Raymond v. U.S., 2:01-CV-142.

• Decision Date: 17 December 2002
• Docket Number: No. 2:01-CV-142.,2:01-CV-142.
• Citation: 247 F.Supp.2d 548
• Parties: David A. RAYMOND and Lori Raymond, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Vermont

247 F.Supp.2d 548

David A. RAYMOND and Lori Raymond, Plaintiffs, v. UNITED STATES of America, Defendant.

No. 2:01-CV-142.

United States District Court, D. Vermont.

December 17, 2002.

James Wayland Runcie, Ouimette & Runcie, Vergennes, VT, for David A Raymond, Lori Raymond, plaintiffs.

Lydia Bottome, Esq., U.S. Department of Justice, Trial Attorney, Tax Division, Washington, DC, for United States of America, defendant.

OPINION AND ORDER

SESSIONS, Chief Judge.

In this action to recover an alleged overpayment of taxes, Plaintiffs David A. Raymond and Lori Raymond ("the Raymonds") and Defendant United States of America ("the IRS") have filed cross-motions for summary judgment, asserting that there are no material facts at issue in this proceeding, and that each is entitled to judgment as a matter of law. For the reasons that follow, the Raymonds' motion (Doc. 9) is granted, and the IRS's motion (Doc. 14) is denied.

The material facts are not in dispute.¹ After being terminated from employment at IBM in 1993, Plaintiff David Raymond retained the law firm of Ouimette & Runcie to represent him in a wrongful termination suit. The firm filed a complaint against IBM in 1995 in the United States District Court for the District of Vermont, Civil Action Docket Number 2:95-cv-158.

Under the fee agreement between Raymond and his attorneys, the firm would receive a contingency fee of 1/3 of the net recovery, plus expenses. Any fees incurred as a result of an appeal were to be paid at an hourly rate.²

Trial by jury resulted in a verdict in favor of Raymond in the amount of $869,156.00. Judgment was entered on the verdict on July 14, 1997. The judgment was affirmed on appeal by the United States Court of Appeals for the Second Circuit. After appeal, IBM satisfied the judgment in a total amount of $929,585.90, including $60,429.90 in interest. IBM broke down the total amount as follows:

                Interest                               $ 60,429.90
                Check to Raymond                       $548,107.84
                Federal Income Tax Withholding         $243,363.68
                Social Security Tax                    $ 16,843.56
                State Income Tax Withholding           $ 60,840.92
                Total                                  $929,585.90
                

IBM sent checks for the interest and principal to Ouimette & Runcie. After receipt by the law firm, Raymond's share of the proceeds was deposited into his account at the Chittenden Bank and Ouimette & Runcie's share was deposited into its account at the Chittenden Bank. Of the total amount recovered, Ouimette & Runcie received $306,898.01 under the contingency fee agreement, and an additional $32,732.11 in attorneys' fees and expenses for the appeal.

On the Raymonds' original 1998 federal income tax return, they included in their adjusted gross income the entire amount of the judgment, including the amounts paid as attorneys' fees. Because of the amount of their income for that year, the Raymonds' income tax was determined by the Alternative Minimum Tax ("AMT"). Ordinarily they would have been able to take a miscellaneous deduction for their attorneys' fees to the extent those fees exceeded 2% of their adjusted gross income, but miscellaneous deductions are not allowed under the AMT. The effect of the inclusion of the entire amount of the judgment as income and the operation of the AMT was to require the Raymonds to pay income tax on the full $929,585.90, although $306,898.01 of that amount went directly to their attorneys.

On December 28, 1999, the Raymonds filed an amended federal tax return and requested a refund of $55,489.00. On the amended return, the Raymonds excluded from their income amounts paid to Ouimette & Runcie under the contingency fee agreement. On April 14, 2000, the Raymonds' request for refund was denied by the IRS. They filed the instant suit for recovery of internal revenue taxes pursuant to 28 U.S.C. § 1346(a)(1) in the United States District Court for the District of Vermont on May 4, 2001.

DISCUSSION

Under the Internal Revenue Code, "gross income means all income from whatever source derived." 26 U.S.C.A. § 61(a) (2002); see also 26 C.F.R. § 1.61-1 (2002) (gross income includes income realized in any form). In the landmark case of Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 75 S.Ct. 473, 99 L.Ed. 483 (1955), the United States Supreme Court emphasized the "sweeping scope" of the definition of gross income, "in recognition of the intention of Congress to tax all gains except those specifically exempted." Id., 348 U.S. at 429-30, 75 S.Ct. 473. Although the Internal Revenue Code's definition of gross income is to be broadly construed, exclusions from income are to be narrowly construed, however. Taggi v. United States, 35 F.3d 93, 95 (2d Cir.1994).

Not all economic gain to a taxpayer is taxable income. Generally the "realization" of income—when the income is paid—is the taxable event, rather than the acquisition of the right to receive it. Helvering v. Horst, 311 U.S. 112, 115, 61 S.Ct. 144, 85 L.Ed. 75 (1940). Realization occurs when the taxpayer "obtains the fruition of the economic gain which has already accrued." Id. This rule has not been interpreted as permitting a taxpayer to escape taxation because the taxpayer has not personally received payment, however. See id., 311 U.S. at 116, 61 S.Ct. 144. Thus if a taxpayer arranges for a creditor to be paid directly from income due the taxpayer, "he does not escape taxation because he did not actually receive the money." Id.

At issue is whether fees paid directly to an attorney under a contingency fee agreement should be excluded from the client's gross income because it was income to the attorney and not to the client. There is a split of authority on the subject; the Fifth, Sixth and Eleventh Circuits exclude contingency fees from clients' gross incomes; the Third, Fourth, Seventh, Ninth, Tenth and Federal Circuits include them. See Campbell v. Comm'r, 274 F.3d 1312, 1314 (10th Cir.2001), cert, denied, 535 U.S. 1056, 122 S.Ct. 1915, 152 L.Ed.2d 824 (2002); Kenseth v. Comm'r, 259 F.3d 881, 885 (7th Cir.2001); Young v. Comm'r, 240 F.3d 369, 379 (4th Cir.2001); Coady v. Comm'r, 213 F.3d 1187, 1191 (9th Cir.2000), cert, denied, 532 U.S. 972, 121 S.Ct. 1604, 149 L.Ed.2d 470 (2001); Davis v. Comm'r, 210 F.3d 1346, 1347 (11th Cir.2000) (per curiam); Estate of Clarks v. United States, 202 F.3d 854, 858 (6th Cir.2000); Baylin v. United States, 43 F.3d 1451,1454 (Fed.Cir. 1995); O'Brien v. Comm'r, 319 F.2d 532, 532 (3rd Cir.1963) (per curiam); Cotnam v. Comm'r, 263 F.2d 119, 126 (5th Cir.1959).

The Second Circuit has not had occasion to decide the issue.

Those courts that have included contingency fees paid directly to attorneys as gross income to their clients have relied on the anticipatory assignment of income doctrine first articulated in Lucas v. Earl, 281 U.S. Ill, 50 S.Ct. 241, 74 L.Ed. 731 (1930). The anticipatory assignment of income doctrine was devised to prevent a taxpayer from assigning income before it is realized in order to avoid the tax consequences of earning it. Traditionally, the doctrine was applied to the donative transfer of income or property between family members. See id., 281 U.S. at 113-14, 50 S.Ct. 241; Horst, 311 U.S. at 114, 61 S.Ct. 144; see also Comm'r v. Sunnen, 333 U.S. 591, 602-03, 68 S.Ct. 715, 92 L.Ed. 898 (1948).

In Lucas v. Earl, a husband and wife agreed to grant to each spouse one-half of their respective incomes. On the husband's tax return, he claimed only one-half of the income he earned. Justice Holmes, writing for a unanimous Court, concluded that the husband could not avoid paying tax on income he earned by making an anticipatory assignment of that income to another:

There is no doubt that the [Revenue Act of 1918] could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skillfully devised to prevent the salary when paid from vesting even for a second in the man who earned it. That seems to us the import of the statute before us and we think that no distinction can be taken according to the motives leading to the arrangement by which the fruits are attributed to a different tree from that on which they grew.

Id., 281 U.S. at 114-15, 50 S.Ct. 241. The essence of the doctrine thus was that income should be taxed to the one who earns it. See also United States v. Basye, 410 U.S. 441, 447, 93 S.Ct. 1080, 35 L.Ed.2d 412 (1973).

In Helvering v. Horst, a taxpayer owner of negotiable bonds made a gift to his son of the interest coupons prior to the bonds' maturity. The taxpayer, who continued to keep the bonds, was required to include the interest in his gross income: "[h]e, who owns or controls the source of the income, also controls the disposition of that which he could have received himself." Id., 311 U.S. at 116-17, 61 S.Ct. 144. Had the taxpayer transferred the bonds themselves, he would have given up the right to control the disposition of the income and would not have been taxed. In sum, the Court concluded, "[t]he power to dispose of income is the equivalent of ownership of it." Id., 311 U.S. at 118, 61 S.Ct. 144.

The Court continued to employ the Lucas v. Earl orchard metaphor in Horst, stating that "[t]he import of the [1934 Revenue Act (taxing interest as well as income derived from wages) ] is that the fruit is not to be attributed to a different tree from that on which it grew." Id., 311 U.S. at 120, 61 S.Ct. 144. It distinguished the situation in which a gift of income-producing property is made, as opposed to a gift of income derived from property, using another agricultural metaphor: "[u]nlike income thus derived from an obligation to pay interest or compensation, the income [from trust property] was regarded as no more the income of the donor than would be the rent from a lease or a crop raised on a farm after the leasehold or the farm had been given away." Id., 311 U.S. at 119, 61 S.Ct. 144 (citing Blair v....