Contingency Fee Payments to Attorneys Not Taxable to Oregon Plaintiffs

When plaintiff Sigitas Banaitis won $8.7 million after a successful appeal of his wrongful termination action, $3.8 million of his award was paid directly to counsel to satisfy his attorney’s contingency fee. On his federal tax return, Banaitis claimed that the $3.8 million was not includable in his gross income, but the IRS disagreed. In Banaitis v. CIR, No. 02-70421 (9th Cir. Aug. 27, 2003), the Ninth Circuit sided with the taxpayer because of state law. While federal law governs taxation of particular legal interests and property rights, state law defines those interests and rights. Here, unique features of Oregon law established that fees paid directly to counsel should be excluded from Banaitis’ gross income. The court distinguished its own decisions applying California or Alaska law, noting that Oregon law was substantially different and controlling.