In class action lawsuits, a class member does not have to report as income the amount of the classwide settlement fund awarded as attorney fees.1  However, in a mass tort action in which clients have entered into contingency fee agreements with individual attorneys, the portion of a client’s individual award that is taken as the lawyer’s contingency fee may be taxable.2

• 1GCM PRENO-111606-07 (May 18, 2007).
• 2See Comm’r v. Banks, 543 U.S. 426 (2005). On the treatment of contingency fees, see Section 18.2.

Generally, the portion of a litigation recovery retained by an attorney as a contingency fee is taxable if the recovery itself constitutes taxable income.1  In the American Jobs Creation Act (AJCA), Congress created an exception to this rule to preclude taxation of contingency fees in most civil rights and employment law actions payable after October 22, 2004.2  In cases governed by the AJCA, the taxpayer takes an above-the-line deduction for the contingency fees rather than a Schedule A deduction.

• 1See Comm’r v. Banks, 543 U.S. 426 (2005). On the classification of various types of monetary awards for tax purposes, see Section 16.
• 2I.R.C. § 62(a)(20); see Pub. L. No. 108-357, § 703, 118 Stat. 1546, 1548 (2004).

In a private letter ruling, the IRS has ruled that statutory attorney fees paid directly to a legal aid or pro bono program are not taxable to the client because the client had no obligation to pay those fees.1

However, statutory attorney fees awarded to other attorneys may trigger tax liability for the client. This comports with the theory that the client has received a benefit by having the attorney fees paid. Although statutory attorney fees awarded to the prevailing party’s attorney in many discrimination and employment cases are no longer treated as taxable income for that party,2  statutory attorney fees awarded to a prevailing party under consumer protection laws are still taxable to the client.

• 1Priv. Ltr. Rul. 135328-09 (Jan. 5, 2010). Note that private letter rulings may not be used or cited as precedent unless otherwise authorized by Treasury Regulations. I.R.C. § 6110(k)(3). However, letter rulings provide some guidance as to how the IRS might view a tax law issue under the facts assumed in the letter ruling.
• 2I.R.C. § 62(a)(20).