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Category: Fee Shifting

Taxation of Attorney Fee Awards in Legal Malpractice Cases

July 24, 2018

A recent New Jersey Law Journal article by Paul J. Maselli, “Taxation of Attorney Fee Awards in Legal Malpractice Cases,” reports on the taxation of attorney fee awards in legal malpractice cases.  This article was posted with permission.  The article reads:

The recent tax law changes may impact and increase damage awards in legal malpractice cases.  In New Jersey, when a former client successfully sues a former attorney for legal malpractice, the client is entitled to recover the fees incurred for the malpractice lawsuit as part of the measure of damages.  New Jersey’s Supreme Court established this fee-shifting rule, which is an exception to the American Rule that provides each party pays their own attorney fees for a lawsuit, in the 1996 case Saffer v. Willoughby, 143 N.J. 256 (1996).  The court stated that attorney fees in a legal malpractice case are consequential damages and available “to put a plaintiff in as good a position as he [or she] would have been had the [attorney] kept his [or her] contract.” Id. at 271.

Under the tax laws that expired at the end of 2017, an individual’s attorney fees (whether incurred or reimbursed) were either fully excluded from income or deductible as a miscellaneous expense to the extent the attorney fees exceeded 2 percent of the individual’s adjusted gross income, and the individual was not subject to the Alternative Minimum Tax.  The Tax Cuts and Jobs Act of 2017 eliminated miscellaneous expenses as a deduction from adjusted gross income, which means that attorney fee awards are now taxable in a whole category of situations not previously taxed.

If the underlying claim is for recovery of money that will be taxed (such as a claim for unpaid wages or lost profits), the award of attorney fees is not taxed.  26 U.S.C.A. §212(1). Where the claim is for non-taxable damages, the award of attorney fees is taxed.  This means that, with some exceptions, a plaintiff awarded attorney fees pursuant to a statute, case or court rule must treat the recovery as income subject to taxation by the Internal Revenue Service and State of New Jersey, including the legal fees paid to plaintiffs in legal malpractice cases where the compensatory damages are not taxable.

As for exceptions, the compensatory damages in personal injury or sickness cases are not taxable whether the funds are retained by the client or paid to the attorney. 26 U.S.C.A. §104(a).  Awards for damages and attorney fees in discrimination suits and whistleblower claims are not included in adjusted gross income and thus not taxable.  26 U.S.C.A. §62(a)(20) and (21).  But awards of attorney fees to individuals are now taxable in all other cases not related to the collection of taxable money.

Attorney fee awards in legal malpractice cases handled on a contingency fee basis are not subject to the time spent/hourly rate lodestar, instead, courts may award the one-third contingency fee if that is the arrangement between malpractice lawyer and client.  Distefano v. Greenstone, 357 N.J. Super. 352, 361 (App. Div. 2003).  Awards can be quite high.

Whether the compensatory damages awarded in a legal malpractice case are taxable depends on the nature of the underlying claim.  United States v. Gilmore, 372 U.S. 39, 49 (1963).  If the plaintiff sues her attorney for professional negligence in her representation in a claim for an inheritance, the compensatory damages recovered in the malpractice case are not taxable because there is no federal or state inheritance tax.  If the plaintiff sues the attorney for malpractice in handling a case for the recovery of unpaid wages, on the other hand, the compensatory damages are taxable because the unpaid wages would have been taxed.  26 U.S.C.A. §104(a)(1)(a).  Finally, if the attorney’s negligence occurred in a claim to recover the client’s security deposit, the compensatory damages would not be taxed since there is no tax on the recovery of a party’s capital.  Clark v. Commissioner, 40 B.T.A. 333 (1939), acq., 1957-1 C.B. 4 and Rev. Rul. 57-47, 1957-1 C.B. 23.

In the inheritance and security deposit case, the attorney fee awards are taxed because they do not fall within an exception and the claim for compensatory damages is not taxable income.  If the measure of damages is to place the plaintiff “in as good a position” as he or she would have enjoyed had the attorney not malpracticed, then the plaintiff’s obligation to treat the attorney fee award as income and pay taxes on it certainly detracts from the plaintiff being in as a good a position.

Plaintiffs now will be seeking an augmentation of any attorney fee award to recoup an amount sufficient to pay the taxes. Known as a “tax gross up,” this concept is not new.  In Oddi v. Ayco Corporation, 947 F.2d 257 (7th Cir. 1992), the court considered a negligent tax planning and advice claim in which the tax advisor made an error calculating the tax impact of a transaction for his investor client.  The court awarded damages not only for the difference between the advised amount and the actual amount, but augmented the award to include an amount for the income taxes that would be incurred on the award. Id. at 261.  The trial court’s award was not disturbed on appeal.

In Jobe v. International Insurance Company, 933 F.Supp. 844 (D. Ariz. 1995), the court relied on Oddi as it outlined the damages available to a plaintiff in a tax malpractice case:

Damages in a tax malpractice case are the difference between what the plaintiff would have owed if the tax returns had been properly prepared and they owe now because of the professional’s negligence, plus incidental damages.  Thomas v. Cleary, 768 P.2d 1090, 1091–92 n. 5 (Alaska 1989).  The injured plaintiff in a tax malpractice action may recover: (1) the taxes paid after audit, appeal and/or settlement attributable to the negligence; Thomas, 768 P.2d at 1092; (2) interest paid on those taxes; (3) prejudgment interest on taxes and interest paid, Wynn v. Estate of Holmes, 815 P.2d 1231, 1235–36 (Okla. Ct. App.1991); (4) professional fees incurred in defending the audit, Thomas, 768 P.2d at 1092; (5) all fees paid to a lawyer who acts while in a conflict situation, Day v. Rosenthal, 170 Cal. App.3d 1125, 217 Cal.Rptr. 89, 113 (Ct.App.), cert denied, 475 U.S. 1048, 106 S.Ct.1267, 89 L.Ed.2d 576 (1986); and (6) additional taxes a plaintiff will incur on receipt of the damages award. Oddi v. Ayco Corp, 947 F.2d 257 (7th Cir.1991).

Id. at 860 (emphasis added).

While it benefits the clients, the attorneys and the insurance company to pay taxes that the government uses for education, roads and police, most litigants see it differently—not welcoming the opportunity to pay taxes.  One tax-avoidance strategy for settlement negotiations is to attribute all or as much of the settlement amount to compensatory damages that have some justification in fact.  The plaintiff may be asserting $100,000 in compensatory damages but may have proof problems with $30,000 of that amount which results in the plaintiff accepting an $80,000 settlement offer.  Instead of itemizing the settlement as $70,000 for compensatory damages and $10,000 for taxable attorney fees, the parties can agree to settle for $80,000 in compensatory damages with the plaintiff waiving the claim for attorney fees.  The settlement number is still less than the maximum compensatory claim and the itemization is justifiable, and no part of the settlement was paid for attorney fees.

This strategy is supported by the finding of the United States Tax Court in Concord Instruments Corp. v. C.I.R., 67 T.C.M. (CCH) 3036 (T.C. 1994) (1994 WL 232364).  There, a taxpayer sued for compensatory damages of $466,000 arising from legal malpractice for its attorney’s failure to file an appeal of a tax assessment.  The $466,000 was comprised of taxes and interest paid from the taxpayer’s capital.  The case settled for $125,000 and the IRS wanted to tax the settlement, asserting that it was income to the taxpayer.  The tax court ruled that $125,000 was paid to settle a claim in which the taxpayer sought a return of capital, and since damages for a return of capital are not taxed, the $125,000 settlement was not taxed.

The court reasoned that the nature of the settlement (whether taxable income or non-taxable return of capital) is determined by looking at the nature of the claim, not the merits of the claim.  “The tax consequences of an award for damages depend on the nature of the litigation and on the origin and character of the claims adjudicated, but not the validity of such claims.” Id.

The IRS argued that the taxpayer would never have won its appeal if the attorney had timely filed the appeal, and since the taxpayer would not have won the appeal, the payment of $125,000 must be considered income to the taxpayer.  The court disagreed.  As the tax gross up issue evolves with the settlement and adjudication of legal malpractice cases in New Jersey, practitioners will likely develop more strategies for the avoidance of the payment of taxes on attorney fee awards. Creative minds are required.

Paul J. Maselli is a shareholder with Maselli Warren in Princeton.

Ninth Circuit Affirms $46M Fee Award in NCAA Antitrust Class Action

July 5, 2018

A recent Metropolitan News story, “Ninth Circuit Affirms $46 Million Award Against NCAA,” reports that the Ninth U.S. Circuit Court of Appeals has affirmed a $41 million attorney fee award against the National Collegiate Athletic Association, plus $5.1 million in costs, in connection with an action in which former and current college football and basketball players established that the ban on them receiving money for publicity rights was an unlawful restraint of trade.  That award was made by District Court Judge Claudia Wilken of the Northern District of California pursuant to the Clayton Act, which provides—in 15 U.S.C. §26—that in an action to enjoin antitrust violations “in which the plaintiff substantially prevails, the court shall award the cost of suit, including a reasonable attorney’s fee, to such plaintiff.”

The class action was brought in 2009 by Ed O’Bannon, who had been an All-American basketball player at UCLA (later a professional, now a car salesman in Nevada).  He was spurred to sue the NCAA after seeing his likeness, which he did not authorize, in a videogame.  NCAA and its member schools licensed “names, images and likenesses” (“NILs”) of its players to commercial outfits, for fees, but the players were not allowed to share in the proceeds because compensation to college athletes was viewed, under NCAA rules, as incompatible with their amateur statuses.

O’Bannon claimed that barring college athletes from receiving pay for their NILs was violative of §1 of the Sherman Antitrust Act which forbids “[e]very contract, combination..., or conspiracy, in restraint of trade or commerce.”  He won in the District Court on Aug. 8, 2014, and Wilken’s decision was, for the most part, affirmed by the Ninth Circuit on Sept. 30, 2015.  The U.S. Supreme Court denied certiorari on Oct. 3, 2016.

Friday’s memorandum opinion declares:  “The district court entered judgment against the NCAA for violating the Sherman Act and permanently enjoined it from prohibiting its member schools from compensating the plaintiff class for the use of their NILs by awarding grants-in-aid up to the full cost of attendance.  The plaintiffs did not prevail on every issue, but their enforceable judgment materially altered the legal relationship of the parties and clearly demonstrates success on a significant issue.  The prospective injunctive relief obtained in this class action directly benefits the certified class and can be enforced by the class.  Neither the named plaintiffs nor any other individual class member must prove they will personally receive a direct or material benefit for plaintiffs to be entitled to attorneys’ fees.  The plaintiffs substantially prevailed in their antitrust action seeking injunctive relief, and accordingly are entitled to attorneys’ fees under §26.”

Wilken not only held that athletes could receive scholarships that included cost-of-living expenses, not normally a part of scholarships—which was affirmed by the Ninth Circuit—but also that colleges could, instead, place $5,000-a-year in trust for their athletes.  The latter proviso, the Ninth Circuit ordered, was to be vacated.  Judge Jay Bybee said in the circuit’s 2015 opinion that Wilken “clearly erred in finding it a viable alterative to allow students to receive NIL cash payments untethered to their education expenses.”

In contesting the attorney-fee award, the NCAA stressed that O’Bannon’s action was not wholly successful.  In oral argument in Pasadena on Feb. 15, its counsel, Michigan attorney Gregory L. Curtner, maintained that it is established by case law that “[i]f you seek a bundle, and you get a pittance, that must be reflected in a subsequent fee award.”  He asserted that while Wilken’s decision was “reversed in substantial part,” Wilken improperly made an “all-or-nothing, winner-take-all” award giving the plaintiffs nearly all that they sought.

The opinion points out that where there is partial success, time spend on unsuccessful claims must be disregarded, and was, and the level of success must be assessed.  It quotes Wilken as saying that even with the partial reversal, “the finding of liability and the remaining injunctive relief are together an excellent result."  The opinion rejects the contention that Wilken took an “all or nothing” approach, saying she weighed the factors and “simply reached a conclusion the NCAA docs not like: that the award of injunctive relief against the NCAA in an antitrust action brought by private parties is an ‘excellent result.’ ”

It adds:  “The district court’s focus on the plaintiffs’ success in achieving injunctive relief, as opposed to their failure to win damages, was entirely appropriate, as the basis for the fee request was §26.  Under §26, attorneys’ fees are mandatory in antitrust cases achieving injunctive relief under a private attorney general theory.”

The precise award was $40,794,245.89 in attorney fees and $1,540,195.58 in costs.  The case is O’Bannon v. NCAA, No. 16-15803.

$11M in Attorney Fees Sought in IP Action

November 17, 2017

A recent Law 360 story by Dorothy Atkins, “VMware Seeks $11M Atty Fees for Beating Phoenix IP Suit,” reports that VMware Inc. urged a California federal judge to award it $11.2 million in attorneys’ fees and litigation costs after a jury cleared it of Phoenix Technologies Ltd.’s claims it infringed Phoenix’s software copyright and breached their licensing agreement, arguing that the case was “ill founded from the outset.”

Michael Jacobs of Morrison & Foerster LLP argued that staff at Phoenix knew that its suit was premised on an "implausible legal contention," because they waited 15 years to sue over their licensing contract, and that's highlighted by the fact that they shifted their legal theory dramatically after the close of fact discovery.  “This case was ill-founded from the outset,” Jacobs said.  “To go back and read the complaint is to remind ourselves how odd it was to receive it on its face.”

Phoenix’s bid for attorneys' fees and costs comes after a jury cleared VMware of all allegations in June.  Phoenix had sought $110 million in damages and alleged in its March 2015 complaint that VMware broke its contract with Phoenix and infringed copyrights by limiting its use of software that controls basic input and output operations, known as BIOS.

Jacobs argued that Phoenix had evidence of weakness of their case since the beginning, but failed to do its due diligence to ensure its claims were viable.  The company unfairly forced VMware to spend millions to defend itself against the suit, he said.  “This case cries out for an award of attorneys’ fees lest there be a lot more cases like it,” he said.

But Phoenix’s attorney, Michael Attanasio of Cooley LLP, argued that nothing about this case would make it objectively unreasonable to pursue.  Also, Attanasio said, VMware can't cite a single case in which claims were deemed objectively unreasonable, despite having survived summary judgment and going to trial.  Even the Supreme Court has observed that sometimes cases go to trial, and the plaintiffs lose, but that doesn’t turn it into fee shifting award, Attanasio said.

U.S. District Judge Haywood S. Gilliam Jr. said he would take the arguments under submission, along with Phoenix's motion for judgment as a matter of law and request for new trial.  In that motion, Phoenix claimed that the jury was prejudiced by VMware’s defense argument, which the court shouldn’t have allowed VMware to present.  But during the hearing, Judge Gilliam suggested that the appeals court might be a better place for that particular challenge to be resolved.

The case is Phoenix Technologies Ltd. v. VMware Inc., case number 4:15-cv-01414, in the U.S. District Court for the Northern District of California.

Jones Day Seeks Fees from EEOC After “Baseless Suit”

November 13, 2017

A recent NLJ story by Erin Mulvaney, “Jones Day Seeks $446K in Fees From EEOC After ‘Baseless Suit’ Goes Nowhere” reports that Jones Day lawyers are seeking hundreds of thousands in legal fees from the U.S. Equal Employment Opportunity Commission, saying federal regulators unfairly targeted CVS Pharmacy Inc. for alleged employment abuses that no judge sustained.  Eric Dreiband, the lead partner for CVS in the litigation, is the Trump administration's pick to lead the U.S. Justice Department's Civil Rights Division.

The EEOC sued CVS in 2014 over a severance agreement the agency said limited the rights of employees to file complaints.  The EEOC called the severance agreement “overly broad” and argued it was part of a CVS “pattern or practice of resistance” to restrict the civil rights of the company’s employees.  The agency lost its case, EEOC v. CVS Pharmacy, in the U.S. District Court for the Northern District of Illinois and in its appeal in the U.S. Court of Appeals for the Seventh Circuit.  The appeals court concluded the agency too broadly interpreted its enforcement powers.

The dispute is back in the Seventh Circuit as Jones Day--led by partner Eric Dreiband—seeks attorney fees for the work the firm did for CVS.  The district court said CVS was entitled to legal fees.  Dreiband and the Jones Day team want $446,339 for 250 hours of work.

The dispute provides a glimpse at the billing practices at Jones Day.  In court filings, Dreiband requested legal fees for himself and Jones Day associates.  Dreiband identified his hourly rate at $560.  Ninth-year associate Jacob Roth, a former clerk to the late Justice Antonin Scalia, billed at $475 per hour; Nikki McArthur at $275 per hour; and staff attorney Adria Villar at $175 per hour.

“These rates are significantly less than what Jones Day actually billed, and was paid, for the firm’s work on this matter,” Dreiband said in a declaration.  “These rates are also lower than what Jones Day typically bills for these timekeepers on other similar matters.”

Dreiband argued in the request for legal fees that the EEOC “concocted what it admits to be a novel interpretation of Title VII that would give the agency vast power” to challenge employment practices that it doesn’t like.  He argued the EEOC exceeded its authority in filing the suit—refusing any conciliation with CVS—and issuing a press release announcing the case.

“The EEOC instead rushed to file a baseless lawsuit, and blasted CVS with an inflammatory press release falsely accusing the company of interfering with Title VII rights,” Dreiband told the appeals court.  EEOC lawyers, responding to the claims, said the agency had reason to believe it would prevail and that the fees awarded were an abuse of direction.

“Although the EEOC did not prevail, this theory—which was consistent with the statutory language and this court’s precedents—was entirely plausible, and the EEOC had no reason to believe with any certainty that it would not succeed,” EEOC lawyers told the Seventh Circuit.

John Darrah, the federal trial judge who said Jones Day was entitled to fees, concluded the EEOC had violated its own internal regulations in the case against CVS.  “The EEOC’s own regulations require the agency to use informal methods of eliminating an unlawful employment practice where it has reasonable cause to believe that such a practice has occurred or is occurring,” Darrah wrote in his ruling.

PA Justices Consider “Loser Pays” for Workers Comp Cases

October 18, 2017

A recent Legal Intelligencer story by Max Mitchell, “Justices Urged to Avoid Chilling Effect of Lower Court ‘Loser-Pays’ Ruling in Comp Case” reports that, if the state Supreme Court upholds a decision that workers’ compensation lawyers can be ordered to pay the employer’s attorney fees for unreasonable contest, if the employer prevails on appeal, there will be a chilling effect on smaller cases, a lawyer representing a claimant told the justices.  Attorney David Landay of Pittsburgh, who is representing the claimant in County of Allegheny v. Workers’ Compensation Appeal Board (Parker), argued that the Commonwealth Court’s decision in his client’s case was against the statutory scheme of the Workers’ Compensation Act.

“Judges will think twice before awarding attorneys fees if they think they may be taken away,” Landay said.  He gave the example of a dispute over $2,500 in medical bills.  Even if it is absolutely clear that the claimant was entitled to benefits, he said he would not be able to take the case, because, if he were unable to recover unreasonable contest fees, he would only be able to recover $5,000.  “I can’t afford to take that case,” Landay said.

The dispute stems from a December decision from the Commonwealth Court, which remanded claimant Harold Parker’s workers’ compensation case with instructions to order Parker’s lawyer to refund $14,750 in unreasonable contest fees to Parker’s employer, Allegheny County.

That decision had been based on the Commonwealth Court case Barrett v. WCAB (Sunoco), which held that “where litigation costs are awarded and are paid by the employer as a result of denial of a stay and the award of costs is later reversed on appeal, the employer is entitled to an order requiring the claimant’s counsel to repay the erroneously awarded costs.”  Although Barrett involved non-attorney fee litigation costs, the majority said the reasoning in Barrett applied to Parker’s case.

Landay, however, told the justices that Barrett was based on a plurality decision in a case that did not involve contingency fees.  “Once you take those out, then the opinion [in Parker] collapses of its own weight,” Landay said.  Landay contended the way unreasonable contest fees are paid is outlined in the Workers’ Compensation Act, and the act does not allow for disgorgement of the fees, but rather the fees should be paid out of the supersedeas fund.

Bradley R. Andreen of O’Brien, Rulis & Bochicchio, who represented Allegheny County, said the Workers’ Compensation Act was not meant to provide a windfall for plaintiffs’ attorneys.  “The claimant didn’t need to get more fees when we ultimately prevailed,” Andreen said.

Parker was receiving total disability benefits for a 1993 work-related injury when the county filed a petition in 2007 seeking to suspend his benefits.  A workers’ compensation judge granted the suspension petition in 2008, given that Parker had failed to follow through in good faith with a job referral that was within his physical limitations.  Parker was 80 years old at the time.

In 2009, however, the WCAB reversed and held that Parker was entitled to unreasonable contest attorney fees.  The employer, Allegheny County, successfully appealed that ruling in the Commonwealth Court, which also held that Parker was not entitled to unreasonable contest fees since he was ultimately not the prevailing party.

In the wake of the 2012 Commonwealth Court ruling, the county sought reimbursement from the supersedeas fund for more than $100,000 in compensation it paid Parker as well as $14,750 in unreasonable contest fees.  The Bureau of Workers’ Compensation approved reimbursement for the compensation paid, but not for the unreasonable contest fees.  So the county filed a petition seeking an order that would require Parker’s lawyer to pay the refund.

Andreen said the process ensures claimants do not have their benefits reduced due to a mistake the employer made, and any decision by the justices in Parker would not affect the claimant’s attorneys’ ability to recover fees.

Mootness Attorney Fee Awards

October 16, 2017

A recent New York Law Journal article by David F. Wertheimer and Justine S. Brenner, “Mootness Attorney Fee Awards: Will New York Prove Friendly Than Delaware?,” reports on mootness attorney fee...

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