Attorney’s Fees Deductible Above the Line

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The Tax Court ruled that an award for an employment discrimination settlement should be included in a taxpayer’s gross income – but that he could deduct his attorney’s fees in the case above the line.

Car salesman Abraham George received $45,000 during 2012 under a settlement for employment discrimination with his former employer. Zurich American Insurance Co. issued a check for the amount to George’s attorney, who retained $15,000 as the agreed-upon legal fee. Zurich issued George a Form 1099-MISC reporting the payment of $45,000 as settlement proceeds.

 George did not report income from the settlement on his 2012 tax return. The IRS issued a notice of deficiency determining that the $45,000 should have been included in his gross income.  George petitioned the Tax Court, contending that the $45,000 payment was excludable from gross income under Code Section 104(a)(2). Both parties filed motions for summary judgment.

The Tax Court concluded that the $45,000 was includable in George’s gross income, but disagreed with the IRS on the deductible nature of the attorney’s fees (George v. Commissioner, T.C. Memo 2016-156 (Aug. 22, 2016)).

“Although George’s complaint included a general allegation of ‘psychological and physical harms,’ he did not allege with any specificity that he had suffered actual physical injury or physical sickness,” the court said. Therefore, this amount was includible in his gross income.

The IRS contended that the $15,000 attorney’s fee was deductible on Schedule A as a miscellaneous itemized deduction. However, the court agreed with George that the fee was deductible above the line.

“Section 62(a)(20) allows an above-the-line deduction for attorney’s fees and court costs paid by a taxpayer in connection with any action involving a claim of unlawful discrimination,” the court reasoned. The settlement agreement specifically stated that it applied to claims for compensation “with respect to the employment relationship and termination thereof.” Since the legal fees were paid to secure settlement of the claim for unlawful employment discrimination, George was entitled to an above-the-line deduction of $15,000 for his legal fees, the court concluded.

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