Contingency Fee Trap Under Federal Tax Law: Avoiding Hidden Settlement Obstacles and Malpractice Issues

Description

The U.S. Supreme Court in Commissioner v. Banks conclusively established that in certain types of contingency fee arrangement cases, the plaintiff must include the attorney fee portion of the recovery as gross income on the plaintiff's Form 1040. That is, a plaintiff may not report their recovery net of the attorney fee.

Then, under more recent statutory changes to the federal tax laws, the previous, corresponding, separate deduction for attorney fees is not available from tax year 2018 through 2025, except for particular litigation types. The combination of the Supreme Court ruling and the changes to the tax law is adverse for plaintiffs.

Including the attorney portion of the recovery in gross income without a corresponding deduction results in substantially higher federal and state income taxes for the plaintiff because the attorney fees cannot be "written off." Thus, the "contingency fee trap" leaves plaintiffs with a much lower "net" recovery. Plaintiffs may see 80 percent or more of their recovery go to taxes and attorney fees, particularly in states with high income tax rates.

Listen as our expert panel explains the contingency fee trap, its impacts, and the best tactics for mitigating it. Our panelists will also walk attendees through case studies and examples of the contingency fee trap to show how this issue bears out in real life.