John W. Banks II, settled an employment discrimination case against the California Department of Education for $464,000, with $150,000 of that going to his lawyer under their fee agreement. The Supreme Court ruled Monday that Banks is liable for taxes on the full amount, even though a good portion was paid to his attorney, the New York Times reported.
The justices ruled 8-0, with Chief Justice William H. Rehnquist not participating, to overturn decisions by the federal appeals courts in San Francisco and Cincinnati. Both courts had rejected the position of the Internal Revenue Service that all economic gain is taxable to the person who earned it, unless specifically exempted by Congress, the Times reported.
Congress changed the law in November, just before the cases involved in this week's ruling were argued before the high court. The new tax law includes a subcategory of lawsuit-winning taxpayers. Under that law, the American Jobs Creation Act of 2004, taxpayers can deduct lawyers' fees and court costs "in connection with any action involving a claim of unlawful discrimination." Discrimination is broadly defined to include many kinds of employment disputes, the Times reported.
Justice Anthony M. Kennedy, writing for the court on Monday, acknowledged that the new law would probably have applied to the cases at issue, since Bank's case and another one brought before the high court involve employment-related lawsuits. However, the law is not retroactive and doesn't apply to other types of lawsuits.
In his opinion in favor of the I.R.S., Justice Kennedy cited the long-established rule that "a taxpayer cannot exclude an economic gain from gross income by assigning the gain in advance to another party," even if the assignment was a valid business arrangement that was not undertaken for the purpose of avoiding taxes, the Times reported.