A Correct Analysis of the Tax Treatment of Contingent Attorney's Fee Arrangements: Enough with the Fruits and the Trees

Abstract

The tax treatment of contingent attorney's fee arrangements has been the subject of much recent debate and litigation. Some courts and commentators conclude that a plaintiff must include the entire settlement amount, including attorney's fees, in her gross income, while other courts and commentators conclude that a plaintiff must include only her recovery net of attorney's fees. Because of the alternative minimum tax, the resolution of this issue may have a significant effect on the plaintiff's tax liability.

In analyzing the issue, courts and commentators have focused on the assignment of income doctrine by inquiring whether, upon execution of a contingent fee agreement, the plaintiff should be treated as transferring merely the income from the attorney fee portion of the claim (the fruit) or the attorney fee portion of the claim itself (the tree). This Article explains that this focus on the assignment of income doctrine is misplaced because that doctrine does not apply to commercial arm's length transactions, such as contingent fee arrangements. Because courts and commentators have begun their analysis by focusing on the wrong issue (i.e., the assignment of income doctrine), no one has set forth a correct analysis of this controversial issue. This Article attempts to provide such an analysis.