Individuals who win or settle discrimination cases will no longer have to pay taxes on portions of their awards that cover attorney’s fees and court costs. On October 22, 2004 President Bush signed into law the American Jobs Creation Act of 2004 which includes the Civil Rights Tax Relief Act (the Act). The Act eliminates awards of attorney’s fees from a prevailing plaintiff’s gross income. Under the former law, employees who won discrimination cases had to include in gross income any portion of the award paid to their attorney as fees. Even though the employee could generally deduct these amounts as an itemized deduction, this often triggered the alternative minimum tax, resulting in large tax burdens on plaintiffs.
The Act is good news for employers, particularly in states such as Washington where the adverse tax consequences of an award are chargeable to the employer as part of the underlying damages. The Act creates an incentive for employees to settle discrimination lawsuits for less. For example, under the old tax law, an employee who settled a discrimination case for $50,000 and was awarded $75,000 in attorney’s fees could potentially take home as little as $16,707 after taxes were assessed. The new Act does not tax the employee on attorney’s fees, so the same employee would take home $44,624. Plaintiffs in employment discrimination cases now will be able to keep a higher percentage of any settlement or judgment and therefore may be willing to settle discrimination claims for lower amounts.
The Civil Rights Tax Relief Act becomes effectively immediately. Tax relief under the Act will only apply to settlements and judgments occurring after October 22nd, 2004. The tax relief does not apply retroactively. Before Congress passed this legislation, several federal circuit courts of appeal had split on the issue of whether plaintiffs had to include attorney's fees from awards in taxable income, and last spring the Supreme Court granted certiorari in two of those cases in which the courts had held for the plaintiffs. Oral argument in these cases has been scheduled for November 1. Since the passage of the Act, however, the taxpayers in the two cases have filed a brief pointing the attention of the Supreme Court to the legislation and suggesting that the Court may wish to dismiss the cases on the ground that the impact of the cases has been severely limited by the legislation and the Court may therefore conclude that certiorari was improvidently granted. At the time of this update, it is not known whether the Court will decide the cases or dismiss them.