# Petition for Writ of Certiorari — Freeman v. Commissioner

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition for Writ of Certiorari
- **Published:** January 1, 2005
- **Citation:** 543 U.S. 1145

## Text

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yO 8 660 OCT 23 2003

OFFICE OF THE CLERK
In The

Supreme Court Of The Anited States

JACK FREEMAN and
JANET FREEMAN,
Petitioners,

COMMISSIONER OF
INTERNAL REVENUE,
Respondent.

ON PETITION FOR A WRIT OF CERTIORARI TO
THE UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT

PETITION FOR WRIT OF CERTIORARI

William E. Dannemeyer*
*Counsel of Record
Bruce W. Dannemeyer
1105 E. Commonwealth, Box 13
Fullerton, CA 92831
(714) 871-4318
Counsel for Petitioners.

(i)
QUESTION PRESENTED

Does entry into a contingency arrangement with an
attorney constitute an assignment of income such that 100%
of the eventual jury award is income to the client?

(ii)
PARTIES TO THE PROCEEDINGS

Petitioners Jack and Janet Freeman petition for a writ
of certiorari to review the judgment of the Court of Appeals
for the Ninth Circuit in this case. They are represented by
William E. Dannemeyer and Bruce W. Dannemeyer.
Respondent Commissioner of Internal Revenue presumably
will be represented by the Office of the Solicitor General of
the United States. .

i eA L ABATED: EK. 0000

(iii)

Page
a TABLE OF CONTENTS

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(iv)
Page
TABLE OF AUTHORITIES

United States Supreme Court Decisions:
Helvering v. Horst, 311 U.S. 112 (1940).........cceeeeee 25 4, 5
Leces ¥. Gard, ZE1 U.S. VEL CEG SD) eosccvccssesssecsevvesereees Os GO
Federal Couris of Appeal Decisions:
Banaitis v. Comm’'r, 340 F.3d 1074 (9" Cir. 2003) ......0.00+ 3 i
Campbell v. Comm'r, 274 F.3d 1312 ( 10" Cir.

BE ceciecucbovavencecaeiseplsastsausiateiadalsccdactnibinunbaile 3 : |
Estate of Clarks v. United States 202 F.3d 854

"ge a ERR UN not re EE: A
Foster v. United States, 249 F.3d 1275 (11™ Cir.

BED sisricckcsciniiiekiec ibd anaeaieciia deed auawie a aiabcailanimaiads 2
Kenseth vy. Comm'r, 259 F.3d 881 (7" Cir. 2001).......+4+. 3,5
O'Brien v. Comm ’r, 319 F.2d 532 (3d Cir. 1963),

cert. Gentbed,, 75 U.S. F3i CUFG) vciccesscssevessessesascsvsevsens 2
Sinvard v. Comm’r, 268 F.3d 756 (9"" Cir. 2001) ...c.seeesee 3
Srivastava v. Comm'r, 220 F.3d 353 5" Cir. |

PE ccs tiadanisaccicieetin teas ematical baaenedataaaeuien 2
Young v. Comm’r, 240 F.3d 369 (4™ Cir. 2001) ....ssssseeeeee 3
Federal Statutes:
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OPINIONS BELOW

The opinion of the Court of Appeals for the Ninth
Circuit is not published. The memorandum is included in the
accompanying appendix. The memorandum opinion of the
United States Tax Court is not published, but is included in
the appendix.

JURISDICTION

The judgment of the Ninth Circuit was filed on
March 5, 2003, and petitioners’ timely petition for rehearing
and suggestion for hearing en banc was rejected on July 25,
2003, as reflected in the order included in the appendix.
Jurisdiction is proper in the United States Supreme Court
pursuant to 28 U.S.C. sections 1254(1) and 2101(c) and Rule
13 of the Rules of the Supreme Court of the United States.

STATUTORY PROVISIONS INVOLVED

26 U.S.C. § 61(a), which reads in relevant part:
“Except as otherwise provided in this subtitle, gross income
means all income from whatever source derived....”

STATEMENT OF THE CASE

Petitioner Jack Freeman’s employer wrongfully
terminated his 34-year career. The $300,000 jury award was
divided $199,642 to Freeman and $114,470 to his attorney
(in addition to the $82,764 Freeman previously paid on an
hourly basis before entering into the contingency
agreement).' The Internal Revenue Service seeks $115,415
in taxes and interest, claiming the entire jury award was
income to Freeman. The State of California will seek

‘ When the judgment was paid, interest had accrued so that the payment
exceeded the award.

2

$40,792. Asa result, Freeman will be worse off than if he
had never filed the lawsuit; his lawyers and the government
will take $39,329 more than the jury awarded.

REASONS FOR GRANTING THE PETITION

The inequity stems from a misapplication of this |
Court's rule concerning assignment of income. See |
Helvering v. Horst, 311 U.S. 112 (1940); Lucas v. Earl, 281
U.S. 111 (1930). Under that rule, a taxpayer cannot escape
tax liability by assigning the right to income. Having earned
a salary or purchased a negotiable bond, the taxpayer cannot j
escape taxation by making an anticipatory transfer of the |
right to collect the fruits of his efforts. However, the
situation is different when the taxpayer unites with an
attorney, for all practical purposes in a joint venture, and the
two of them engage in an enterprise that results in a jury
award. Were it not for the combination of the two, there
would be no award. Had they remained separate, neither
would have realized a cent. But together they generate a
single fund which they divide according to the terms of their
agreement.

The misapplication of the assignment rule has led to a )
split in the Circuits. The Fifth, Sixth, and Eleventh Circuits |
have found that entry into a contingency agreement with an
attorney is not an assignment of income; the client, therefore,
realizes income only on his portion of a jury award.

Srivastava v. Comm’r, 220 F.3d 353, 363-365 (5" Cir.
2000): Estate of Clarks v. United States, 202 F.3d 854, 857-
858 (6" Cir. 2000); Foster v. United States, 249 F.3d 1275,

1279-1281 (11" Cir. 2001). The Third, Fourth, Seventh, and

Tenth Circuits have attributed the entire award to the client,

finding there has been an assignment and under state law, the

attorney is merely a lienholder. O’Brien v. Comm’r, 319

3

F.2d 532 (3d Cir. 1963), cert. denied, 375 U.S. 931 (1963):
Young v. Comm’r, 240 F.3d 369, 376-379 (4" Cir. 2001 );
Kenseth v. Comm’r, 259 F.3d 881, 883-885 (7" Cir. 2001);
Campbell v. Comm’r, 274 F.3d 1312, 1314 (10" Cir. 2001).
The Ninth Circuit agrees an assignment has occurred, but has
reached different conclusions, based on state law, on whether
the award is income to the client. Sinvard v. Comm’r, 268
F.3d 756 (9" Cir. 2001) (entire award taxed to client based
on Arizona law); Banaitis v. Comm'r, 340 F.3d 1074, 1082
(9"" Cir. 2003) (client taxed only on his portion based on
Oregon law).

This Court recently has denied certiorari on similar
cases, but those cases did not focus on the actual source of
the error — misapplication of the assignment of income rule.
If entry into a contingency fee arrangement is viewed as an
assignment, then examination of state law is obligatory and
the result inexorable. But entry into a contingent fee
arrangement is not an assignment. Once the assignment of
income analysis was imposed, a logical result followed. But
that analysis never should have been imposed. Instead a
uniform, nationwide rule should apply which says that
contingent fee arrangements do not involve assignment of
income. The money resulting from the contingent
attorney/client joint venture should be taxed to each
according to their allocation of the proceeds of that venture.

Estate of Clarks v. United States, supra, analyzed the
issue properly and consequently reached the just result. The
court recognized that by entering into a contingency
arrangement with his lawyer, by which the proceeds of a
lawsuit would be split, Mr. Clarks had not assigned income.
“Like an interest in a partnership agreement or joint venture,
Clarks contracted for services and assigned his lawyer a one-

4

third interest in the-venture-u order that he might have a
chance to recover the remaining two-thirds.” /d. at p. 857.
The court distinguished Lucas v. Earl, supra, and Helvering
v. Horst, supra. \n Lucas, this Court rejected the taxpayer's
claim that a contract with his wife, which recited that all
income generated by either would be considered earned
jointly, meant that each would be taxed on half the husband’s
salary. This Court reasoned that since the taxpayer did all
the work to earn the salary, he should be taxed on the entire
amount. He would have earned the salary even if he had
never entered into the contract with his wife. Similarly in
Helvering, the taxpayer could not escape taxation on the
interest paid on negotiable bonds simply by giving his son
the interest coupons. Because the interest was earned
regardless of the gift to the son, it was still income to the
father.

A contingent fee arrangement between an attorney
and a client is far different. Without that arrangement there
would be no income to tax. The client had nothing until the
lawyer was hired and the case tried. The lawyer had nothing
until approached by the client. Each gave the other an _
opportunity otherwise unavailable. When labor is performed
or bonds purchased, sa!ary has been earned and interest is
due. All that remains is cashing the check. But far more is
required when a contingent fee arrangement is created. The
client has assigned nothing. He has contributed the capital to
a joint venture, and his lawyer contributes his labor to that
same venture. If the venture is successful, they will share in
the rewards. If unsuccessful, they also will share in the loss.
There is no assignment.

The tax treatment of assignment of income best
demonstrates why a contingency arrangement is not an

5

assignment. In a genuine assignment of income situation, as
in Helvering and Lucas, only the assignor pays tax on the
income. The assignment is ignored for tax purposes. In a
contingency situation, the client is taxed on 100% of the jury
award, and the attorney is taxed on the contingency amount.
The award is taxed twice. The “assignment” to the attorney
is both ignored and recognized: ignored in the sense that the
entire award is attributed as income to the client, and
recognized in the sense that the attorney's portion is
attributed as income to him. This Court created the
assignment of income rule in response to a tax scheme
designed to shift income to persons in lower tax brackets.
The rule has been twisted in some Circuits so that income is
taxed twice.

An argument has been made in the past that Congress
should solve the inequity by amending the statute concerning
deductibility of attorneys’ fees. elimination of the 2%
limitation on miscellaneous deductions (which currently
includes attorneys’ fees), and/or modifying the alternative
minimum tax. But simply because the problem can be
solved by legislation does not mean this Court should wait
for Congress. Every tax issue can be solved by legislation,
yet this Court has intervened when appropriate. That is what
happened when it created the assignment of income rule. It
is that rule, or rather its misapplication, that has created this
problem. “[T]he assignment of income doctrine is judges
made law, not a rule of statutory interpretation of the more
recently enacted itemized deduction and AMT provisions.
Contrary to the claims of the majority and a recent
commentator, we need not wait for Congress to change those
provisions.” Kenseth vy. Comm'r, 114 T.C. 399, 427 (Beghe.,
J. dissenting), aff'd 259 F.3d 881, 883-885 (7" Cir. 2001).
This Court, therefore, should intervene now.

CONCLUSION

Without a uniform rule, taxpayers in identical
situations will be taxed differently. The Circuits are split
with respect to application of the assignment of income rule.
In those Circuits where the rule is misapplied, such as the
Ninth Circuit, the inequity impacts every plaintiff who is
awarded compensation for non-physical injuries, of which
there are thousands, if not millions, each year. Clarifying the
assignment of income rule will not require abrogation of that
rule. Just the opposite, it will emphasize its underlying
policy by reinforcing the concept that income will be taxed
to the person who earned it. When the effort is joint,
taxation will be joint. When the effort is individual, so is
taxation. Ruses to hide income still will be exposed, and
combinations to create income that would not exist if the
participants remained separate will be recognized. The
assignment of income rule will be applied as intended and
great inequity will be avoided.

The petition for certiorari should therefore be
granted.

Respectfully submitted,

‘

Dated: October*?> 2003 William E. Dannemeyer a
Attorney for
petitioners Jack
and Janet
Freeman

eS I EES 2S roe

(i)

APPENDIX

Page
TABLE OF CONTENTS

Order filed July 25, 2003 [denying petition for
rehearing and suggestion for rehearing en banc].... App. 1

Memorandum filed March 5, 2003 [affirming
decision of the United States Tax Court].............. App. 2

Memorandum Opinion of the United States Tax
Court filed September 28, 2001.................sseeeeeeees App. 4

App. |

[NOT FOR PUBLICATION]
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT

No. 02-70006 ~~
IRS No. 13195-99

JACK FREEMAN; JANET FREEMAN,
Petitioners — Appellants,

V.
COMMISSIONER OF INTERNAL REVENUE,

Respondent — Appellee.

Filed July 25, 2003

ORDER

Before: BEEZER, THOMAS and CLIFTON, Circuit Judges.

The panel has voted to deny the petition for rehearing
and to reject the suggestion for rehearing en banc.

The full court has been advised of the suggestion for
rehearing en banc, and no judge of the court has requested a
vote on the suggestion for rehearing en banc. Fed. R. App. P.
35(b).

The petition for rehearing is denied and the
suggestion for rehearing en banc is rejected.

App. 2

[NOT FOR PUBLICATION]
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT

No. 02-70006
Tax Ct. No. 13195-99

JACK FREEMAN; JANET FREEMAN,
Petitioners — Appellants,

V.
COMMISSIONER OF INTERNAL REVENUE,

Respondent — Appellee.

MEMORANDUM*
Appeal from a Decision of the United States Tax Court

Argued and Submitted February 14, 2003
San Francisco, California

Filed March 25, 2003

App. 3

Before: BEEZER, THOMAS and CLIFTON, Circuit Judges.
The judgment of the United States Tax Court is

affirmed for the reasons stated by Judge Whalen in his
memorandum opinion dated September 28, 2001.

AFFIRMED.

* This disposition is not appropriate for publication and may
not be cited to or by the courts of this circuit except as may
be provided by Ninth Circuit Rule 36-3.

App. 4

UNITED STATES TAX COURT
T.C. Memo. 2001-254

JACK AND JANET FREEMAN, Petitioners
V.

COMMISSIONER OF INTERNAL REVENUE,
Respondent.

Docket No. 13195-99.
Filed September 28, 2001.

William E. Dannemeyer, for petitioners.
James J. Posedel, for respondent.

MEMORANDUM OPINION

WHALEN, Judge: Respondent determined a
deficiency in petitioners' Federal income tax for 1994 of
$77,415. Petitioners filed the instant petition seeking
redetermination of that deficiency. They resided in Los
Alamitos, California, at the time. We must decide the
following three substantive issues: (1) Whether petitioners
are entitled, pursuant to section 104(a)(2), to exclude from
the gross income reported on their 1994 return the proceeds
of a judgment in a State court action in the amount of
$314,173.91; (2) if not, whether petitioners may exclude
from their gross income for 1994 a portion of the proceeds of
the judgment equal to the amount of the attorney's fees paid
under a retainer agreement to one of the attorneys who
represented them in the State court action; and (3) whether
the alternative minimum tax imposed by section 55 violates

App. 5

the Constitution of the United States. All section references
are to the Internal Revenue Code as in effect during 1994,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.

The facts have been fully stipulated by the parties and
are so found. The stipulated facts and the accompanying
exhibits are incorporated into this opinion by this reference.

Petitioners were husband and wife at the end of 1994,
the taxable year at issue, and they filed a joint return for that
year. In this opinion, references to petitioner are to Mr. Jack
Freeman.

In 1991, after 34 years of service, petitioner was
summarily fired by his employer, Thrifty Corp. (Thrifty), a
corporation that operates a large chain of retail stores. At
that time, he was vice president/regional manager in charge
of coordinating and directing the activities of 11 district
managers, and he was responsible for 130 retail stores in the
Los Angeles area and Nevada with retail sales of $349
million.

In June 1991, petitioner filed suit against Thrifty in
the Superior Court of the State of California for the County
of Los Angeles (herein referred to as superior court).
Petitioner's complaint included counts for: Breach of
contract, breach of the covenant of good faith and fair
dealing, intentional infliction of emotional distress, fraud and
deceit, and specific performance. Thereafter, petitioner
amended his complaint by deleting his claim for intentional
infliction of emotional distress and adding a claim for age
discrimination under the California Fair Employment and
Housing Act, Cal. Govt. Code secs. 12900-12996 (Deering
1982 & Supp. 1988) (FEHA).

Initially, petitioner was represented in his suit against
Thrifty by Gregory S. Koffman, Esquire. On or about
December 15, 1992, petitioner substituted a new attorney to

App. 6

represent him in the suit. Petitioner paid Mr. Koffman a total
of $83,411.44 for his services.

Petitioner entered into a retainer agreement with the
law offices of his new attorney, the Law Offices of Paul A.
Greenberg. The agreement states in pertinent part as follows:

2. Client shall pay to Attorney, upon
execution of this Retainer Agreement, the sum of
$7,500.00, which shall constitute a nonrefundable
retainer fee, in exchange for substituting into this
case.

3. Client shall pay to Attorney, after receipt of
the first Trial or Arbitration date set, the sum of
$7,500.00, payable equally over a three month
period, $2,500.00 per month.

4. Client shall pay to Attorney upon receiving
or filing a Notice of Appeal, the sum of $5,000.00,
payable equally over a two month period, $2,500.00
per month.

5. Attorney shall receive as an additional fee a
contingency fee equal to thirty five percent (35%) of
the total amount of any sums recovered in this matter,
after deducting fifty percent (50%) of the fees paid
pursuant to Paragraphs 2, 3 and 4 above. For
example, if $100,000.00 is received as a settlement or
award and client has paid $7,500.00 in fees, then
Attorney will receive 35% of $96,250.00. Attorney is
hereby given a lien for its fees and advances upon
any settlement, judgment or award made or secured
herein. IF NO RECOVERY IS OBTAINED,
ATTORNEY WILL RECEIVE NO ADDITIONAL
FEE, other than those specified in Paragraphs 2, 3
and 4 above. The fee schedule as set forth above is
not set by law but is negotiable between Attorney and
client.

App. 7

* KKK KK KKK KK KK KK KK KK K

8. As security for the fees and costs that will
become due to Attorney, Client does hereby give to
Attorney a lien on all papers, documents and records
of Client, and judgments and settlements concerning
the matter. Client authorizes Attorney to retain from
any recovery an amount sufficient to liquidate client's
accrued fees and expenses, on this or any other
matter.

Ultimately, petitioner's suit against Thrifty was tried
in superior court before a jury on the following four causes
of action: Breach of contract, breach of the covenant of good
faith and fair dealing, fraud and deceit, and age
discrimination under FEHA. The jury returned a special
verdict in petitioner's favor. The special verdict states as
follows:

We, the jury in the above entitled action, find
the following Special Verdict on the questions
submitted to us:

Issue No. | Was there an implied agreement
between the parties that the plaintiff, Jack Freeman,
would not be terminated except for good cause?

Answer "yes" or "no".

Answer: Yes

If you answered Issue No. | "yes", then
answer the next issue. If you answered Issue No. |
"no", then answer Issue No. 5.

Issue No. 2 Did the defendant, Thrifty Corp.,
either actually terminate the plaintiff, Jack Freeman,
without good cause or constructively terminate the
plaintiff, Jack Freeman, without good cause?

“Bien cig neni:

App. 8

Answer "yes" or "no".
_ Answer: No

If you answered Issue No. 2 "yes", then
answer the next issue. If you answered Issue No. 2
"no", then answer Issue No. 5.

Issue No. 5 Did defendant, Thrifty Corp..
breach the implied covenant of good faith and fair ©
dealing?

Answer "yes" or "no".
Answer: Yes

If you answered Issue No. 5 "yes" then
answer the next issue. If you answered issue No. 5
"no", then sign and return this veridct [sic].

Issue No. 6 Did such conduct by defendant,
Thrifty Corp., cause damage to the plaintiff, Jack
Freeman?

Answer "yes" or "no".
Answer: Yes

If you answered Issue No. 6 "yes", then
answer the next issue. If you answered issue No. 6
"no", the [sic] sign and return this verdict.

Issue No. 7 What is the total amount of
damages suffered by plaintiff, Jack Freeman, as a
result of defendant, Thrifty Corp.'s breach of the
implied covenant of good faith and fair dealing?

App. 9

Answer: $300,000.00

According to the above special verdict, the jury found that
Thrifty had breached an implied covenant of good faith and
fair dealing and that Thrifty's conduct had damaged
petitioner. The jury further found that the damages suffered
by petitioner by reason of Thrifty's breach amounted to
$300,000. Petitioner's claim for damages due to Thrifty's
breach of the covenant of goed faith and fair dealing was the
only cause of action as to whicl the jury found for petitioner
and awarded damages. Petitioner's final award, including
interest, totaled $314,173.91.

Thrifty issued a check dated August 11, 1994, in the
amount of $314,173.91 in full satisfaction of the judgment
against it. The check was made payable jointly to petitioner
and his attorneys.

Petitioner's attorney, Mr. Greenberg, received
Thrifty's check. He deducted his fees of $114,532.39 from
the award, as authorized by the retainer agreement, and
disbursed the remaining proceeds of Thrifty's payment,
$199,641.52, to petitioner by check dated August 26, 1994.
Mr. Greenberg also issued a check to petitioner in the
amount of $62.69 to reimburse him for unused cost
advances.

Petitioners timely filed their 1994 Federal income tax
return, but they did not include any portion of the jury award
in their gross income. Respondent issued a notice of
deficiency to petitioners. Among other adjustments,
respondent determined that petitioners should have included
the entire jury award of "$314,174.00" in their gross income
for 1994. The notice of deficiency states in part as follows:

It is determined that you received an award in the
amount of $314,174.00 from Thrifty which was not

LO LL A PE NO PEE OS

BATS eens ns

App. 10

reported on your return for the taxable year ended

December 31, 1994. This amount is determined to be

taxable to you because you have failed to establish

that this amount is excludable from gross income
under the provisions of the Internal Revenue Code.

Accordingly, income is increased in the amount of

$314,174.00.

Respondent also adjusted the miscellaneous itemized
deductions claimed on Schedule A of petitioners’ return,
$610, by adding $194,595 to arrive at total miscellaneous
itemized deductions of $195,205, before taking into account
the 2-percent floor as required by section 67(a). It appears
that the additional miscellaneous itemized deductions
allowed in the notice of deficiency relate to the attorney's
fees that petitioner paid with respect to his suit against
Thrifty, but the record does not readily disclose how
respondent computed the amount of the adjustment. The
parties agree that that amount is not correct and the correct
amount of the additional miscellaneous itemized deductions
is $129,698.70, computed as follows:

Attorney's fees paid $114,532.39
to Paul Greenberg, Esq.

Less: reimbursement for ‘. 62.69
unused cost advance

Plus: attorney's fees paid $ 15,229.00
in 1994 before trial

Total additional miscellaneous $129,698.70
itemized deductions

App. 11

Respondent also determined that for 1994 petitioners
are liable for alternative minimum tax of $52,303. The notice
of deficiency states as follows:

It is determined that you are subject to the alternative

minimum tax imposed by the Internal Revenue Code

on items of tax preference for the taxable year ended

December 31, 1994. We have attached an an [sic]

alternative minimum tax worksheet to explain how

we computed the alternative minimum tax.
Whether the Court Properly Granted Respondent's Motion
To Quash Subpoenas To Compel the Testimony of a
Revenue Agent and an Appeals Officer

Petitioners ask the Court to reconsider the granting of
respondent's motion to quash the subpoenas issued to a
revenue agent and to a manager in respondent's Appeals
Office. According to petitioners' posttrial brief, the agent
would have testified that he advised petitioners’ accountant
that petitioners’ "return should be accepted as filed", and the
Appeals officer would have testified that he informed
petitioners’ accountant that "the return was correct when filed
and [he] removed the penalties but * * * that Petitioner still
owed the tax."

The proffered testimony would be immaterial to the
issues in this case. As we have often observed. a trial before
this Court is a proceeding de novo in which our
determination as to a texpayer's tax liability must be based
on the merits of the case and not any record developed at the
administrative level. See, e.g.. Greenberg's Express, Inc. v.
Commissioner, 62 T.C. 324, 328 (1974). Accordingly, we
properly quashed the subject subpoenas.

Whether Petitioners-May Exclude From Gross Income the
Entire Amount of the Jury Award Under Section 104(a)(2)

The first substantive issue in this case is whether
petitioners are entitled to exclude from their gross income for

abe aprons Matas

ih AR, Em RA AG tail bd 5 Abe eS Roan 8

App. 12

1994 the amount of the judgment awarded in petitioner's suit
against Thrifty, $314,173.91. Petitioners argue that their
gross income does not include any part of that amount by
reason of section 104(a)(2). During 1994, that provision
stated: "gross income does not include * * * the amount of
any damages received (whether by suit or agreement and
whether as lump sums or as periodic payments) on account
of personal injuries or sickness". The regulations
promulgated under section 104(a)(2) make clear that the
scope of excludable damages is limited to those received
through prosecution of an action based upon tort or tortlike
rights:
The term "damages received (whether by suit or
agreement)" means an amount received (cther than
workmen's compensation) through prosecution of a
legal suit or action based upon tort or tort type rights,
or through a settlement agreement entered into in lieu
of such prosecution. [Sec. 1.104- 1(c), Income Tax
Regs. |

After reviewing section 104(a)(2) and the above regulation,
the U.S. Supreme Court stated that a taxpayer must meet the
following two independent requirements before a recovery
may be excluded under section 104(a)(2):
First, the taxpayer must demonsirate that the
underlying cause of action giving rise to the recovery
is "based upon tort or tort type rights"; and second,
the taxpayer must show that the damages were
received "on account of personal injuries or
sickness." * * * [Commissioner v. Schleier, 515 U.S.
323, 337 (1995). ]
Petitioners acknowledge that the damages of
$300,000 awarded by the jury were based entirely on
petitioner's claim for breach of a covenant of good faith and

App. 13

fair dealing and that the amount paid by Thrifty included
interest of $14,173.91. Petitioners' brief states:
On May 23, 1994, the jury returned a verdict for
Petitioner on the Second Cause of Action, Breach of
the Covenant of Good Faith and Fair Dealing in the
amount of $300,000, and with interest, totaling
$314,173.91.

Petitioners also acknowledge that their claim against Thrifty
for breach of the covenant of good faith and fair dealing is a
contract claim and not a claim based upon tort or tortlike
rights. Petitioners’ brief states:
Petitioner went to trial on four causes of action:
1 - Breach of Contract, contract
2 - Breach of Covenant of Good Faith and Fair
Dealing, contract
3 - Fraud and Deceit, tort
4 - Violation of Fair Employment and Housing Act,
tort-like

Petitioners’ brief also states:

The jury in Petitioner's case may have given him an
award on the second cause of action for breach of the
covenant of good faith and fair dealing, but the
allegations of the complaint clearly involved a tort
and tort like claim.

Nevertheless, petitioners contend that the entire award is
excludable from gross income under section 104(a)(2) as
damages from personal injuries. To restate petitioners’
position more succinctly, petitioners contend that even
though the amount awarded in the superior court action
consists of damages for the breach of a contractual obligation

Bidet

App. 14

owed to petitioner and of interest, and does not involve
damages received through prosecution of tort or tort-type
rights, the entire award is excluded from gross income under
section 104(a)(2).

Petitioners ask us to reach the same conclusion, i.e.,
that the entire jury award is excluded from gross income
under section 104(a)(2), on the basis of a reading of
Threlkeld v. Commissioner, 87 T.C. 1294 (1986), affd. 848
F.2d 81 (6th Cir. 1988). Petitioners’ posttrial brief makes the
following argument:

[In Threlkeld v. Commissioner, supra,] The
court noted at page 1307 that even though the
settlement agreement allocated the sum of $75,000
for damages to petitioners [sic] professional
reputation, (the taxability of $21.500 [of] which was
the issue in the case), the settlement agreement does
not necessarily control in deciding whether the claim
being settled arises from a personal injury. The court
said:

"We therefore, look to the petitioners [sic]
allegations in his complaint in the State court."

The relevance of this last statement to
Petitioner is most important to note. Namely, the jury
may have given an award on the second cause of
action for breach of the covenant of good faith and
fair dealing, but the meaning of the language from
Threlkeld is that to answer the question of whether
the award represents compensation for personal
injuries, the court said the allegations in the
complaint must be examined.

App. 15

Petitioners do not adequately explain how an examination of
the complaint in the superior court action supports the
conclusion that the entire award is excludable from income
under section 104(a)(2).

We disagree with petitioners’ reading of Threlkeld v.
Commissioner, supra, and with their conclusion that the
entire award in the superior court action is excludable from
income under section 104(a)(2). In our view, none of the
award is excludabdle.

In Threlkeld v. Commissioner, supra at 1298, the
Court held that in deciding in a particular case whether the
damages were received on account of "personal injuries", the
nature of the claim as defined under State law, and the
concept of personal injury thereby embodied, are the
appropriate criteria in a case in which "damages are clearly
allocated to an identifiable claim". Id. at 1305- 1306. The
Court pointed out that State law may be of limited assistance
in certain cases, such as in a settlement where it is unclear
what claim is settled or where there are several claims not all
of which involve personal injuries. Id. In such cases, the
Court pointed out: "We must look to various factors,
including the allegations in the State court pleadings, the
evidence adduced at trial, a written settlement agreement,
and the intent of the payer." Id. at 1306.

In this case, unlike Threlkeld v. Commissioner,
supra, the award to petitioner in the superior court action is
set forth in the jury's special verdict. The award was based
entirely on petitioner's claim that Thrifty breached an
implied covenant of good faith and fair dealing. Thus, in this
case, in determining the basis for the damages awarded to
petitioner in the superior court action, the jury's special
verdict takes precedence over any of the other factors
mentioned by the Court in Threlkeld v. Commissioner,

supra.

App. 16

The jury award in the instant case was based upon a
single identifiable cause of action, breach of an impiied
covenant of good faith and fair dealing. Under California
law, that cause of action is not a tort. Mundy v. Household
Fin. Corp., 885 F.2d 542, 544 (9th Cir. 1989) ("the
California Supreme Court has spoken decisively, holding in
Foley [v. Interactive Data Corp., infra} that an allegation of
breach of the implied covenant is a purely contractual
claim"); Foley v. Interactive Data Corp., 765 P.2d 373 (Cal.
1988): see Cade v. Commissioner, T.C. Memo. 1999-394.
Accordingly, in the instant case, no part of the recovery in
the superior court action can be excluded from gross income
under section 104(a)(2) because the underlying cause of
action giving rise to the recovery was based entirely upon a
contract cause of action and not upon tort or tortlike rights as
required by section 1.104-1(c), Income Tax Regs. See
Commissioner v. Schleier, 515 U.S. 323 (1995).

Whether Petitioners May Exclude From Gross Income a
Portion of the Recovery Equal to the Amount Paid to Their
Attorneys Under the Contingent Fee Agreement

Petitioners argue that if we hold that section
104(a)(2) does not apply, with the result that the judgment
proceeds are includable in their 1994 gross income, then the
portion of the judgment paid directly to their attorneys under
the retainer agreement is excludable from gross income.
Petitioners ask us to follow Cotnam v. Commissioner, 263
F.2d 119 (Sth Cir. 1959), revg. in part and affg. on another
issue 28 T.C. 947 (1957), and Estate of Clarks v. United
States, 202 F.3d 854 (6th Cir. 2000). In Cotnam v.
Commissioner, supra, the Court of Appeals for the Fifth
Circuit held that the amount of a contingent fee paid to the
taxpayer's attorneys out of a judgment was not income to the
taxpayer because under Alabama law a contingent fee
contract operates as a lien on the recovery that, in effect,

App. 17

transfers part of a plaintiff's claim to the attorneys. See also
Srivastava v. Commissioner, 220 - 17 -F.3d 353, 365 (Sth
Cir. 2000), revg. and remanding in part, and affg. on another
issue T.C. Memo. 1998-362; Davis v. Commissioner, 210
F.3d 1346 (11th Cir. 2000) ("this panel [of the Court of
Appeals for the 11th Circuit] is bound by Cotnam, which can
be overruled only by the en banc Court"), affg. T.C. Memo.
1998-248. In Estate of Clarks v. United States, supra, the
Court of Appeals for the Sixth Circuit followed Cotnam v.
Commissioner, supra, and held that the interest portion of a
judgment in an action for personal injuries could be offset by
the contingent legal fees paid to the taxpayer's attorney
because an attorney's lien under Michigan law was similar to
an attorney's lien under Alabama law.

Petitioners acknowledge that we recently
reconsidered the same issue and reached the opposite
conclusion in Kenseth v. Commissioner, 114 T.C. 399
(2000), affd. 259 F.3d 881 (7th Cir. 2001). In that case, the
taxpayer was one of a class of persons who had entered into
an agreement with their former employer in settlement of a
class action for age discrimination. The taxpayer's share of
the gross settlement amount was $229,501.37, of which the
taxpayer received $126,470.42, after the former employer
had withheld employment taxes of $11,230.41 and the
taxpayer's attorneys had withheld attorneys’ fees of
$91,800.54. The issue in that case was whether the taxpayer
could offset his recovery in the age discrimination suit by the
attorney's fees withheld by his attorney, $91,800.54.

We held that the taxpayer's gross income included all the _
proceeds of the settlement, including the portion used to pay
his attorneys under the contingent fee agreement. We
explained our position regarding this issue as follows:
This Court has, for an extended period of
time, held the view that taxable recoveries in lawsuits

App. 18

are gross income in their entirety to the party-client
and that associated legal fees—-contingent or
otherwise—are to be treated as deductions.” See
Bagley v. Commissioner, 105 T.C. 396, 418-419
(1995), affd. 121 F.3d 393, 395-396 (8th Cir. 1997);
O'Brien v. Commissioner, 38 T.C. 707, 712 (1962),
affd. per curiam 319 F.2d 532 (3d Cir. 1963); Benci-
Woodward v. Commissioner, T.C. Memo. 1998-395,

oe on appeal (9th Cir. Feb. 2, 1999). In O'Brien, we held
that "even if the taxpayer had made an irrevocable
assignment of a portion of his future recovery to his
attorney to such an extent that he never thereafter
became entitled thereto even for a split second, it
would still be gross income to him under" assignment
of income principles. O'Brien v. Commissioner, supra
at 712. "Although there may be considerable equity
to the taxpayer's position, that is not the way the
statute is written." Id. at 710. * * *

This view is based on the well-established assignment of income
doctrine that was originated by the Supreme Court in Lucas v. Earl, 281
U.S. 111 (1930). Lucas v. Earl. supra, has been relied on by this Court
for assignments of income involving both related and unrelated
taxpayers. [Id. at 411.]

In Kenseth v. Commissioner, supra, we reviewed and
declined to follow the cases relied upon by petitioners,
Cotnam v: Commissioner, supra, and Estate of Clarks v.
United States, supra. We stated as follows:

After further reflection on Cotnam and now
Estate of Clarks v. United States, supra, we continue
to adhere to our holding in O'Brien that contingent
fee agreements, such as the one we consider here,
come within the ambit of the assignment of income

App. 19

doctrine and do not serve, for purposes of Federal
taxation, to exclude the fee from the assignor's gross
income. We also decline to decide this case based on
the possible effect of various States' attorney's lien
statutes. [Kenseth v. Commissioner, supra at 412; fn.
ret. omitted. |

In Kenseth v. Commissioner, supra, we noted that
there is a disagreement about this issue among the Courts of
Appeals. We reviewed and agreed with Baylin v. United
States, 43 F.3d 1451 (Fed. Cir. 1995), and Alexander v.
Commissioner, 72 F.3d 938 (Ist Cir. 1995), affg. T.C.
Memo. 1995-51, cases in which the courts had rejected
arguments similar to the argument made by petitioners in the
instant case; see also Young v. Commissioner, 240 F.3d 369
(4"" Cir. 2001), affg. 113 T.C. 152 (1999).

Petitioners acknowledge that the court to which an
appeal of this case lies, the Court of Appeals for the Ninth
Circuit, has rejected their position in Benci- Woodward v.
Commissioner, 219 F.3d 941 (9th Cir. 2000), affg. T.C.
Memo. 1998-395. In that case, the court held that an award
of punitive damages was fully includable in the taxpayers'
gross income, notwithstanding the fact that a portion of the
award was retained by the taxpayers' attorney, pursuant to a
contingent fee agreement. Id. The Court of Appeals noted
that under California law, the law applicable in that case and
in the instant case, "an attorney lien does not confer any
ownership interest upon attorneys or grant attorneys any
right and power over the suits, judgments, or decrees of their
clients." Id. at 943; see also Brewer v. Commissioner, T.C.
Memo. 1997-542 (attorney's fees paid with respect to action
for statewide discrimination in California), affd. without
published opinion 172 F.3d 875 (9th Cir. 1999).
Accordingly, the Court of Appeals found no reason to

App. 20

distinguish the payment to the taxpayers' attorney under the
contingent fee agreement in that case from the attorneys’ fees
at issue in Coady v. Commissioner, 213 F.3d 1187 (9th Cir.
2000), affg. T.C. Memo. 1998-291.

ln Coady v. Commissioner, supra, the Court of
Appeals for the Ninth Circuit rejected a taxpayer's argument
that a judgment for lost wages and benefits arising out of her
wrongful termination should be reduced by contingent legal
fees and litigation costs on the ground that the taxpayer had
"assigned" those amounts to her attorneys. Id. The court
reasoned that the judgment in the wrongful termination
action was fully includable in the taxpayer's gross income
under the broad sweep of section 61, which defines gross
income as "all income from whatever source derived" and
the taxpayers had "simply used a portion of the award
subsequently to discharge their personal liability to their
attorneys." Id. at 1190-1191. The Court of Appeals noted
that, under longstanding authority of the U.S. Supreme
Court. income must be taxed to the person who earns it, and
a taxpayer cannot escape such taxation by procuring
payment directly to creditors or by making an anticipatory
assignment of the income. See United States v. Basye. 410
U.S. 441, 449 (1973); Helvering v. Eubank, 311 U.S. 122,
124-125 (1940); Helvering v. Horst, 311 U.S. 112 (1940):
Lucas v. Earl, 281 U.S. 111, 114-115 (1930).

Most recently, the Court of Appeals for the Ninth
Circuit again declined to follow Cotnam in Sinyard v.
Commissioner, F.3d (9th Cir. 2001), affg T.C.
Memo. 1998-364. That case involved attorney's fees paid in
connection with the settlement of two class actions brought
under the Age Discrimination in Employment Act, Pub. L.
90- 202. 81 Stat. 602, currently codified at 29 U.S.C. secs.
621-634 (1994).

App. 21

Arguments similar to petitioners’ in the instant case
were fully considered and rejected by this Court in Kenseth
vy. Commissioner, 114 T.C. 399 (2000), and by the Court of
Appeals for the Ninth Circuit in Sinyard v. Commissioner,
supra, Benci- Woodward v. Commissioner, supra, and Coady
v. Commissioner, supra. We have no reason to reconsider the
issue in this case. Accordingly, we sustain respondent's
determination that the judgment is fully includable in
petitioners’ gross income and cannot be reduced by the
amount retained by petitioner's attorney under the retainer
agreement.

Whether the Alternative Minimum Tax Is Unconstitutional

In the notice of deficiency. respondent treated the
attorneys’ fees that petitioner paid in connection with his
superior court action as a "miscellaneous itemized
deduction", as defined by section 67(b). In the case of an
individual, a miscellaneous itemized deduction is not
deductible in computing alternative minimum taxable
income. See sec. 56(b)(1)(A)(i). In petitioners' case, this has
the effect of causing the tentative minimum tax computed
under section 55(b) to exceed petitioners’ regular tax and,
thus, causes petitioners to be liable for the alternative
minimum tax in the amount of the excess. See sec. 55(a). See
generally Benci- Woodward v. Commissioner, supra at 994
(holding that legal expenses are classified as miscellaneous
itemized deductions and, as such, are not allowed as
deductions for purposes of computing alternative minimum
tax liability).

In the notice of deficiency, respondent determined
that petitioners are liable for alternative minimum tax of
$52,303. This was based upon the treatment of attorneys'
tees of $194,595 as an additional miscellaneous itemized
deduction. As mentioned above. the parties agree that the
attorneys’ fees, to be treated as an additional miscellaneous

App. 22 -

itemized deduction, are $129,698.70, rather than $194,595.
Petitioners do not take issue with respondent's computation
of the amount of alternative minimum tax in this case. They
argue:
THE FAILURE OF THE ALTERNATIVE -
MINIMUM TAX TO ALLOW A DEDUCTION
FOR ATTORNEYS FEES AND COSTS, WHICH
RESULTS IN A DOUBLE TAXATION OF THE
SAME INCOME TO PETITIONER AND HIS
ATTORNEYS, [IS] A VIOLATION OF THE
CONSTITUTIONAL RIGHTS OF PETITIONER IN
THAT IT IS A TAKING WITHOUT DUE
PROCESS OF LAW AND A DENIAL OF THE
EQUAL PROTECTION OF THE LAW IN
VIOLATION OF THE 5TH AND 14TH
AMENDMENT [sic] TO THE FEDERAL
CONSTITUTION.

Petitioners acknowledge that the constitutionality of the
alternative minimum tax was upheld in Okin v.
Commissioner, T.C. Memo. 1985-199, affd. 808 F.2d 1338
(9th Cir. 1987), but they argue that their case "is totally
different" from Okin. We disagree.

In Okin v. Commissioner, supra, the taxpayer's
principal argument was that under a prior version of the
alternative minimum tax, viz the Revenue Act of 1978, Pub.
L. 95-600, sec. 421. 92 Stat. 2763, 2871, alternative
minimum taxable income should be computed using
"average annual adjusted gross income", a concept taken
from the income averaging provisions of sections 1301-
1305. We rejected the taxpayer's argument and pointed out
that, in defining alternative minimum taxable income, the
statute used the words "gross income" and did not refer to

App. 23

the income averaging provisions or to any adjusted figure.
Okin v. Commissioner, supra. After trial, the taxpayer made
a general argument, "not supported by any specific
references to the Constitution or citations to precedent", that
section 55 is unconstitutional. Id. We rejected that argument
on the basis of cases upholding the constitutionality of the
so-called add-on minimum tax under former section 56. See
Wyly v. United States, 662 F.2d 397, 403-406 (Sth Cir.
1981); Graff v. Commissioner, 74 T.C. 743, 765-767 (1980),
affd. per curiam 673 F.2d 784 (Sth Cir. 1982).

On appeal, the Court of Appeals for the Ninth Circuit
also rejected the taxpayer's challenge to the constitutionality
of the alternative minimum tax imposed by section 55. Okin
v. Commissioner, 808 F.2d at 1341-1342. The Court of
Appeals rejected the taxpayer's argument that, as applied in
his case, the alternative minimum tax constitutes a "taking of
property without due process of law and without adequate
compensation." Id. The court agreed that the effect of the
alternative minimum tax was to virtually nullify the
taxpayer's tax savings under the income averaging provisions
but pointed out that that effect was consistent with
congressional intent. Id. at 1341. The court noted that “the
due process clause ordinarily places no limits upon the
congressional taxing power." Id. at 1341-1342; see A.
Magnano Co. v. Hamilton, 292 U.S. 40, 44 (1934). The court
further rejected the taxpayer's contention that taking away
the benefits of averaging through the application of the
alternative minimum tax is discriminatory. According to the
court, in enacting the alternative minimum tax, Congress
intended "to remedy general taxpayer distrust of the system
growing from large numbers of taxpayers with large incomes
who were yet paying no taxes." Okin v. Commissioner, 808

F.2d at 1342. The court stated that that intent is a legitimate

App. 24

governmental end as to which reducing the benefits of
averaging bore a reasonable relation. Id.

The instant case involves the benefits of a
miscellaneous itemized deduction, rather than the benefits of
income averaging. Nevertheless, the reasoning of the Court
of Appeals in Okin v. Commissioner, supra, applies.
Congress provided that, in computing alternative minimum
taxable income, no deduction shall be allowed for
miscellaneous itemized deductions as defined by section
67(b). Sec. 56(b)(1)(A)(i). Congress thereby restricted the
benefits from miscellaneous itemized deductions through the
application of the alternative minimum tax. Cf. Weiser v.
United States. 959 F.2d 146 (9th Cir. 1992). The alternative
minimum tax no more violates the due process or equal
protection requirements of the U.S. Constitution in this case,
involving miscellaneous deductions, than in Okin, which
involved the benefits of income averaging. See Lickiss v.
Commissioner, T.C. Memo. 1994-103. See generally
Wallach v. United States, 800 F.2d 1121 (Fed. Cir. 1986);
Gajewski v. Commissioner, 84 T.C. 980, 984-985 (1985):
Klaassen v. Commissioner, T.C. Memo. 1998-241, affd.
without published opinion, 182 F.3d 932 (10th Cir. 1999):
Keese v. Commissioner, T.C. Memo. 1995-417; Christine v.
Commissioner, T.C. Memo. 1993-473: Ross v.
Commissioner, T.C. Memo. 1987-500.

Finally, even if we agreed with petitioners that the
application of the alternative minimum tax produces an
inequitable result in this case, it is not for us to change that
result. It is well established that such an equitable argument
cannot overcome the plain meaning of the statute. See,
Sinyard v. Commissioner, F.3d ___; Benci- Woodward
v. Commissioner, 219 F.3d at 944; Alexander v.
Commissioner, 72 F.3d at 946-947; Weiser v. United States,

supra at 148-149; Okin v. Commissioner. 808 F.2d at 1342.

parties,

App. 25
Based upon the foregoing, and concessions of the

Decision will be entered under Rule 155.

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386015_2364%3A1. Public record. Not legal advice.