Tax Alert: Civil Rights Tax Relief
Congress last week passed the so-called "Civil Rights Tax Relief" provision as part of the American Jobs Creation Act of 2004, HR 4520. The bill presently is awaiting President Bush’s signature. Assuming that the bill is signed, the provision will provide tax relief to claimants who pay attorney fees in connection with settlements or court awards for certain kinds of claims.
The provision allows a claimant to take an "above-the-line" deduction for attorney fees incurred in connection with the claim. This benefits the claimant because:
- The claimant can deduct the entire amount of the attorney fees. Current law generally requires the claimant to reduce the deduction by two percent of the claimant’s adjusted gross income, and may require a phase-out, because the attorney fees are treated as a below-the-line miscellaneous itemized deduction.
- The claimant generally should not be subject to "alternative minimum tax" on the attorney fee portion of the settlement or award. Current law generally treats the award or settlement as a below-the-line deduction and requires the plaintiff to include the amount in alternative minimum taxable income.
The provision does not exclude the attorney fee award from the claimant’s income. In fact, in order to claim the deduction that the provision allows, the claimant must first include the award or settlement in income. By contrast, the claimant in Banaitis v. Commissioner, 340 F3d 1074 (9th Cir 2003), cert granted 124 S Ct 1713 (2004), prevailed in the Ninth Circuit on the grounds that the attorney fee amount is excluded from income because Oregon law gives the attorney prior rights to the amount. The new provision does not affect the result in Banaitis, although it removes the incentive for similar future claims.
This treatment is important for a payor of these claims because it means that there is no change to the payor’s reporting requirements. Because the attorney fee amount is income to the claimant, the payor must report that amount as non-wage income on Form W-2 or Form 1099 just as under current law. Also, the provision does not change the requirement that the payor issue a separate Form 1099 to the claimant’s attorney. Withholding of income tax or social security/Medicare tax should not be required with respect to the attorney fee amount, assuming that the language of the judgment or settlement agreement makes a proper allocation between the attorney fee amount and amounts that are wages or other non-wage income.
The provision contains several important limitations:
- Effective Date: To qualify for the deduction allowed by the new provision, both of the following must be true: (1) the attorney fees and costs must be paid after the bill has been signed and (2) the settlement must "occur" after the bill has been signed.
- Amount: The claimant may take the deduction only to the extent that the claimant includes other portions of the award or settlement in income. In other words, the above-the-line deduction may not exceed the amount that the claimant included for the year.
- Type of claim limitation: The claim must involve "unlawful discrimination" as defined in the bill. This includes claims pursuant to any provision of federal, state or local law, including common-law claims, for enforcement of civil rights or regulating employment. The full definition is set forth below:
"(e) UNLAWFUL DISCRIMINATION DEFINED. -- For purposes of subsection (a)(19), the term 'unlawful discrimination' means an act that is unlawful under any of the following:
"(1) Section 302 of the Civil Rights Act of 1991 (2 U.S.C. 1202).
"(2) Section 201, 202, 203, 204, 205, 206, or 207 of the Congressional Accountability Act of 1995 (2 U.S.C. 1311, 1312, 1313, 1314, 1315, 1316, or 1317).
"(3) The National Labor Relations Act (29 U.S.C. 151 et seq.).
"(4) The Fair Labor Standards Act of 1938 (29 U.S.C. 201 et seq.).
"(5) Section 4 or 15 of the Age Discrimination in Employment Act of 1967 (29 U.S.C. 623 or 633a).
"(6) Section 501 or 504 of the Rehabilitation Act of 1973 (29 U.S.C. 791 or 794).
"(7) Section 510 of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1140).
"(8) Title IX of the Education Amendments of 1972 (20 U.S.C. 1681 et seq.).
"(9) The Employee Polygraph Protection Act of 1988 (29 U.S.C. 2001 et seq.).
"(10) The Worker Adjustment and Retraining Notification Act (29 U.S.C. 2102 et seq.).
"(11) Section 105 of the Family and Medical Leave Act of 1993 (29 U.S.C. 2615).
"(12) Chapter 43 of title 38, United States Code (relating to employment and reemployment rights of members of the uniformed services).
"(13) Section 1977, 1979, or 1980 of the Revised Statutes (42 U.S.C. 1981, 1983, or 1985).
"(14) Section 703, 704, or 717 of the Civil Rights Act of 1964 (42 U.S.C. 2000e-2, 2000e-3, or 2000e-16).
"(15) Section 804, 805, 806, 808, or 818 of the Fair Housing Act (42 U.S.C. 3604, 3605, 3606, 3608, or 3617).
"(16) Section 102, 202, 302, or 503 of the Americans with Disabilities Act of 1990 (42 U.S.C. 12112, 12132, 12182, or 12203).
"(17) Any provision of Federal law (popularly known as whistleblower protection provisions) prohibiting the discharge of an employee, the discrimination against an employee, or any other form of retaliation or reprisal against an employee for asserting rights or taking other actions permitted under Federal law.
"(18) Any provision of Federal, State, or local law, or common law claims permitted under Federal, State, or local law -- "(i) providing for the enforcement of civil rights, or
"(ii) regulating any aspect of the employment relationship, including claims for wages, compensation, or benefits, or prohibiting the discharge of an employee, the discrimination against an employee, or any other form of retaliation or reprisal against an employee for asserting rights or taking other actions permitted by law."