In a recent case out of the United States District Court for the Middle District of Tennessee, the Court held that attorney fees awarded plaintiff’s counsel who was handling the case pro bono, that is, free of charge, were not income to the plaintiff who was represented by the attorneys receiving the fees.[1] In the case, the parties submitted a Joint Motion for Clarification (“Motion”) asking the Court for guidance with regard to the proper distribution of $249,000 in attorney fees awarded to plaintiff. At issue was whether the fees were income to the plaintiff, and thus required a W-9 from plaintiff. If not, then the proceeds could be distributed directly to plaintiff’s counsel since defendant’s counsel already had a W-9 in its possession for them.
It is important to note that this case did not involve the Internal Revenue Service or the Department of Justice, it was simply between the two parties to provide guidance on how to properly distribute the attorney fees awarded. Presumably, the IRS or DOJ is still free to disagree. It is also important to note that the Court did not say the fees were not income to plaintiff’s counsel, the presumption is they were, as the opinion mentions plaintiff’s counsel’s W-9. The Court simply said the fees awarded were not income to plaintiff like they would be in a case where a party owed an attorney for services, and such fees were awarded by a court to relieve said party of the obligation to pay such fees himself or herself, akin to a discharge of indebtedness which is income under Section 108. The key fact here, and what the decision ultimately turned on, was that plaintiff’s counsel was handling the case pro bono and plaintiff had no obligation to pay plaintiff’s counsel. Thus, plaintiff was not relieved of any obligation to pay by the Court’s awarding of attorney fees.
What is Income?
Webster’s Dictionary defines the word “income” as “a gain or recurrent benefit usually measured in money that derives from capital or labor”, and this may be in line with what one would typically think of when they hear the word “income”. One’s mind might immediately think of wages or earnings on an investment or the like, something that was earned whether through work or wise investment. When it comes to income for tax purposes, Section 61 defines “gross income” as “all income from whatever source derived” and goes on to list a host of examples.[2] However, Section 61 fails to define “income” in the first place, making it a somewhat circular provision. In fact, nowhere in the Internal Revenue Code is the stand-alone term “income” defined. As a result, the Supreme Court has had to define income, and in fact did so in 1955 in the Glenshaw Glass case.[3] The Supreme Court determined that “income” is any “undeniable accession to wealth, clearly realized, and over which the taxpayer has complete dominion.” This definition leaves plenty of room for interpretation and evolvement rather than trying to narrowly define a standard.
Application to Pro Bono Attorney Fees
Based on the definition of “income” and “gross income” as noted above, it would be a hard sell to argue the fees paid to plaintiff’s counsel were not income to plaintiff’s counsel, but that’s not what this case was about. Rather, were those fees considered income to plaintiff as they would be in a case where plaintiff was required to pay its counsel and the fees awarded relieved plaintiff of that obligation?
Courts have always considered “[t]he discharge of an obligation by a third person” to be income to the person discharged of the obligation.[4] This is also in line with Section 108 which states that, in general, the discharge of indebtedness is income to the debtor. However, it appears that the Supreme Court has never addressed the issue at hand, that is, “whether an award of attorney fees constitutes taxable income to the litigant where, as here, counsel was retained on a pro bono basis and, therefore, the litigant has no obligation to pay fees or costs for their representation.” Ultimately, plaintiff had no financial obligation to pay its counsel any fees, and thus was not discharged of any obligation. Accordingly, since plaintiff was not relieved of any obligation, the ruling in Old Colony regarding a discharge of an obligation being income was not applicable nor was Section 108, and the attorneys’ fees were determined to not be income to the plaintiff.
Conclusion
As stated above, this case did not involve the Internal Revenue Service and was not a tax dispute, but rather was between two parties to litigation jointly seeking proper instruction as to the disbursement of fees. Nevertheless, the opinion reads almost like a tax dispute in which the Court determines whether the attorney fees awarded are income the plaintiff. The Court’s analysis and conclusion is logical, if plaintiff did now owe anything to its attorney, and thus had no debt or obligation to be discharged in the first place, then why would plaintiff be subject to income tax on fees awarded and paid to plaintiff’s attorney? While it is certainly income to the attorney, and we don’t have all the facts as to why the attorney took the case pro bono in the first place, whether for charitable reasons or because he or she saw the opportunity to get awarded fees by the court, one can hope it was for charitable reasons and that charity was rewarded with $249,000 in unexpected income.
[1] Adams & Boyle, P.C., Et al. v. Slatery III, Et al., 129 AFTR 2d 2022-1790 (DC TN).
[2] §61(a)(1)-(14).
[3] Comm’r v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
[4] Old Colony Trust Co. v. Comm’r, 279 U.S. 716 (1929); See also Comm’r v. Banks, 543 U.S. 426 (2005).
