument that Congress did not anticipate or consider an application of the disputed statute to the scenario and context presented by this case.”

He added:

“We will not stretch the statutory language to cover a situation not contemplated by Congress.”

The jurist concluded:

“The Biehls fail to establish the business connection as is required under [Sec.] 62(a)(2)(A). Even though, preliminarily, these fees might broadly qualify for treatment as a deduction under [Sec.] 162(a), the legal fees associated with a wrongful termination lawsuit against a former employer are not ‘in connection with the performance—of services as an employee.’ This issue is dispositive, and therefore we do not address whether there was a reimbursement arrangement. If this result strikes some as bad policy, or unfair, the remedy is with Congress, not the courts.”

Judge David R. Thompson and Senior U.S. District Judge Charles R. Weiner of the Eastern District of Pennsylvania, sitting by designation, concurred.

The case is Biehl v. Commissioner of Internal Revenue, 02-72723.


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