## Facts

- John W. Banks II brought a federal employment discrimination suit against a California state agency and retained counsel under a contingent-fee agreement.
- Banks settled for $464,000 and paid $150,000 to his attorney, reporting only the net amount as gross income.
- Sigitas J. Banaitis brought an Oregon employment-related action and retained counsel under a contingent-fee agreement, likewise excluding the contingent-fee portion from reported gross income.
- The IRS issued notices of deficiency in both cases, asserting the entire recoveries were includable in gross income.
- The Tax Court upheld the IRS in both cases.
- The Sixth Circuit (Banks) and Ninth Circuit (Banaitis) reversed in part, concluding the contingent-fee portion was not includable, with the Ninth Circuit relying on Oregon law granting attorneys a superior lien.
- The Supreme Court granted certiorari and consolidated the cases.

## Issues

1. Whether, when a litigation recovery constitutes taxable income, the taxpayer must include in gross income the portion paid to the attorney under a contingent-fee agreement.
2. Whether state-law attorney lien or property-interest doctrines can shift federal tax attribution of the contingent-fee portion away from the client.

## Decision

- The Supreme Court reversed the Sixth and Ninth Circuits.
- The Court held that when a litigant’s recovery constitutes income, the litigant’s gross income includes the portion paid to the attorney as a contingent fee.
- The Court rejected the argument that state-law attorney liens (including a “superior lien”) change the federal tax result.
- Chief Justice Rehnquist took no part; there was no dissent among the participating Justices.

## Legal Principles

- Gross income is defined broadly to include all economic gains not otherwise exempted.
- Under the anticipatory assignment-of-income doctrine, a taxpayer cannot avoid taxation by assigning expected income to another before it is realized; income is taxed to the one who earns it.
- A contingent-fee agreement is treated as an anticipatory assignment to the attorney of a portion of the client’s income from the recovery, not a transfer of the underlying income-producing claim.
- State-law lien protections may secure the attorney’s right to payment but do not determine federal income attribution from the client’s cause of action.
- Harsh results linked to limited deductibility of attorney’s fees (including effects of the Alternative Minimum Tax) are addressed by Congress through deductions rules, not by redefining what constitutes gross income; later statutory deductions for certain fees were not retroactive to the tax years at issue.

## Conclusion

The Court held that taxable litigation recoveries are included in the plaintiff’s gross income in full, including amounts paid directly to counsel as contingent fees, and that state attorney-lien rules do not alter federal assignment-of-income analysis.


Commissioner v. Banks, 543 U.S. 426 (2005)