The issue before the U.S. Supreme Court in this case was whether income taxable to a plaintiff includes the portion of the recovery paid to the plaintiff’s lawyer as a contingency fee. In its decision issued on January 24, 2005, the Supreme Court held in the Commissioner’s favor that the contingency fee amount had to be included in the plaintiff’s income, thereby resolving a split that had developed in the Circuit Courts on this issue.
An amicus curiae brief was filed by NELF and other nonprofit Public Interest Law Firms (“PILFs”) including Mountain States Legal Foundation (which was the principal drafter of the brief), because of a concern among PILFs that the IRS would view a favorable result in this case as support for its recently developed position that, likewise, when attorneys’ fees are paid by the federal government to a PILF under a federal fee-shifting statute (for example under 42 U.S.C. § 1988), those fees are taxable to the PILF’s client. NELF and the other amici argued that if the Supreme Court’s decision gave any credence to this position it would have a severely adverse impact on the PILFs’ ability to undertake their vital role in the judicial system of providing free legal services in matters of broad public interest to clients who could not otherwise afford legal representation. In such cases, while NELF and the other amici do not charge for legal representation, Congress intended for them to take advantage of various federal fee-shifting statutes. This intent would be violated if the IRS attempted to tax clients for amounts paid to organizations like NELF under these statutes.
Acknowledging these concerns in its decision, the Supreme Court stated that, in its view, it did not have to address them because, first, in the matter before it the fees paid to attorneys were calculated solely on the basis of private contingent fee contracts and, second, the Jobs Creation Act (“Act”) of 2004, which was passed after this case arose, “redresses the concern for many, perhaps most, claims governed by fee-shifting statutes.” Specifically, Section 703 of the Act amended the Internal Revenue Code by adding a section that 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.” The Act defines “unlawful discrimination” to include a number of specific federal statutes, any federal whistleblower statute, any federal, state or local law “providing for the enforcement of civil rights” or “regulating any aspect of the employment relationship….,” etc. It should be noted that the Act was signed into law on October 22, 2004, well after all briefs were filed in this case.