Contingent Attorneys' Fees Not Really Deductible

In November, I commented on the cases cases of Commissioner v. Banks and Commissioner v. Banaitis. I also commented on Rev. Rul. 2004-109 and Rev. Rul. 2004-110. In concluding, I pointed out that:

If the Service prevails in Banks and Banaistis, as a practical matter, pro athletes will not be able to deduct the consideration paid to their agents since virtually all of these athletes are subject to the alternative minimum tax. Of course, this dramatically increases the transactional costs that they incur in the course of the negotiation.

Today, by an 8 to 0 vote, the Supreme Court upheld the Service's position in Banks and Banaistis.

The opinion is relatively straight-forward, rejecting the taxpayers' claims that by entering into contingent fee contracts they had assigned something other than income or, alternatively, that they had entered into partnerships or quasi-partnerships with their attorneys. The Court also rejected the taxpayers' variations on these themes, where they contended that some state attorney lien statutes effectively divested them of a portion of their rights to recovery before those rights had ripened into income.

One part of the opinion is curious and, I think, clearly wrong. The Court took note of the passage of the American Jobs Creation Act of 2004 which amended the Internal Revenue Code by adding §62(a)(19). (A copy of the Conference Committee Report for the Act can be found here.) That portion of the Act allows a taxpayer, in computing adjusted gross income, to deduct "attorney fees and court costs paid by, or on behalf of, the taxpayer in connection with any action involving a claim of unlawful discrimination." It defines "unlawful discrimination" to include a number of specific federal statutes, §§62(e)(1) to (16), any federal whistle-blower statute, §62(e)(17), and any federal, state, or local law "providing for the enforcement of civil rights" or "regulating any aspect of the employment relationship . . . or prohibiting the discharge of an employee, the discrimination against an employee, or any other form of retaliation or reprisal against an employee for asserting rights or taking other actions permitted by law." These deductions are permissible even when the alternative minimum tax applies.

Taking note of the Jobs Creation Act, the Court stated that "[h]ad the Act been in force for the transactions now under review, these cases likely would not have arisen." While that might be true with respect to Banks' claims which were squarely articulated as civil rights claims, it does not seem to be correct with respect to Banaitis. As described by the Court, Banaitis contended "that Mitsubishi Bank willfully interfered with [his] employment contract, and that the Bank of California attempted to induce [him] to breach his fiduciary duties to customers and discharged him when he refused." I simply do not understand these claims to arise out of "a claim of unlawful discrimination."

The Court's action today underlines the concerns that I voiced in November concerning the "warping of the negotiation process . . . putting the employee at a severe disadvantage when negotiating the end of an employment relationship gone sour."