Blawgletter often handles business cases on a contingent fee basis. We earn a percentage of the client's recovery. No recovery, no fee.
But guess what? The client may owe tax on the recovery. Which could of course affect the client's net. And the Internal Revenue Service may regard the entire recovery — including the contingent fee that goes to the lawyer — as taxable income to the client. See Roco v. Commissioner, 121 T.C. 160, 165 (Tax Ct. 2003) (holding that payment to False Claims Act relator for exposing contractor's fraud on the federal government amounted to a "reward" and therefore counted as gross income). Which would reduce the client's net further.
But we got decent news yesterday from the U.S. Tax Court, which ruled on whether another False Claims Act/qui tam relator, Albert D. Campbell, "must include the entire $8.75 million qui tam payment in gross income or is entitled to exclude the $3.5 million attorney's fee payment and thus include only the $5.25 million qui tam payment in gross income." Campbell v. Commissioner, 134 T.C. No. 3 (Tax Ct. Jan. 21, 2010). Yes, the court held. No surprise there.
But the court went on to decide that Mr. Campbell "may deduct" the contingent fee "as a miscellaneous itemized deduction." Because he testified he paid the fee and corroborated his testimony with the contingent fee agreement between him and his lawyers, the court concluded, Mr. Campbell "has substantiated the payment of the fees" and thus could deduct them. Hooray.
The tax treatment of qui tam proceeds may not apply to other sorts of recoveries — such as ones that compensate for actual loss. We suggest you get advice from a tax professional.