Double Taxation Avoided in Employment Cases

On Monday, January 24, 2005, the U.S. Supreme Court held that plaintiffs in taxable non-physical injury cases must pay taxes on the full amount of any settlement. The Court ruled that someone who received a settlement from an employment discrimination claim may not exclude the attorney’s fee portion of the settlement. Both the plaintiff and the attorney have to pay the tax on the attorney’s fee. John W. Banks, II v. Commissioner of Internal Revenue and Sigitas Banaitis v. Commissioner of Internal Revenue.

At least two newspapers that we are aware of (The Los Angeles Times and The Dallas Morning Star) erroneously reported that the Supreme Court’s decision also applies to physical injury and wrongful death lawsuit settlements, including medical malpractice and auto accidents. These reports are inaccurate. In fact, The Los Angeles Times has already printed a retraction. The Supreme Court’s decision only applies to taxable settlements and not to tax free physical injury and wrongful death claims.

Additionally, as we previously reported (click here to see previous update) The Civil Rights Tax Relief Act which became law in October 2004 renders the Supreme Court’s decision moot with respect to all prospective employment related (and certain other) settlements. The Civil Rights Tax Relief Act specifically eliminated plaintiff’s taxation on the attorney’s fee (and expense) portion of every employment related settlement.

Summary

• Physical injury and wrongful death settlements continue to be tax free (to plaintiffs) and plaintiffs DO NOT pay any taxes on the attorney’s fee portion of the settlement.
• The recently enacted Civil Rights Tax Relief Act protects plaintiffs in employment discrimination (and certain other taxable) settlements entered into in or after 2005 from double taxation of attorney’s fees. The recent U.S. Supreme Court decision in Banks v. Commissioner and Banaitis v. Commissioner was anticipated by Congress in its enactment of The Civil Rights Tax Relief Act and applies only to old (pre October 2004) employment discrimination settlements.
• In cases not covered by The Civil Rights Tax Relief Act (e.g. defamation and other non-employment related taxable recoveries) the double taxation issue still looms large. Blindly settling such cases without employing strategies to protect the plaintiff from double taxation may ultimately prove very costly.

Creative Capital Inc. has settlement solutions for all tax-free physical injury, wrongful death and Workers’ Compensation settlements as well as for taxable settlements in employment discrimination and other cases. We never charge for any of our services. We look forward to hearing from you to help you better serve your clients.

back to top