Ninth Circuit Says Attorney Fees Paid by Defendant Taxable to Plaintiff

Wednesday, September 26, 2001

Page 1

Ninth Circuit Says Attorney Fees Paid by Defendant Taxable to Plaintiff

By KENNETH OFGANG, Staff Writer/Appellate Courts

Attorney fees incurred by a plaintiff in an Age Discrimination in Employment Act case, paid directly to the lawyers by the defendant as part of a settlement, are taxable income to the plaintiff, the Ninth U.S. Circuit Court of Appeals ruled yesterday.

A divided panel affirmed the Tax Court’s ruling assessing James and Monique Sinyard a deficiency under the alternative minimum tax. Both courts ruled that the Sinyards are liable for tax on the fees paid to the St. Paul, Minn. firm of Winthrop & Weinstine as part of a settlement with James Sinyard’s former employer, IDS Financial Services, Inc.

“[T]he Sinyards bound themselves to pay Winthrop & Weinstine one-third of what they received,” Senior Judge John T. Noonan Jr. wrote for the court. “When IDS satisfied this obligation, the Sinyards were so much the richer. That they never laid hands on the money paid to the lawyers does not obliterate their constructive receipt.”

Dissenting Opinion

Judge Kim McLane Wardlaw concurred in the opinion. Judge M. Margaret McKeown dissented, arguing that the decision was inconsistent with the make-whole purpose of the attorney fee provision in the ADEA.

Sinyard was the division manager for IDS in Mobile, Ala. when he was allegedly forced to resign in 1987 at the age of 49. He later joined with 31 other plaintiffs represented by the Winthrop firm in a lawsuit, which was later joined by the Equal Employment Opportunity Commission.

The case was settled in 1992, with IDS agreeing to pay $35 million and change a number of its employment practices. Of the $35 million, $1.7 million was allocated to costs, and the balance divided equally among tort compensation, lost wages, and attorney fees.

Sinyard received $547,000, with $438,000 being allocated to taxable back wages and tort damages and the balance to nontaxable personal injury damages. Of Sinyard’s $315,000 share of the attorney fees, the Internal Revenue Service allocated $63,000 to the nontaxable portion of the settlement, but insisted that the balance was taxable.

While $240,000—the amount of fees allocated to taxable wages and damages, less two percent of gross income—was allowable as a miscellaneous deduction, the IRS maintained, the full amount of the deduction could not be taken because the amount of the settlement made Sinyard subject to the alternative minimum tax.

The Tax Court judge and the Ninth Circuit majority agreed with the IRS.

Plain Language

The IRS position, Noonan wrote, is consistent with case law and the plain language of the ADEA. Like other fee-shifting laws, including civil rights laws, the judge said, the ADEA provides for fee awards in favor of the client, not the attorney.

Noonan also rejected Sinyard’s contention that because he was an Alabama resident at the time he contracted with the law firm, he was entitled to the benefit of Alabama law holding that a lawyer holds a creditor’s lien against contingency fees.

Noonan said that even if Alabama law does in fact so hold, it doesn’t follow that the satisfaction of the debt represented by the lien doesn’t produce income to the taxpayer. A 1959 Fifth Circuit decision so holding is wrong, Noonan said.

McKeown argued in dissent that attorney fees in ADEA cases aren’t taxable because they are awarded “in addition to” the judgment, according to the statute. Since the fees “are a mandatory obligation…which the statute has imposed directly upon the defendant,” the judge wrote, they should not be taxable to the plaintiff.

The result reached by the majority is also inequitable, McKeown argued, because it would result in some cases in a plaintiff having a net after-tax loss after winning or settling a case.

Citing a Southern California Law Review article entitled How the Income Tax Undermines Civil Rights Law, McKeown gave the example of a plaintiff who settled for $250,000 but incurred $245,000 in attorney fees. Under the AMT, the plaintiff would incur a $53,000 tax liability, for a “Draconian” after-tax loss of $48,000, McKeown said.

Noonan said the inequities suggested by McKeown do not appear in the Sinyards’ case, and that the prevention of such unfairness in future cases is a matter for Congress rather than the court.

The case is Sinyard v. Commissioner of Internal Revenue, 99-71369.