Return to Sharecropping: Lawyers andClients as Tenants and Landlords in theTax Treatment of Contingency Fees

I. Introduction In 1993, after filing suit against his employer, Eldon Kenneth received $229,501.37 from his employer pursuant to a settlement agreement.1 Of that $229,501.37, Kenneth's attorneys kept $91,800 in accordance with the contingency fee agreement they had with Kenseth.2 The question that emerges from this transaction is deceptive and ultimately difficult to answer: Is the $91,800 part of Kenseth's income for tax purposes?3 This question becomes very important as the negative tax implications of the alternative minimum tax (AMT) factor into the equation.4 Given the Internal Revenue Code's standard that gross income means all income from whatever source derived, the answer would seem to be a straightforward yes.5 Yet, various courts have struggled with that question and reached divergent conclusions, resulting in a circuit split.6 Courts have utilized two primary theories of attribution to determine who bears the tax liability for contingency fees: the assignment of income doctrine7 and state attorney's liens laws.8 As courts have used these theories of attribution, the resulting disagreement over the tax consequences of contingency fees has emerged as a by-product of the courts' failure to characterize accurately the attorney-client relationship under a contingency fee agreement.9 Courts have suggested that the attorney and client are involved in a partnership, a joint venture, or a division of property.10 Yet, none of these analogies have successfully characterized the relationship between an attorney and a client bound by a contingency fee agreement.11 Courts have struggled to ascertain who is really in control of the client's lawsuit, the client or the attorney. 12 The relative amount of control that an attorney maintains over the client's cause of action is the key to understanding the tax consequences of any contingency fee.13 Clients often surrender a large degree of control over their claim to their attorney by signing a contingency fee at.14 Under these agreements, an attorney agrees to work for the client in exchange for a portion of any recovery obtained through the representation.15 The attorney handles almost all aspects of the client's case: filing the complaint, taking depositions, negotiating, and, if necessary, going to trial.16 Upon the successful completion of legal action, an attorney's lien immediately controls the disbursement of the recovery to insure the attorney's compensation.17 This shift in control often obscures the fact that it is the client's underlying claim and rights that are to be vindicated with the assistance of counsel.18 In contingency fee cases, with control over the claim constantly flowing to the attorney, none of the previously suggested analogies answer all the federal income tax and ethical questons arising from contingency fee-based representation. …