Eldon R. Kenseth and Susan M. Kenseth v. Commissioner

114 T.C. No. 26

UNITED STATES TAX COURT

ELDON R. KENSETH AND SUSAN M. KENSETH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2385-98. Filed May 24, 2000.

In 1993, P recovered a $229,501 settlement under
the Federal Age Discrimination in Employment Act of
1967, Pub. L. 90-202, sec. 2, 81 Stat. 602, current
version at 29 U.S.C. secs. 621-633a (1994). A portion
of the settlement proceeds was deposited in the trust
account of P’s attorney, X. In distributing the
settlement proceeds, X retained $91,800 in attorney’s
fees pursuant to a contingent fee agreement. The
remaining amount was paid to P. P excluded the
settlement proceeds designated as personal injury
damages under the settlement agreement. R determined
that the entire $229,501 recovered was includable in
gross income but allowed the attorney’s fees paid as a
miscellaneous itemized deduction. P concedes that the
settlement proceeds are not excludable in their
entirety but contends that the amount allocable to
attorney’s fees should be excluded from gross income.
Held, the amount retained by X for attorney’s fees
is includable in P’s gross income for 1993 under the
assignment of income doctrine. This Court respectfully
 - 2 -

declines to follow the reasoning of the Federal Courts
of Appeals in Estate of Clarks v. United States, 202
F.3d 854 (6th Cir. 2000), and Cotnam v. Commissioner,
263 F.2d 119 (5th Cir. 1959), revg. in part and affg.
in part 28 T.C. 947 (1957).

Cheryl R. Frank, Chaya Kundra, and Gerald W. Kelly, Jr., for

petitioners.

George W. Bezold, for respondent.

RUWE, Judge:* Respondent determined a deficiency of $55,037

in petitioners’ 1993 Federal income tax. The sole issue for

decision is whether petitioners’ gross income includes the

portion of the settlement proceeds of a Federal age

discrimination claim that was paid as the attorney’s fees of

Eldon R. Kenseth (petitioner) pursuant to a contingent fee

agreement.

FINDINGS OF FACT

The parties have stipulated some of the facts, and the

stipulations of facts and the attached exhibits are incorporated

in this opinion. At the time of filing their petition,

petitioners resided in Cambridge, Wisconsin.

In a complaint filed with the Wisconsin Department of

Industry, Labor, and Human Relations (DILHR) in October 1991,

petitioner alleged that on March 27, 1991, APV Crepaco, Inc.

*
This case was reassigned to Judge Robert P. Ruwe by order
of the Chief Judge.
 - 3 -

(APV), terminated his employment. The complaint also alleged

that, at the time of his discharge, petitioner was 45 years old,

held the position of master scheduler, was earning $33,480 per

year, and had been employed by APV for 21 years. It further

alleged that, around the time of petitioner’s discharge, APV did

not terminate younger employees also acting as master schedulers

but did terminate other employees over age 40.

Prior to filing the DILHR complaint, petitioner and 16 other

former employees of APV (the class) retained the law firm of

Fox & Fox, S.C. (Fox & Fox), to seek redress against APV. In

July 1991, petitioner executed a contingent fee agreement with

Fox & Fox that provided for legal representation in his case

against APV. Each member of the class entered into an identical

contingent fee agreement with Fox & Fox.

The contingent fee agreement was a form contract prepared

and routinely used by Fox & Fox; the client’s name was manually

typed in, but the names of Fox & Fox and APV had already been

included in preparing the form used for all the class members.

Fox & Fox would have declined to represent petitioner if he had

not entered into the contingent fee agreement and agreed to the

attorney’s lien provided therein.

The contingent fee agreement provided in relevant part:1

1
The portions of the Agreement not quoted are secs. “I.
INTRODUCTION”, “IV. THE ATTORNEYS’ FEES WHERE THERE IS A
SEPARATE PAYMENT OF ATTORNEYS’ FEES”, and “V. EXPLANATION OF FEE
(continued...)
 - 4 -

FOX & FOX, S.C.

CONTINGENT FEE AGREEMENT: (Case involving Statutory Fees)

* * * * * * *

II. CLIENT TO PAY LITIGATION EXPENSES

The client will pay all expenses incurred in
connection with the case, including charges for
transcripts, witness fees, mileage, service of process,
filing fees, long distance telephone calls,
reproduction costs, investigation fees, expert witness
fees and all other expenses and out-of-pocket
disbursements for these expenses according to the
billing policies and procedures of FOX & FOX, S.C. The
client agrees to make payments against these bills in
accordance with the firm’s billing policies.

III. THE ATTORNEYS’ FEES WHERE THERE IS NO SEPARATE
PAYMENT OF ATTORNEYS’ FEES

In the event that there is recovered in the case a
single sum of money or property including a job that
can be valued in monetary advantage to the client,
either by settlement or by litigation, the attorneys’
fees shall be the greater of:

A. A reasonable attorney’s fee in a contingent
case, which shall be defined as the
attorneys’ fees computed at their regular
hourly rates, plus accrued interest at their
regular rate, plus a risk enhancer of 100% of
the regular hourly rates (but in no event
greater than the total recovery), or:

B. A contingency fee, which shall be
defined as:

1
(...continued)
CONCEPTS”. Sec. V sets forth a justification for the provisions
of the agreement that is couched in terms of obviating the
potential for conflicts of interest between the attorneys and the
client by creating an identity of economic interests of attorneys
and client in the prosecution of the claim.
 - 5 -

Forty percent (40%) of the recovery if
it is recovered before any appeal is taken;

Forty-Six percent (46%) of the recovery
if it is recovered after an appeal is
taken.

Any settlement offer of a fixed sum which includes
a division proposed by the offeror between damages and
attorneys’ fees shall be treated by the client and the
attorneys as an offer of a single sum of money and, if
accepted, shall be treated as the recovery of a single
sum of money to be apportioned between the client and
the attorneys according to this section. Any division
of such an offer into damages and attorneys’ fees shall
be completely disregarded by the client and the
attorneys.

* * * * * * *

VI. CLIENT NOT TO SETTLE WITHOUT ATTORNEYS’ CONSENT

The client will not compromise or settle the case
without the written consent of the attorneys. The
client agrees not to waive the right to attorneys’ fees
as part of a settlement unless the client has reached
an agreement with the attorney for an alternative
method of payment that would compensate the attorneys
in accordance with Section III of this agreement.

VII. WIN OR LOSE RETAINER

The client agrees to pay a Five Hundred ($500.00)
Dollar win or lose retainer. This amount will be
credited to the attorney fees set forth in Section III
in the event a recovery is made. If no recovery is
made, this amount is non-refundable to the client.

VIII. LIEN

The client agrees that the attorney shall have a
lien against any damages, proceeds, costs and fees
recovered in the client’s action for the fees and costs
due the attorney under this agreement and said lien
shall be satisfied before or concurrent with the
dispersal of any such proceeds and fees.
 - 6 -

IX. CHANGE OF ATTORNEY

In the event the client chooses to terminate the
contract for legal services with Fox & Fox, S.C., said
firm will have a lien upon any recovery eventually
obtained. Said lien will be for the fees set forth in
Section III of this agreement.

In the event the client chooses to terminate the
contract for legal services with Fox & Fox, S.C., the
client will further make immediate payment of all
outstanding costs and disbursements to the firm of
Fox & Fox, S.C. and will do so within ten (10) days of
the termination of the contract.

In entering into this contract Fox & Fox, S.C. has
relied on the factual representations made to the firm
by the client. In the event such representations are
intentionally false, Fox & Fox, S.C. reserves the right
to unilaterally terminate this agreement and to charge
the client for services to the date of termination
rendered on an hourly basis plus all costs dispersed
and said amount shall be due within ten (10) days of
termination.

At the time of entering into the contingent fee agreement,

petitioner had paid only the $500 “win or lose” retainer to

Fox & Fox. This amount was to be credited against the contingent

fee that would be payable if there should be a recovery on the

claim; if there should be no recovery, this amount was

nonrefundable. Under section II of the agreement, petitioner

expressly agreed to reimburse Fox & Fox for out-of-pocket

expenses, in accordance with the firm’s normal billing policies

and procedures. In contrast, under section III of the agreement

(which set forth the contingent fee agreement), petitioner did

not expressly agree to pay anything. Instead, section III

provided how the amount of the contingent fee was to be
 - 7 -

calculated if there should be a recovery. Other sections of the

agreement summarized below provided for the attorney’s lien.

The contingent fee agreement required aggregation of the

elements of any settlement offer divided between damages and

attorney’s fees and provided that any division of such an offer

into damages and attorney’s fees would be disregarded by Fox &

Fox and petitioner. The contingent fee agreement provided that

petitioner could not settle his case against APV without the

consent of Fox & Fox. Under the contingent fee agreement,

petitioner agreed that Fox & Fox “shall have a lien” for its fees

and costs against any recovery in petitioner’s action against

APV. This lien by its terms was to be satisfied before or

concurrently with the disbursement of the recovery. The

contingent fee agreement further provided that, if petitioner

should terminate his representation by Fox & Fox, the firm would

have a lien for the fees set forth in section III of the

agreement, and all costs and disbursements that had been expended

by Fox & Fox would become due and payable by petitioner within 10

days of his termination of his representation by Fox & Fox.

APV had proposed that petitioner and the other members of

the class sign separation agreements in return for some severance

pay. Fox & Fox advised the class members that the form of

separation agreement used by APV did not comply with the Older

Workers Benefits Protection Act of 1990, Pub. L. 101-433, 104
 - 8 -

Stat. 978. As a result, petitioner and the class members who

signed the separation agreements and received severance pay were

able to file administrative discrimination complaints and bring

suit against APV, notwithstanding any purported release of their

claims against APV in the separation agreements.

On October 16, 1991, petitioner filed an administrative

complaint, using documents prepared by Fox & Fox, setting forth

the basis of his age discrimination claim against APV, with

DILHR. Around March 1992, DILHR sent a copy of petitioner’s

complaint to the U.S. Equal Employment Opportunity Commission

(EEOC). The initiation of these administrative discrimination

claims was a condition precedent to bringing suit against APV

under the Federal Age Discrimination in Employment Act of 1967

(ADEA), Pub. L. 90-202, sec. 2, 81 Stat. 602, current version at

29 U.S.C. secs. 621-633a (1994).

On June 16, 1992, Fox & Fox filed a complaint on behalf of

petitioner and the other class members against APV in the U.S.

District Court for the Western District of Wisconsin. The

complaint alleged a deprivation of their rights under ADEA and

sought back wages, liquidated damages, reinstatement or front pay

in lieu of reinstatement, and attorney’s fees and costs, and

demanded a trial by jury.

EEOC had initially recommended that the members of the class

settle their age discrimination suit for less than $1 million in
 - 9 -

the aggregate. The total settlement that Fox & Fox negotiated on

behalf of the claimants amounted to $2,650,000, which was

apportioned as follows pursuant to the contingent fee agreements:

Total recovery to class members $1,590,000
Total fee to Fox & Fox 1,060,000
Total settlement 2,650,000

On February 15, 1993, the dispute between petitioner and APV

was resolved by their execution of a “Settlement Agreement and

Full and Final Release of Claims” (settlement agreement). Each

member of the class entered into an identical settlement

agreement. The entire amount received by the members of the

class under their settlement agreements represented a recovery

under ADEA. However, the settlement agreements required

petitioner and the other members of the class to relinquish all

their claims against APV, including claims for attorney’s fees

and expenses but did not specifically allocate any amount of the

recovery to attorney’s fees. The settlement agreement required

petitioner to cause the administrative actions pending before

EEOC and DILHR to be dismissed with prejudice. The settlement

agreement provided that it was to be “interpreted, enforced and

governed by and under the laws of the State of Wisconsin”.

Petitioner’s allocated share of the gross settlement amount

of $2,650,000 was $229,501.37. Of this amount, $32,476.61 was

paid as lost wages by an APV check issued directly to petitioner.

APV withheld applicable Federal and State employment taxes from
 - 10 -

this portion of the settlement; the actual net amount of the

check to the order of petitioner was $21,246.20.

The portion of the settlement proceeds allocated to

petitioner and not designated as lost wages was $197,024.76,

which the settlement agreement characterized “as and for personal

injury damages which the parties intend as those types of damages

excludable from income under section 104(a)(2) of the Internal

Revenue Code as damages for personal injuries and the

corresponding provisions of the Tax Code of the State of

Wisconsin.” APV issued a check for this amount directly to the

Fox & Fox trust account. Fox & Fox calculated its fee, pursuant

to the contingent fee agreement, using 40 percent of the gross

settlement amount of $229,501.37 allocated to petitioner. After

deducting its fee of $91,800.54 and crediting petitioner with the

$500 “win or lose” retainer payment, Fox & Fox issued a check for

$105,724.22 from the Fox & Fox trust account to petitioner.

With the check that was received from Fox & Fox, petitioner

and every other class member received a settlement statement,

prepared by Fox & Fox, setting forth the recipient’s share of the

total settlement, the legal fee after credit for the retainer,

the net proceeds to the recipient, and the portion from which

taxes would be “deducted”. The recipient signed the settlement

statement, accepting and approving “the distribution of the

proceeds as set forth on this statement.” The recipient also
 - 11 -

acknowledged in the settlement statement that a portion of the

settlement proceeds had been characterized as personal injury

damages not subject to tax, but that this characterization was

not binding on taxing authorities, and agreed to pay any taxes

that might become due on the proceeds.

The settlement agreement provided that APV would be held

harmless for any taxes (other than on the amount allocated to

lost wages) “imposed on the amounts dispersed under this

agreement”.

On their 1993 income tax return, petitioners reported as

income only that portion of the settlement proceeds that was

allocated to wages--$32,476.61. They did not report or disclose

all or any part of the $197,024.76 that was allocated to personal

injury damages, nor did they claim or otherwise report a

deduction for all or any part of the attorney’s fees.

The notice of deficiency that was issued to petitioners made

an adjustment to their 1993 income to increase gross income in

respect of the settlement of petitioner’s ADEA claims by $197,024

(from $32,477 to $229,501). The notice also allowed $91,800 in

legal fees as an itemized deduction, reduced by $5,298 for the

2-percent floor on miscellaneous itemized deductions under

section 672 and by $4,694 for the overall limitation on itemized

2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
(continued...)
 - 12 -

deductions under section 68. The deficiency of $55,037 that was

determined by respondent included a liability of $17,198 for

alternative minimum tax arising from the disallowance of the

miscellaneous itemized deduction of the attorney’s fees for the

purpose of the alternative minimum tax under section

56(b)(1)(A)(i).

Petitioner and the other members of the class relied on the

guidance and expertise of Fox & Fox in signing the separation

agreements tendered to them by APV and then seeking redress

against APV. Commencing with the advice to petitioner that he

could sign the separation agreement with APV without giving up

his age discrimination claim, Fox & Fox made all strategic and

tactical decisions in the management and pursuit of the age

discrimination claims of petitioner and the other class members

against APV that led to the settlement agreement and the recovery

from APV.

Fox & Fox was aware of the relationship between any gross

settlement amount and the resulting fee that Fox & Fox would

receive. In the effort to ensure that the amounts ultimately

received by petitioner and the other class members would

approximate the full value of their claims, Fox & Fox factored in

an amount for the attorney’s fee portion of the settlement in

2
(...continued)
Procedure.
 - 13 -

preparing for and conducting their negotiations with APV and its attorneys.

Petitioner’s complaint filed with DILHR, his civil complaint

with the District Court for the Western District of Wisconsin,

and the settlement agreement were signed by Michael R. Fox or

Mary E. Kennelly of Fox & Fox. Fox & Fox’s office is in Madison,

Wisconsin; Mr. Fox and Ms. Kennelly are admitted to practice law

in Wisconsin.

OPINION

Petitioners concede that the proceeds from the settlement

are includable in gross income except for the portion of the

settlement used to pay Fox & Fox under the contingent fee

agreement. Specifically, petitioners argue that they exercised

insufficient control over the settlement proceeds used to pay Fox

& Fox and should, therefore, not be taxed on amounts to which

they had no “legal” right and could not, and did not, receive.

Conversely, respondent argues that (1) the amount petitioners

paid or incurred as attorney’s fees must be included in

petitioners’ gross income and (2) the contingent fee is

deductible as a miscellaneous itemized deduction, subject to the

2-percent floor under section 67 and the overall limitation under

section 68 and also nondeductible in computing the alternative

minimum tax (AMT) under section 56.
 - 14 -

This controversy is driven by the substantial difference in

the amount of tax burden that may result from the parties’

approaches.3 The difference, of course, is a consequence of the

plain language of sections 56, 67, and 68, so the

characterization of the attorney’s fees as excludable or

deductible becomes critical. There have been attempts to provide

relief from the resulting tax burden by creative approaches,

including attempts to modify long-standing tax principles. This

Court believes that it is Congress’ imposition of the AMT and

limitations on personal itemized deductions that cause the tax

burden here. We perceive dangers in the ad hoc modification of

established tax law principles or doctrines to counteract

hardship in specific cases, and, accordingly, we have not

acquiesced in such approaches. See Alexander v. IRS, 72 F.3d

938, 946 (1st Cir. 1995) (stating that the effect of the AMT on

3
Under respondent’s position in this case, the settlement
proceeds are included in petitioners’ gross income in full, but
the itemized deduction is subject to limitations and is not
available in computing the alternative minimum tax (AMT). Under
these circumstances, it is possible that the attorney’s fees and
tax burden could consume a substantial portion (possibly all) of
the damages received by a taxpayer. It is noted, however, that
if the recovery or income was received in a trade or business
setting, the attorney’s fees may be fully deductible in arriving
at adjusted gross income, thereby obviating the perceived
unfairness that may be occasioned in the circumstances we
consider in this case. Commentators and courts have long
observed this potential for unfairness in the operation of the
AMT in this and other areas of adjustments and tax preference
items. See, e.g., “State Bar of California Tax Section, Partial
Deduction of Attorneys’ Fees Proposed for Computing AMT”, 1999
TNT 125-45 (June 30, 1999); Wood, “The Plight of the Plaintiff:
The Tax Treatment of Legal Fees”, 98 TNT 220-101 (Nov. 16, 1998).
 - 15 -

an individual taxpayer’s deduction of legal expenses “smacks of

injustice” because the taxpayer is effectively robbed of any

benefit from the deductibility of legal expenses as miscellaneous

itemized deductions), affg. T.C. Memo. 1995-51. Despite this

potential for unfairness, however, these policy issues are in the

province of Congress, and we are not authorized to rewrite the

statute. See, e.g., Badaracco v. Commissioner, 464 U.S. 386, 398

(1984); Warfield v. Commissioner, 84 T.C. 179, 183 (1985).

There is a split of authority among the Federal Courts of

Appeals on this issue. The U.S. Court of Appeals for the Fifth

Circuit reversed this Court and held that amounts awarded in

Alabama litigation that were assigned and paid directly to cover

attorney’s fees pursuant to a contingent fee agreement are

excludable from gross income. See Cotnam v. Commissioner,

263 F.2d 119 (5th Cir. 1959), affg. in part and revg. in part 28

T.C. 947 (1957). In Cotnam, the taxpayer entered into a

contingent fee agreement to pay her attorney 40 percent of any

amount recovered on a claim prosecuted for the taxpayer’s behalf.

A judgment was obtained on the claim, and a check in the amount

of the judgment was made jointly payable to the taxpayer and her

attorney. The attorney retained his share of the proceeds and

remitted the balance to the taxpayer. The Commissioner treated

the total amount of the judgment as includable in the taxpayer’s

gross income and allowed the attorney’s fees as an itemized
 - 16 -

deduction. This Court agreed with the Commissioner, holding that

the taxpayer realized income in the full amount of the judgment,

even though the attorney received 40 percent in accordance with

the contingent fee agreement.

The U.S. Court of Appeals for the Fifth Circuit’s reversal

was based on two legal grounds. An opinion by Judge Wisdom on

behalf of the panel reasoned that, under the Alabama attorney

lien statute, an attorney has an equitable assignment or lien

enabling the attorney to hold an equity interest in the cause of

action to the extent of the contracted for fee. See id. at 125.

Under the Alabama statute, attorneys had the same right to

enforce their lien as clients have or had for the amount due the

clients. See id.

The other judges in Cotnam, Rives and Brown, in a separate

opinion, stated that the claim involved was far from being

perfected and that it was the attorney’s efforts that perfected

or converted the claim into a judgment. Judge Wisdom, in the

second of his opinions, dissented, reasoning that the taxpayer

had a right to the already-earned income and that it could not be

assigned to the attorneys without tax consequence to the

assignor. The Cotnam holding with respect to the Alabama

attorney lien statutes has been distinguished by this Court from

cases interpreting the statutes of numerous other states.

Significantly, this Court has, for nearly 40 years, not followed
 - 17 -

Cotnam with respect to the analysis in the opinion of Judges

Rives and Brown that the attorney’s fee came within an exception

to the assignment of income doctrine. See, e.g., Estate of

Gadlow v. Commissioner, 50 T.C. 975, 979-980 (1968) (Pennsylvania

law); O’Brien v. Commissioner, 38 T.C. 707, 712 (1962), affd. per

curiam 319 F.2d 532 (3d Cir. 1963); Petersen v. Commissioner, 38

T.C. 137, 151-152 (1962) (Nebraska law and South Dakota law);

Srivastava v. Commissioner, T.C. Memo. 1998-362, on appeal (5th

Cir., June 14, 1998) (Texas law); Coady v. Commissioner, T.C.

Memo. 1998-291, on appeal (9th Cir., Nov. 3, 1998) (Alaska law).

Addressing the assignment of income question in similar

circumstances, the U.S. Court of Appeals for the Federal Circuit

reached a result opposite from that reached in Cotnam. See

Baylin v. United States, 43 F.3d 1451, 1454-1455 (Fed. Cir.

1995). In Baylin, a tax matters partner entered into a

contingent fee agreement with the partnership’s attorney in a

condemnation proceeding. When the litigants entered into a

settlement, the attorney received his one-third contingency fee

directly from the court in accordance with the fee agreement. On

its tax return, the partnership reduced the amount realized from

the condemnation by the amount of attorney’s fees attributable to

recovery of principal and deducted from ordinary income the

attorney’s fees attributed to the interest income portion of the

settlement. The Government challenged this classification of the
 - 18 -

attorney’s fees, determining that the attorney’s fees constituted

a capital expenditure and could, therefore, not reduce ordinary

income.

The Court of Federal Claims agreed with the Government. On

appeal, the taxpayer argued that the portion of the recovery used

to pay attorney’s fees was never a part of the partnership’s

gross income and should be excluded from gross income. The

Federal Circuit, rejecting the taxpayer’s argument, held that

even though the partnership did not take possession of the funds

that were paid to the attorney, it “received the benefit of those

funds in that the funds served to discharge the obligation of the

partnership owing to the attorney as a result of the attorney’s

efforts to increase the settlement amount.” Id. at 1454. The

Court of Appeals for the Federal Circuit sought to prohibit

taxpayers in contingency fee cases from avoiding Federal income

tax with “skillfully devised” fee agreements. See id.

The U.S. Court of Appeals for the Ninth Circuit reached the

same result as the court in Baylin regarding the includability of

attorney’s fees in a taxpayer’s gross income. In Brewer v.

Commissioner, 172 F.3d 875 (9th Cir. 1999), affg. without

published opinion T.C. Memo. 1997-542, the Court of Appeals

affirmed the Tax Court decision holding that the portion of a

Title VII settlement that was paid directly to the taxpayer’s

attorney was not excludable from the taxpayer’s gross income.
 - 19 -

In a recent holding, the U.S. Court of Appeals for the Sixth

Circuit reached a result based on similar reasoning to that used

in Cotnam. See Estate of Clarks v. United States, 202 F.3d 854

(6th Cir. 2000). In Estate of Clarks, after a jury awarded the

taxpayer personal injury damages and interest, the judgment

debtor paid the taxpayer’s lawyer the amount called for in the

contingent fee agreement. Because the portion of the attorney’s

fee that was attributable to the recovery of taxable interest was

paid directly to the attorney, the taxpayer excluded that amount

from gross income on the estate’s Federal income tax return. The

Commissioner determined that the portion of the attorney’s fees

attributable to interest was deductible as a miscellaneous

itemized deduction and was not excludable from gross income. The

taxpayer paid the deficiency and sued for a refund in Federal

District Court.

The District Court granted summary judgment in favor of the

Government. The U.S. Court of Appeals for the Sixth Circuit

reversed, employing reasoning similar to that used in Cotnam.

The Court of Appeals held that, under Michigan law, the

taxpayer’s contingent fee agreement with the lawyer operated as a

lien on the portion of the judgment to be recovered and

transferred ownership of that portion of the judgment to the

attorney. The court seemed to place greater emphasis on the fact

that the taxpayer’s claim was speculative and dependent upon the
 - 20 -

services of counsel when it was assigned. In that respect, the

court held that the assignment was no different from a joint

venture between the taxpayer and the attorney. The court

explained that this case was distinguishable from other

assignment of income cases in that there was “no vested interest,

only a hope to receive money from the lawyer’s efforts and the

client’s right, a right yet to be determined by judge and jury.”

Id. at 857. The court stated:

Here the client as assignor has transferred some of the
trees in his orchard, not merely the fruit from the
trees. The lawyer has become a tenant in common of the
orchard owner and must cultivate and care for and
harvest the fruit of the entire tract. Here the
lawyer’s income is the result of his own personal skill
and judgment, not the skill or largess of a family
member who wants to split his income to avoid taxation.
The income should be charged to the one who earned it
and received it, not as under the government’s theory
of the case, to one who neither received it nor earned
it. The situation is no different from the transfer of
a one-third interest in real estate that is thereafter
leased to a tenant. [Id. at 858.4]

This Court has, for an extended period of time, held the

view that taxable recoveries in lawsuits are gross income in

their entirety to the party-client and that associated legal

fees--contingent or otherwise--are to be treated as deductions.5

4
The Court of Appeals’ analogy is, to some extent,
inapposite because the transfer of trees in and of itself could
be consideration in kind and result in gains to the taxpayer.
More significantly, if the trees are analogous to the taxpayer’s
chose in action or compensatory rights, then the transfer
represents a classic anticipatory assignment of income.
5
This view is based on the well-established assignment of
(continued...)
 - 21 -

See Bagley v. Commissioner, 105 T.C. 396, 418-419 (1995), affd.

121 F.3d 393, 395-396 (8th Cir. 1997); O’Brien v. Commissioner,

38 T.C. 707, 712 (1962), affd. per curiam 319 F.2d 532 (3d Cir.

1963); Benci-Woodward v. Commissioner, T.C. Memo. 1998-395, on

appeal (9th Cir., Feb. 2, 1999). In O’Brien, we held that “even

if the taxpayer had made an irrevocable assignment of a portion

of his future recovery to his attorney to such an extent that he

never thereafter became entitled thereto even for a split second,

it would still be gross income to him under” assignment of income

principles. O’Brien v. Commissioner, supra at 712. “Although

there may be considerable equity to the taxpayer’s position, that

is not the way the statute is written.” Id. at 710. In reaching

this conclusion, we rejected the distinction made in Cotnam v.

Commissioner, supra, with respect to the Alabama attorney’s lien

statute, stating that it is “doubtful that the Internal Revenue

Code was intended to turn upon such refinements.” O’Brien v.

Commissioner, supra at 712. Numerous decisions of this Court

have reached the same result as O’Brien by distinguishing other

States’ attorney’s lien statutes from the Alabama statute

considered in Cotnam. See Estate of Gadlow v. Commissioner, 50

T.C. 975, 979-980 (1968) (Pennsylvania law); Petersen v.

5
(...continued)
income doctrine that was originated by the Supreme Court in Lucas
v. Earl, 281 U.S. 111 (1930). Lucas v. Earl, supra, has been
relied on by this Court for assignments of income involving both
related and unrelated taxpayers.
 - 22 -

Commissioner, 38 T.C. 137, 151-152 (1962) (Nebraska law and South

Dakota law); Sinyard v. Commissioner, T.C. Memo. 1998-364, on

appeal (9th Cir., Oct. 15, 1999) (Arizona law); Srivastava v.

Commissioner, T.C. Memo. 1998-362, on appeal (5th Cir., June 14,

1999) (Texas law); Coady v. Commissioner, T.C. Memo. 1998-291

(Alaska law).

After further reflection on Cotnam and now Estate of Clarks

v. United States, supra, we continue to adhere to our holding in

O’Brien that contingent fee agreements, such as the one we

consider here, come within the ambit of the assignment of income

doctrine and do not serve, for purposes of Federal taxation, to

exclude the fee from the assignor’s gross income. We also

decline to decide this case based on the possible effect of

various States’ attorney’s lien statutes.6

6
With the exception of situations where, under our holding
in Golsen v. Commissioner, 54 T.C. 742, 756-757 (1970), affd. 445
F.2d 985 (10th Cir. 1971), we feel compelled to follow the
holding of a Court of Appeals, we have consistently held that
attorney’s fees are not subtracted from taxpayers’ gross income
to arrive at adjusted gross income. In Davis v. Commissioner,
T.C. Memo. 1998-248, affd. per curiam ___ F.3d ___ (11th Cir.
2000), we followed Cotnam v. Commissioner, 263 F.2d 119 (5th Cir.
1959), affg. in part and revg. in part 28 T.C. 947 (1957),
because the appeal would lie to the Court of Appeals for the 11th
Circuit, which follows precedents of the Court of Appeals for the
5th Circuit for cases decided before Oct. 1, 1982. In a per
curiam opinion, the Court of Appeals for the 11th Circuit
affirmed our decision based on the binding Cotnam precedent and
declined to consider the Commissioner’s argument that Cotnam was
wrongly decided, noting that Cotnam can be overruled only by the
court sitting en banc. See Davis v. Commissioner, F.3d
2000 WL 491747 (11th Cir. 2000); see also Foster v. United
States, F. Supp. 2d (N.D. Ala., Mar. 13, 2000), on appeal
(continued...)
 - 23 -

Section 61(a) provides that “gross income means all income

from whatever source derived,” and typically, all gains are taxed

unless specifically excluded. See James v. United States, 366

6
(...continued)
(11th Cir., Apr. 10, 2000), where the District Court generally
followed Cotnam as binding precedent, but denied litigation cost
explaining:

The court does not find, however, that under §
7430(c)(4)(A)(i) the position of the United States
(i.e., with respect to Cotnam) was not substantially
justified. Yes, the court does conclude that Cotnam
does control most of the issues respecting attorney’s
fees and, until the Court of Appeals or Supreme Court
rules otherwise, is binding on this court.

But there are serious and legitimate questions as
to whether the holding in Cotnam should continue to be
followed in this or other circuits. Strong arguments
can be made–-and presumably will be made by the
government in seeking en banc consideration of this
issue in the Davis case or on appeal of this case–-that
Cotnam is not consonant with Supreme Court decisions
like Horst and, indeed, is based on a misinterpretation
of Alabama law involving contingent fee contracts and
attorneys’ lien rights. In particular, Cotnam did not
give attention to the continuing control that, even
after entering into a contingent fee contract, the tort
plaintiff has with respect to settlement of the
entirety of the claim or to the continuing power of the
client to discharge an attorney and effectively cancel
the “assignment” of a share in later recoveries. The
1998 appeal by the government of Davis, filed before
this case was brought, indicated that its attack upon
Cotnam represents a fundamental disagreement with that
decision, and not some personal animus against Foster
in the present case. The rejection in January 2000 by
a second appellate court (the Sixth Circuit in the
Estate of Clarks case) does not support an assertion
that the government’s [sic] in this case was without
substantial foundation. This court determines that
Foster is not entitled to litigation costs under §
7430.
 - 24 -

U.S. 213, 219 (1961). We can identify no specific exclusion from

gross income for the payment made to Fox & Fox. While it is true

that petitioner did not physically receive the portion of the

settlement proceeds used to pay the attorney’s fees, he did

receive the full benefit of those funds in the form of payment

for the services required to obtain the settlement. At the time

that petitioner entered into the contingent fee agreement, he had

already been discriminated against in the form of his wrongful

termination from employment. In other words, petitioner was owed

damages, and the attorney was willing to enter into a contingent

fee agreement to recover the damages owed to petitioner.

Therefore, petitioner must recognize as income the amount of the

judgment.

In coming to this conclusion, we reject the significance

placed by the U.S. Court of Appeals for the Sixth Circuit on the

speculative nature of the claim and/or that the claim was

dependent upon the assistance of counsel. Despite characterizing

petitioner’s right to recovery as speculative, his cause of

action had value in the very beginning; otherwise, it is unlikely

that Fox & Fox would have agreed to represent petitioner on a

contingent basis. We find no meaningful distinction in the fact

that the assistance of counsel was necessary to pursue the claim.

Attorney’s fees, contingent or otherwise, are merely a cost of

litigation in pursuing a client’s personal rights. Attorneys
 - 25 -

represent the interests of clients in a fiduciary capacity. It

is difficult, in theory or fact, to convert that relationship

into a joint venture or partnership. The entire ADEA award was

“earned” by and owed to petitioner, and his attorney merely

provided a service and assisted in realizing the value already

inherent in the cause of action.

An anticipatory assignment of the proceeds of a cause of

action does not allow a taxpayer to avoid the inclusion of income

for the amount assigned.7 A taxpayer who enters into an agreement

for the rendering of services that assists in the recovery from a

third party must include the amount recovered (compensation) in

gross income, irrespective of whether it is received by the

taxpayer. See Hober v. Commissioner, T.C. Memo. 1984-491;

Loeffler v. Commissioner, T.C. Memo. 1983-503. This Court,

relying on Lucas v. Earl, 281 U.S. 111 (1930), has consistently

7
The assignment by a taxpayer of a right to collect a
doubtful and uncertain pending claim against the United States in
exchange for cash and other consideration did not constitute an
anticipatory assignment of income in Jones v. Commissioner, 306
F.2d 292 (5th Cir. 1962), revg. T.C. Memo. 1960-115, and thus the
taxpayer was not taxable on the amount ultimately recovered on
the claim. In Reffett v. Commissioner, 39 T.C. 869 (1963),
however, we distinguished Jones in a factual setting similar to
this case and held that proceeds from a taxpayer’s lawsuit that
were paid to witnesses for their services during the lawsuit were
includable in the taxpayer’s gross income. In addition, the U.S.
Court of Appeals for the Ninth Circuit has factually
distinguished Jones and held that an attorney’s transfer of part
of a contingent legal fee earned by him was an assignment of
income within the meaning of Lucas v. Earl, 281 U.S. 111 (1930).
Koshansky v. Commissioner, 92 F.3d 957, 958 (9th Cir. 1996),
affg. in part, revg. in part T.C. Memo. 1994-160.
 - 26 -

held that a taxpayer cannot avoid taxation on his income by an

anticipatory assignment of that income to another. See id.

Thus, any anticipatory assignment by the taxpayer of the proceeds

of the lawsuit must be included in the taxpayer’s gross income.

We reject petitioner’s contention that he had insufficient

control over his cause of action to be taxable on a recovery of a

portion of the settlement proceeds that was diverted to or paid

to Fox & Fox under the contingent fee agreement. There is no

evidence supporting petitioner’s contention that he had no

control over his claim. In Wisconsin, a lawyer cannot acquire a

proprietary interest that would enable the attorney to continue

to press a cause of action despite the client’s wish to settle.

Indeed, the Supreme Court of Wisconsin has stated that “The claim

belongs to the client and not the attorney, the client has the

right to compromise or even abandon his claim if he sees fit to

do so.” Goldman v. Home Mut. Ins. Co., 22 Wis. 2d 334, 341, 126

N.W.2d 1 (1964).

Likewise, petitioner has not waived his right to settle his

claim at any time, and it would be an ethical violation for his

attorney to press forward with such a case against the will of

the client. Wisconsin Supreme Court rule 20:1.2(a) provides:

A lawyer shall abide by a client’s decisions concerning
the objectives of representation, subject to paragraphs
(c), (d) and (e), and shall consult with the client as
to the means by which they are to be pursued. A lawyer
shall inform a client of all offers of settlement and
 - 27 -

abide by a client’s decision whether to accept an offer
of settlement of a matter. * * *

Although petitioner may have entrusted Fox & Fox with the details

of his litigation, ultimate control was not relinquished. If

petitioner wanted to proceed without Fox & Fox, he could have

obtained new representation.

The assignment of income doctrine was originated by the

Supreme Court and has evolved over the past 70 years. See

Helvering v. Eubank, 311 U.S. 122 (1940); Helvering v. Horst, 311

U.S. 112 (1940); Lucas v. Earl, supra. Although legislation may

result in anomalous or inequitable results with respect to

particular taxpayers, we are not in a position to address those

policy questions. So, for example, if the AMT computation

effectively renders de minimis a taxpayer’s recovery due to the

nondeductibility of the attorney’s fees, we should not be tempted

to modify established assignment of income principles to remedy

the situation. That could result in a certain class of

taxpayer’s (those who receive reportable income from judgments)

being treated differently from all other taxpayers who are

subject to the AMT. These are matters within Congress’ authority

to decide. Congress, not the Courts, is the final arbiter of how

the tax burden is to be borne by taxpayers.

Even if we were willing to follow the Cotnam and/or Estate

of Clarks “attorney’s lien” rationale, our analysis of the

Wisconsin statutes and case law would not result in excluding the
 - 28 -

attorney’s fee from petitioners’ gross income here. In Cotnam,

the Alabama statute provided that “attorneys at law shall have

the same right and power over said suits, judgments and decrees,

to enforce their liens, as their clients had or may have for the

amount due thereon to them.” Cotnam v. Commissioner, 263 F.2d

119, 125 n.5 (5th Cir. 1959) (quoting Ala. Code sec. 64 (1940)).

The relevant Wisconsin statute does not recognize the same right

and power in favor of attorneys that was identified in the

Alabama attorney’s lien statute. The Wisconsin statute provides:

Any person having or claiming a right of action,
sounding in tort or for unliquidated damages on
contract, may contract with any attorney to prosecute
the action and give the attorney a lien upon the cause
of action and upon the proceeds or damages derived in
any action brought for the enforcement of the cause of
action, as security for fees in the conduct of the
litigation; when such agreement is made and notice
thereof given to the opposite party or his or her
attorney, no settlement or adjustment of the action may
be valid as against the lien so created, provided the
agreement for fees is fair and reasonable. This
section shall not be construed as changing the law in
respect to champertous contracts. [Wis. Stat. Ann.
sec. 757.36 (West 1981).]

This statute provides for an attorney’s lien upon the cause of

action or upon the proceeds or damages from such cause of action

to secure compensation, but it does not give attorneys the same

rights as their clients over the proceeds of suits, judgments,

and decrees. Accordingly, the Wisconsin statute contains obvious

differences and is distinguishable from the Alabama statute.
 - 29 -

A 100-year-old Wisconsin case contains an indication that at

one time, an attorney in Wisconsin may have had the type of

rights described in Cotnam. See Smelker v. Chicago & N.W. Ry.,

106 Wis. 135, 81 N.W. 994 (1900). In Smelker, the Wisconsin

Supreme Court held that an attorney could press the underlying

cause of action to enforce the attorney’s lien even after the

client had settled. While the Wisconsin court expressed doubt

about the propriety of such a policy, the statutory lien

provision in effect at the time appeared to the court to require

such a result. At the time of Smelker, the statute provided for

attorney’s liens only on the “cause of action”. As such, the

Wisconsin Supreme Court reasoned that the only way an attorney’s

lien could withstand settlement was if the cause of action could

continue at the behest of the attorney. This is no longer the

situation. The Wisconsin attorney’s lien statute was revised

after the decision in Smelker. The statute in effect for

purposes of this case provides for an attorney’s lien on the

cause of action as well as the proceeds or damages from the cause

of action and does not give the attorney the right to continue an

action after the client settles. See Wis. Stat. Ann. sec. 757.36

(1981). In light of the statement in Goldman v. Home Mut. Ins.

Co., supra, that a claim belongs to the client and not the

attorney, the fact that Smelker has only been cited by a

Wisconsin court once (in 1902 and even then not for the
 - 30 -

proposition that attorneys have the same rights and power over

suits as their clients), and the fact that Wisconsin’s attorney’s

lien statute was revised, Smelker has not retained its vitality,

and we do not read it as standing for the proposition that

attorneys in Wisconsin have the same rights as their clients over

suits.

We conclude that petitioner’s award, undiminished by the

amount that he paid to Fox & Fox, is includable in his 1993 gross

income. The amount paid to Fox & Fox is deductible subject to

certain statutory limitations as determined by respondent. We

have also considered petitioners’ remaining arguments and, to the

extent not mentioned herein, find them to be without merit. To

reflect the foregoing,

Decision will be entered

under Rule 155.

Reviewed by the Court.

COHEN, WHALEN, CHIECHI, LARO, GALE, THORNTON, and MARVEL,
JJ., agree with this majority opinion.

HALPERN, FOLEY, and VASQUEZ, JJ., did not participate in
consideration of this opinion.
 - 31 -

CHABOT, J., dissenting: The majority opinion sets forth

supra at note 3 and the accompanying text (majority op. pp. 13-

15) concerns as to the injustice resulting from the intersection

of court-made doctrine and statute law--in particular the minimum

tax. The majority opinion states that “these policy issues are

in the province of Congress” (majority op. p. 15) and refuses to

modify court-made doctrine. Although I agree with the majority

that “we are not authorized to rewrite the statute” (majority op.

p. 15), I reject the idea that we are disabled from correcting

court-made error, and so I dissent.

The assignment of income doctrine was created by the courts

to deal with situations where the taxpayer figuratively turned

his or her back on income that would have come to and been

taxable to the taxpayer, but for the taxpayer’s effort to shift

the receipt and taxability of the income. See the three seminal

opinions cited by the majority (majority op. p. 27)--Lucas v.

Earl, 281 U.S. 111 (1930) (husband assigned to wife half of

salary and fees that he earned; Federal taxing statute treats

assigned amounts as taxpayer’s income); Helvering v. Eubank, 311

U.S. 122 (1940) (taxpayer assigned to corporate trustees

insurance renewal commissions; taxpayer remains taxable on the

insurance renewal commissions he had earned); Helvering v. Horst,

311 U.S. 112 (1940) (taxpayer assigned to son negotiable bond
 - 32 -

interest coupons; taxpayer remains taxable on the income that he

would have received but for the transfer). The Supreme Court

made clear that these results were based on the Court’s reading

of the statute as to what was income of the taxpayer rather than

income of another; the intended result was to tax the taxpayer on

the income the taxpayer would have had if he or she had acted to

“earn” the income but had not acted to deflect the income.

Those seminal cases did not present disputes about the

amount of the income, but they focused on whether the taxpayer

had succeeded in deflecting the taxation of it to others.

As the majority opinion notes, there is later case law

dealing with how to measure the amount of the income. This case

law is, in part, responding to needs to interpret and apply

intricate “spread-back” provisions and, in part, to fill in the

gaps in statutory text that become evident when a statute has to

be applied to the real world. The concepts developed by the

courts seemed to be reasonable and seemed to produce reasonable

results. However, the statutory background has changed over the

decades. For example the Congress repealed more than 30 years

ago the statute referred to in the majority opinion’s quotation

(majority op. p. 21) from O’Brien v. Commissioner, 38 T.C. 707,

710 (1962), affd. 319 F.2d 532 (3d Cir. 1963). Application of

court-made rules to the new background has exposed analytical

errors that were originally overlooked because the harm created
 - 33 -

was not then regarded as serious. That is, we held that the

taxpayers in O’Brien v. Commissioner, supra, and in Cotnam v.

Commissioner, 28 T.C. 947 (1957), revd. on this issue and affd.

on other issues 263 F.2d 119 (5th Cir. 1959), were entitled to

some but not all of the relief they claimed from the general

application of the annual accounting period rules.8

However, as the majority opinion notes (majority op. pp. 13-

15), continued application of the court-made rules, in this era

of minimum tax can raise effective tax rates to hardship levels

8
The statute referred to in O’Brien v. Commissioner, 38 T.C.
707, 710 (1962), affd. 319 F.2d 532 (3d Cir. 1963), is sec. 1303,
I.R.C. 1954, which provided a “cap” on taxation of back-pay
awards, calculated by “spreading back” the award over the years
to which the awarded amounts were attributable. We held that the
gross award was to be spread back, unreduced by the taxpayer’s
costs of obtaining the award. We noted that the taxpayer merely
was being denied a special, limited relief from the normal
incidences of income taxation, and that he remained entitled to
deduct his legal fees for the year the award was made. See
O’Brien v. Commissioner, 38 T.C. at 710, 712. In O’Brien v.
Commissioner, 38 T.C. at 711, we relied on Smith v. Commissioner,
17 T.C. 135 (1951), revd. on another issue 203 F.2d 310 (2d Cir.
1953), in which we had ruled the same way under sec. 107(d),
I.R.C. 1939, the predecessor of sec. 1303, I.R.C. 1954. In Smith
v. Commissioner, 17 T.C. at 144, the taxpayer wanted the gross
award spread back and the expenses deducted for the year of the
award, while the Commissioner argued for spreading back the net
cost; we held for the taxpayer. In Cotnam v. Commissioner, 28
T.C. 947, 953-954 (1957), revd. on this issue and affd. on other
issues 263 F.2d 119 (5th Cir. 1959), we also held that the gross
award was to be spread back under sec. 107(d), I.R.C. 1939, and
the expenses deductible for the year of the award.

The spread-back provisions that were the foundations for
Smith, Cotnam, and O’Brien were repealed by the Revenue Act of
1964, Pub. L. 88-272, sec. 232(a), 78 Stat. 19, 105, effective
for taxable years beginning after Dec. 31, 1963. See Pub. L. 88-
272, sec. 232(g)(1), 78 Stat. 112.
 - 34 -

in some real-world instances. The problem arises not from the

statute, but rather from the court-made elaboration of the

assignment of income doctrine and from our refusal to reexamine

the rules that we have devised. I agree with the majority that

the Congress has the power to revise the statute to reduce or

eliminate the effect of court-made errors, but the courts also

have the right and obligation to correct their own errors.

In Teschner v. Commissioner, 38 T.C. 1003 (1962), a majority

of this Court reexamined several of the seminal cases, rejected

respondent’s efforts to analyze by slogan,9 and determined that

9
In Teschner v. Commissioner, 38 T.C. 1003, 1007 (1962), we
explained as follows:

In his ruling, the respondent declared, “The basic
rule in determining to whom an item of income is
taxable is that income is taxable to the one who earns
it.” If by this statement the respondent means that
income is in all events includible in the gross income
of whomsoever generates or creates the income by virtue
of his own effort, the respondent is wrong. If this
were the law, agents, conduits, fiduciaries, and others
in a similar capacity would be personally taxable on
the proceeds of their efforts. The charity fund-raiser
would be taxable on sums contributed as the result of
his efforts. The employee would be taxable on income
generated for his employer by his efforts. Such
results, completely at variance with every accepted
concept of Federal income taxation, demonstrate the
fallacy of the premise.

If, on the other hand, the respondent used the
term “earn,” not in such a broad sense, but in the
commonly accepted usage of “to acquire by labor,
service, or performance; to deserve and receive
compensation” (Webster’s New International
Dictionary),4 then the rule is intelligible but does
not support the conclusion reached by the respondent
(continued...)
 - 35 -

the taxpayer therein was not taxable on the prize that his

daughter received as a result of the taxpayer’s successful entry

in a contest. Under the rules of the contest, only persons under

the age of 17 years and 1 month were eligible to receive prizes.

See id. at 1004. Any contestant over that age was required to

designate a person below that age as the recipient of the prize.

See id. at 1004. The taxpayer designated his daughter as

recipient. See id. at 1005. The taxpayer did not play any part

in creating this restrictive rule. Although the contest was

described as a “Youth Scholarship Contest”, the contest rules did

not limit the daughter in her use of the prize, a fully paid-up

annuity policy. See id. at 1005. The prize was worth $1,287.12;

respondent included this amount in the taxpayer’s income and

determined a deficiency of $283.16. See id. at 1004, 1005. We

summarized our conclusion as follows, id. at 1009:

Granted that an individual cannot escape taxation
on income to which he is entitled by “turning his back”
upon that income, the fact remains that he must have
received the income or had a right to do so before he
is taxable thereon. As noted by the court in United
States v. Pierce, 137 F.2d 428, 431 (C.A. 8, 1943):

The sum of the holdings of all cases is that
for purposes of taxation income is

9
(...continued)
either in the ruling in question or in the case before
us. The taxpayer there, as here, acquired nothing
himself; he received nothing nor did he have a right to
receive anything.
_____________________
4
Cf. Cold Metal Process Co. v. Commissioner, 247
F.2d 864, 872 (C.A. 6, 1957).
 - 36 -

attributable to the person entitled to
receive it, although he assigns his right in
advance of realization, and although, in the
case of income derived from the ownership of
property, he transfers the property producing
the income to another as trustee or agent, in
either case retaining all the practical
benefits of ownership.

Section 1(a) of the 1954 Code imposes a tax on the
“income of every individual.” Where an individual
neither receives nor has the right to receive income,
he is not the taxable individual within the
contemplation of the statute. There is no basis in the
statute or in the decided cases for a construction at
variance with this fundamental rule.

Reviewed by the Court.

Decision will be entered
for the petitioners.

The majority in the instant case tax to petitioners

substantial funds that petitioners did not receive, were never

entitled to receive, and never turned their backs on. They do so

in the name of the assignment of income doctrine. The majority

acknowledge that there may be injustice in so doing, and that the

injustice may well be even greater in other real-life settings

than in the instant case. They contend that precedents compel

them to this result and that relief can come only from the hills

(Psalm 121), or at least from Capitol Hill. But this Court has

shown in Teschner v. Commissioner, supra, that reexamination of

the origins of the assignment of income doctrine can sharpen our

understanding of the concepts and make more rational the

application of that doctrine. We do not lightly overrule our
 - 37 -

prior decisions. But when experience and analysis show that we

have departed from the origins that we once thought to be the

foundations of those decisions, and when it is our judicial

interpretations and not the statute law that lead to results that

increasingly seem to be unjust, then we ought to reexamine the

foundations of the doctrine. See in this connection Phillips v.

Commissioner, 86 T.C. 433 (1986), affd on this issue and revd. on

another issue 851 F.2d 1492 (D.C. Cir. 1988).

We should not declare ourselves incapable of self-

correction, merely because we chose to follow a wrong path

decades ago.

Respectfully, I dissent.

PARR, WELLS, COLVIN, and BEGHE, JJ., agree with this
dissenting opinion.
 - 38 -

BEGHE, J., dissenting: As presiding judge at the trial of

this case, my disagreement with the majority is neither a dispute

about evidentiary facts nor a doctrinal dispute as such. What

divides me from the majority--notwithstanding the majority have

adopted my proposed factual findings pretty much verbatim--is a

disagreement about the significance of those facts. In my view,

those facts do not call for application of the assignment of

income doctrine.

The recitals and reasoning in support of my efforts to

decide this case in favor of petitioners go on and on at such

length that I provide a Table of Contents.

Findings and Resulting Inferences . . . . . . . . . . . . . . 39

Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . 44
1. Issue Is Ripe for Reexamination . . . . . . . . . . 44

2. Tax Court’s Jurisprudence on Tax Treatment of
Contingent Fees--Dicta for Case at Hand . . . . . 48

3. Another Reason for Reexamination: Repeal of
Statutory Spreadback and Averaging Provisions . . 54

4. Cotnam and Estate of Clarks . . . . . . . . . . . . 56
i. Narrow Ground--Significance of State Law . . 60
ii. Broader Ground--Federal Standard . . . . . . 66

5. Significance of Control in Supreme Court’s
Assignment of Income Jurisprudence . . . . . . . . 70

6. Substantial Reduction of Claimant’s Control
by Contingent Fee Agreement . . . . . . . . . . . 75
i. “Contract of Adhesion” . . . . . . . . . . . 76
ii. American Bar Foundation Contingent
Fee Study . . . . . . . . . . . . . . . . . 77
iii. “Two Keys” Simile . . . . . . . . . . . . . . 80

7. Omissions and Distortions: the Majority Opinion . . 82

8. Majority Opinion’s Handling of Authorities . . . . . 86
 - 39 -

9. Preventing Tax Avoidance by Other Transferors . . . 89

10. Cropsharing as Alternative to Joint
Venture/Partnership Analogy . . . . . . . . . . . 90

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . 97

Findings and Resulting Inferences

I would find the ultimate fact that the elements of control

over the prosecution of the ADEA claims ceded by Mr. Kenseth and

assumed and exercised by Fox & Fox under the contingent fee

agreement make it reasonable to include in petitioners’ gross

income only Mr. Kenseth’s net share of the settlement proceeds,

$138,201.10 This means that, in computing Mr. Kenseth’s gross

income from the settlement, his share of the proceeds should be

offset by the $91,800 portion of Fox & Fox’s $1,060,000

contingent fee that reduced his share of such proceeds, not by

10
In Helvering v. Horst, 311 U.S. 112 (1940) (gift of bond
interest coupons to taxpayer’s son), Justice Stone pointed out
that the ultimate question in deciding whether the assignment of
income rule applies is a question of fact whose answer should be
informed by the perceptions and reactions of the trier of fact to
the total situation:

To say that one who has made a gift thus derived from
interest or earnings paid to his donee has never
enjoyed or realized the fruits of his investment or
labor because he has assigned them instead of
collecting them himself and then paying them over to
the donee, is to affront common understanding and to
deny the facts of common experience. Common
understanding and experience are the touchstones for
the interpretation of the revenue laws. [Helvering v.
Horst, 311 U.S. at 117-118; emphasis supplied.]

See also Helvering v. Clifford, 309 U.S. 331, 338 (1940),
discussed, cited, and quoted infra p. 47.
 - 40 -

including $229,501 in his gross income and treating his share of

the fee as an itemized deduction, subject to the alternative

minimum tax (AMT).11

The following evidentiary facts and inferences therefrom

support this ultimate finding.

The contingent fee agreement was a standardized form

contract prepared by Fox & Fox. Fox & Fox would have declined to

represent Mr. Kenseth if he had not entered into the contingent

fee agreement and agreed to the attorney’s lien provided therein.

Mr. Kenseth and the 16 other members of the class had a

common grievance arising from APV’s terminations of their

employment. That grievance impelled them to retain the same law

firm to advise them and prosecute their claims for redress. Once

that law firm had entered an identical contingent fee agreement

with each claimant, there was a substantial additional practical

impediment--as compared with a sole plaintiff who enters into a

contingent fee agreement--to Mr. Kenseth or any other class

member firing Fox & Fox and hiring other attorneys. That

impediment became even more substantial as the prosecution of the

claims by Fox & Fox progressed, from the filing of the

administrative claims, to the commencement of the class action

11
On occasion, the Commissioner has inadvertently taken
this position. See Coblenz v. Commissioner, T.C. Memo. 2000-131.
 - 41 -

lawsuit in the District Court, to settlement negotiations and

reaching of an agreement with APV and its attorneys.

In contrast to the unconditional personal liability Mr.

Kenseth assumed to pay his share of out-of-pocket expenses, he

did not agree to pay a fee, only to the modes of computation and

payment of the contingent fee to which Fox & Fox would be

entitled from the proceeds of any recovery. If there had been no

recovery, Fox & Fox would have received nothing.

The contingent fee agreement required aggregation of the

elements of any settlement offer divided between damages and

attorney’s fees and provided that any division of such an offer

into damages and attorney’s fees would be disregarded by Fox &

Fox and Mr. Kenseth. This means that, if either the defendant’s

settlement offer or the court’s decision had provided for a

separate award of attorney’s fees, the award of attorney’s fees

and the damages would have been grossed up to determine the fee

that Fox & Fox would be entitled to under the terms of the

contingent fee agreement.12

The contingent fee agreement provided that Mr. Kenseth could

not settle his case against APV without the consent of Fox & Fox.

Under Section VIII of the contingent fee agreement, Mr. Kenseth

12
Any issue presented by this provision became moot because
there was no agreement with APV or court award for the payment of
attorney’s fees.
 - 42 -

agreed that Fox & Fox "shall have a lien" for its fees and costs

against any recovery in Mr. Kenseth's action against APV. This

lien by its terms was to be satisfied before or concurrently with

the disbursement of the recovery. The contingent fee agreement

further provided that if Mr. Kenseth should terminate his

representation by Fox & Fox, the firm would have a lien for the

fees set forth in Section III of the agreement, and all out-of-

pocket expenses that had been disbursed by Fox & Fox would become

due and payable by Mr. Kenseth within 10 days of his termination

of Fox & Fox as his attorneys.

Mr. Kenseth and the other members of the class relied on the

guidance and expertise of Fox & Fox in signing the separation

agreement tendered to them by APV and then seeking redress

against APV. Commencing with the advice to Mr. Kenseth that he

could sign the separation agreement without giving up his age

discrimination claim, and culminating with the obtaining by Fox &

Fox of an overall settlement and recovery that substantially

exceeded what EEOC had thought the case was worth, Fox & Fox made

all strategic and tactical decisions in the management and

pursuit of the age discrimination claims of Mr. Kenseth and the

other class members against APV.

Fox & Fox was well aware of the relationship between any

gross settlement amount and the resulting fee that Fox & Fox

would be entitled to. In preparing for and conducting
 - 43 -

negotiations with APV and its attorneys, Fox & Fox tried to

ensure that the amounts actually received by Mr. Kenseth and the

other class members would approximate the full value of their

claims. Fox & Fox did this by including in their demands on

behalf of the claimants an amount for attorney’s fees that would

be included in and paid out of the settlement proceeds.

The bulk of the settlement proceeds was paid by APV directly

to the Fox & Fox trust account, by prearrangement between APV and

Fox & Fox.13 From the gross amount so paid, Fox & Fox paid itself

its agreed upon contingent fee of $1,060,000 and computed and

apportioned the remaining amount for distribution to Mr. Kenseth

and the other class members.14

13
Excluding the back pay portion--14.15 percent of the
total settlement proceeds and 23.58 percent of the total
distribution to class members--paid directly to Mr. Kenseth and
the other class members by APV, and from which employment taxes
were paid and withheld.
14
Mr. Kenseth had the largest share of the settlement of
any member of the class. The range of amounts distributed to
individual class members ranged from 2 percent of the total
amount distributed (Mr. Benisch) to 8.6 percent (Mr. Kenseth).
Although each class member’s back pay portion was the same
percentage of his share of the total settlement distributed to
class members (23.58 percent), the record does not disclose the
basis of the apportionment of the total settlement amount
distributed to each member of the class. The uniform
apportionment between back pay and the remainder of each
claimant’s share of the settlement proceeds seems inconsistent
with the way in which each claimant’s future earnings and
benefits were projected over estimated future work life and then
discounted back to present value by the economist retained by Fox
& Fox to assist in determining the amounts of the claimants’
claims. However, this lack of information and apparent
(continued...)
 - 44 -

There is no evidence in the record that Mr. Kenseth or any

other class member ever expressed dissatisfaction with the

services of Fox & Fox or tried to bring in other attorneys to

participate in or take over the prosecution of any of the ADEA

claims.

Discussion

My task is to persuade the reader that the governing law

permits-–indeed compels--the ultimate finding that Mr. Kenseth

did not retain enough control over his claim to justify including

in his gross income any part of the contingent fee paid to his

attorneys.

1. Issue Is Ripe for Reexamination

My dissatisfaction with the results of recent cases,15

antedating publication of Estate of Clarks v. United States, 202

14
(...continued)
inconsistency have no bearing on the outcome of this case, other
than to indicate uniformity in the treatment of class members
consistent with their lack of individual control over the
outcome.
15
The unsatisfactory results of those cases (cited infra
notes 21-22), both absolutely and from a horizontal equity
standpoint, are highlighted by the treatment of legal fees paid
to prosecute claims arising out of the claimant’s business as an
independent contractor, which are allowed as above-the-line trade
or business expense deductions under sec. 162(a). See Guill v.
Commissioner, 112 T.C. 325 (1999). Kalinka, “A.L. Clarks Est.
and the Taxation of Contingent Fees Paid to an Attorney”, 78
Taxes 16, 23 (Apr. 2000), observes that adoption of the view
espoused in this dissent will still put in an unfavorable tax
position non-business claimants who obligate themselves to pay
attorney’s fees at hourly rates in order to obtain taxable
recoveries. I agree that congressional action would be necessary
to change the unfavorable tax result for such claimants.
 - 45 -

F.3d 854 (6th Cir. 2000), revg. 98-2 USTC par. 50,868, 82 AFTR 2d

7068 (E.D. Mich. 1998), impelled me to ride the case at hand as

the vehicle to reexamine the Tax Court’s treatment of contingent

fees paid to obtain taxable recoveries. Although this case is

not the most egregious recent example, the mechanical interplay

of the itemized deduction rules with the AMT can result--in cases

in which the contingent fee exceeds 50 percent of the recovery--

in an overall effective rate of Federal income tax and AMT on the

net recovery exceeding 50 percent;16 in cases in which the

aggregate fees exceed 72-73 percent of the recovery, the tax can

exceed the net recovery, resulting in an overall effective rate

of tax that exceeds 100 percent of the net recovery.17

16
Coady v. Commissioner, T.C. Memo. 1998-291, on appeal
to the Court of Appeals for the Ninth Circuit, may be a case in
point. The contingent fee and costs approximated 60 percent of
the recovery.

The alternative provision for using the enhanced hourly rate
schedule to calculate the legal fee under Section III of Mr.
Kenseth’s contingent fee agreement could result, in a case in
which the recovery is small relative to the time spent on the
case by the attorneys, in a fee substantially greater than the
40-46 percent contingent fee provided by the agreement. It
should be kept in mind that the enhanced hourly rate provision
was an alternative method of computing the contingent fee, not a
provision for an hourly rate that was payable in all events for
which the client was personally liable, as in Bagley v.
Commissioner, 105 T.C. 396 (1995), affd. on other issues 121 F.3d
393 (8th Cir. 1997), and Estate of Gadlow v. Commissioner, 50
T.C. 975 (1968).
17
Because of the resulting exposure to two sets of fees,
the lien provisions of contingent fee agreements are a
substantial impediment to replacing original attorneys. These
situations contain the potential, if the total contingent fees
(continued...)
 - 46 -

Even if Estate of Clarks v. United States, supra, had not

recently been decided in the taxpayer’s favor by the Court of

Appeals for the Sixth Circuit, it would be appropriate to revisit

this issue. That Congress has not yet responded to comments that

the itemized deduction and AMT provisions are working in

unanticipated and inappropriate ways that support revision or

repeal18 does not mean that courts are powerless to step in on a

17
(...continued)
should exceed approximately 72-73 percent of the gross recovery
and be treated as itemized deductions, of resulting in AMT
liability--assuming the taxpayer has no substantial other income
in the year of recovery--that would exceed the amount of the net
recovery. A case in point may be Jones v. Clinton, 57 F. Supp.
2d 719 (E.D. Ark. 1999) in which, after acrimonious dispute among
three sets of attorneys, $649,000 of the settlement proceeds of
$850,000 were divided among them (the settlement check was made
payable to plaintiff and two sets of attorneys), so as to leave
only $201,000 for the plaintiff. See “Attorneys For Jones
Escalate Fight Over Fees”, Washington Times A6 (1/17/99); “Jones’
Lawyers Battle Over Fees”, Washington Post A9 (1/20/99); “Sharing
Jones Settlement”, N.Y. Times A16 (3/5/99); see also Alexander v.
IRS, 72 F.3d 938, 946-947 (1st Cir. 1995), affg. T.C. Memo. 1995-
51, in which the allocated legal fee approximated 73-74 percent
of the total recovery, and the fee and the tax liability on it
appeared to exceed the net taxable recovery.
18
See, e.g., Gutman, “Reflections on the Process of
Enacting Tax Law”, Tax Notes 93, 94 (Jan. 3, 2000) (Woodworth
Lecture, delivered Dec. 3, 1999) (itemized deduction phaseouts);
IRS National Taxpayer Advocate’s Annual Report to Congress, BNA
Daily Tax Report GG-1, L-2 (AMT), L-9/10, L-22 (itemized
deductions) (Jan. 5, 2000); Meissner, “Repeal or Revamp the AMT:
The Time Has Come”, 86 Stand. Fed. Tax Rep. (CCH) Tax Focus (Aug
19, 1999); Testimony of Stefan F. Tucker on Behalf of Section of
Taxation, American Bar Association, before Subcommittee on
Oversight, U.S. House of Representatives, on Revenue Provisions
in the President’s FY 2000 Budget, Mar. 10, 1999, 52 Tax Law.
577, 580-581 (1999) (AMT and itemized deductions);
(continued...)
 - 47 -

case-by-case basis. As Justice Douglas spoke for the Court in

Helvering v. Clifford, 309 U.S. 331, 338 (1940), responding to

the taxpayer’s argument that the then current statutory revocable

trust rules did not by their terms apply to the short-term trust

arrangement under review:

The failure of Congress to adopt any such rule of thumb
for that type of trust must be taken to do no more than
leave to the triers of facts the initial determination
of whether or not on the facts of each case the grantor
remains the owner for purposes of § 22(a). [Emphasis
supplied.]

What Justices Stone and Douglas said in Horst and Clifford

provides two reminders: First, the Supreme Court regards the

trial courts, including the Tax Court, as the proper arbiters of

the assignment of income doctrine; it’s the trial court’s job to

decide whether a taxpayer, who made an intrafamily or related

party transfer or other transfer of rights to future income or of

income producing property, retained sufficient control over what

was transferred to justify taxing the transferor on the income,

rather than the transferee. Second, the assignment of income

doctrine is judge-made law, not a rule of statutory

interpretation of the more recently enacted itemized deduction

and AMT provisions. Contrary to the claims of the majority and a

18
(...continued)
ABA/AICPA/TEI/release on 10 ways to simplify the tax code
(including repealing AMT and phasing out phaseouts) Doc. 2000-
5573 Highlights & Documents (Feb. 28, 2000).
 - 48 -

recent commentator,19 we need not wait for Congress to change

those provisions. We’re dealing with a problem under the common

law of taxation;20 what the courts have created and applied,

courts can interpret, refine, and distinguish to determine

whether in changed circumstances the conditions for application

of the doctrine have been satisfied.

2. Tax Court’s Jurisprudence on Tax Treatment of Contingent
Fees--Dicta for Case at Hand

The inquiry begins with a reexamination of the original

cases--published as regular Tax Court opinions--cited by the

majority as originating and applying the rule that the Supreme

Court’s assignment of income opinions require that a contingent

fee be allowed only as a deduction, not as an offset in computing

gross income. All these cases were interpretations and

applications of the spreadback provisions of section 107 of the

1939 Code or its statutory successors in the 1954 Code. What the

Tax Court said in these cases about those Supreme Court opinions

was dictum. The Tax Court’s recent opinions on the subject,

concerning itemized deductions and the AMT, are, with one

19
See Kalinka, “A.L. Clarks Est. and the Taxation of
Contingent Fees Paid to an Attorney”, 78 Taxes 16 (Apr. 2000).
20
See Brown, “The Growing ‘Common Law’ of Taxation”, 1961
S. Cal. Tax Inst. 1, 13-21.
 - 49 -

distinguishable exception,21 memorandum opinions, not properly

regarded as binding precedent.22

The regular opinions of the Tax Court on which the majority

rely are not directly in point. There is another ground on which

Smith v. Commissioner, 17 T.C. 135 (1951), revd. on another issue

203 F.2d 310 (2d Cir. 1953); Cotnam v. Commissioner, 28 T.C. 947

(1957), affd. in part and revd. in part 263 F.2d 119 (5th Cir.

1959); Petersen v. Commissioner, 38 T.C. 137 (1962); O'Brien v.

Commissioner, 38 T.C. 707 (1962), affd. per curiam 319 F.2d 532

(3d Cir. 1963); and Estate of Gadlow v. Commissioner, 50 T.C. 975

(1968), were decided that distinguishes them from the case at

hand. Each of these earlier cases applied section 107 of the

1939 Code or a similar provision for relief from high marginal

rates of income tax on bunched receipts in one year (or a

relatively short period) of back pay, compensation from an

21
Bagley v. Commissioner, 105 T.C. 396, 418-419 (1995),
affd. on other issues 121 F.3d 393 (8th Cir. 1997), which was not
appealed on this issue, held, among numerous other things, that
hybrid attorney’s fees (fixed $50-hourly rate and 25-percent
contingency fee), to extent allocable to taxable portion of
awards, were deductible as itemized deductions under sec. 67(a),
rather than as offsets in computing gross income. Stated ground
of decision on this issue, not appealed by the taxpayers, was
that fee agreement did not create partnership or joint venture
within meaning of sec. 7701(a)(2) between plaintiff-taxpayer and
attorney. See infra pp. 70, 90-97.
22
See, e.g., Benci-Woodward v. Commissioner, T.C. Memo.
1998-395; Sinyard v. Commissioner, T.C. Memo. 1998-364;
Srivastava v. Commissioner, T.C. Memo. 1998-362; Coady v.
Commissioner, supra; Brewer v. Commissioner, T.C. Memo. 1997-542,
affd. without published opinion 172 F.3d 875 (9th Cir. 1999).
 - 50 -

employment, etc., attributable to services rendered over a number

of years. The statutory mechanism allowed the taxpayer to

compute income tax for the year of receipt as if the back pay or

other compensation had been ratably received during the years

earned. The theme of those cases, without regard to assignment

of income principles, was this Court’s unwillingness to provide

relief beyond the express terms of what was felt to be a generous

statutory relief provision.

In each of those cases, this Court treated the problem as

one of statutory interpretation, before wrapping itself in the

mantle of Lucas v. Earl, 281 U.S. 111 (1930), and the Supreme

Court’s other landmark cases on assignment of income. So said

Judge Raum, speaking for the Court in O’Brien v. Commissioner, 38

T.C. at 710:23

Although there may be considerable equity to the
taxpayer’s position, that is not the way the statute is
written. Without the benefit of section 1303 [the 1954
Code equivalent of 1939 Code section 107], there would
be no relief whatever, and the relief granted cannot go
beyond these very provisions. They provide merely for
a computation of tax based upon “the inclusion of the
respective portions of such back pay in the gross
income for the taxable years to which such portions are

23
The taxpayer in O’Brien v. Commissioner, 38 T.C. 707
(1962), affd. per curiam 319 F.2d 532 (3d Cir. 1963), had not
claimed on his return that the fee should offset the recovery,
with the resulting reduced amount to be spread back. The
taxpayer had reported on his 1957 income tax return the receipt
of a backpay award, had spread back the gross amount of the award
over the years of service (1952-1955), and then had apportioned
and spread back the legal fees over the same years. This, the
Court held, the statutory spreadback provision did not permit.
 - 51 -

respectively attributable.” There is no provision
whatever for spreading back any related expenses as was
done in petitioner’s returns.

Judge Raum saw the situation as identical with that in Smith

v. Commissioner, 17 T.C. at 144, quoting what the Court said in

that case in upholding the taxpayer’s claim of entitlement to the

deduction in the year of receipt, notwithstanding that the

Commissioner had computed his tax liability by spreading the back

pay award over the years of service:

Without this section, the entire $212,000 would be
income in 1945. Section 107 is silent as to expenses
incurred in connection with any collection of back pay,
and there are no regulations or decisions which we have
been able to find on the question. To limit
application of section 107 to amounts received less
expenses connected with collection is not a function
for the Court, but rather is a task for Congress if
that is the result which they wish. We therefore hold
that petitioner is entitled to deduct the $25,000 legal
expense in 1945.

Judge Raum then discussed the opinions of the Tax Court and

the Court of Appeals for the Fifth Circuit in Cotnam v.

Commissioner, supra, concluding: “In reaching that conclusion

the majority [in the Fifth Circuit] placed considerable stress

upon certain provisions of an Alabama statute relating to

attorney’s liens.”24 O’Brien v. Commissioner, supra at 712.

24
It’s also noteworthy that the final paragraph of Judge
Wisdom’s dissent in Cotnam v. Commissioner, 263 F.2d 119, 127
(5th Cir. 1959), revg. 28 T.C. 947 (1957), like the opinion of
Judge Turner in the Tax Court, and the Tax Court’s prior opinion
in Smith v. Commissioner, 17 T.C. 135 (1951), revd. on another
issue 203 F.2d 310 (2d Cir. 1953), relied upon the lack in sec.
(continued...)
 - 52 -

Turning back to the case before him, Judge Raum found that there

were no such provisions in Pennsylvania law. Judge Raum then

questioned whether State law had any bearing on the matter,

inasmuch as the underlying claim had been prosecuted in the

United States Court of Claims under Federal law. What followed,

Judge Raum’s ipse dixit on assignment of income, is dictum. Id.:

However, we think it doubtful that the Internal Revenue
Code was intended to turn upon such refinements. For,
even if the taxpayer had made an irrevocable assignment
of a portion of his future recovery to his attorney to
such an extent that he never thereafter became entitled
thereto even for a split second, it would still be
gross income to him under the familiar principles of
Lucas v. Earl * * *, Helvering v. Horst * * *, and
Helvering v. Eubank * * *. The fee, of course, would
be deductible, just as it was held to be in Weldon D.
Smith. Cf. Walter Petersen * * *. We reach the same
result here. Petitioner is entitled to the benefit of
section 1303 with respect to his $16,173.05 recovery in
1957 and may deduct the $8,243.10 legal expenses in
that year; such legal expenses may not be spread back
over earlier years, nor may the same result be achieved
indirectly by subtracting the expenses from the
recovery and then applying section 1303 to the reduced
amount.

Estate of Gadlow v. Commissioner, supra, is the last regular

Tax Court opinion in this series. Estate of Gadlow is similarly

distinguishable from the case at hand. Like the earlier cases,

Estate of Gadlow concerned the application of a provision for

computing income tax liability upon the receipt of damages for

breach of contract by prorating the recovery over the earlier

24
(...continued)
107 of any express provision for allocating expenses against the
prorated compensation.
 - 53 -

years that the income would have been received but for the

breach, section 1305 of the 1954 Code. One of the grounds

advanced by the Court in Estate of Gadlow for refusing to follow

the Court of Appeals for the Fifth Circuit in Cotnam was that the

applicable Pennsylvania law did not contain the Alabama

provision.25

The Court’s opinion in Estate of Gadlow summarized and

quoted O’Brien v. Commissioner, supra, and concluded that the

spread back provisions under review:

did not make provision for spreading back related
expenses incurred in the collection of back pay. We
concluded [in O’Brien] that without specific statutory
authority this Court could not allow this treatment.
We reach the same conclusion here. [Estate of Gadlow
v. Commissioner, supra at 981.]

In the case at hand there is no analogous question of

statutory interpretation of a relief provision, only the

application of the Federal common law of taxation26 to determine

25
Estate of Gadlow v. Commissioner, 50 T.C. 975, 980
(1968), is also distinguishable from Cotnam v. Commissioner, 25
T.C. 947 (1957), affd. in part and revd. in part 263 F.2d 119
(5th Cir. 1959), on another ground, not present in the case at
hand:

because Gadlow did not employ the attorneys on a
contingent-fee basis as Mrs. Cotnam did, but rather,
their fee was fixed solely by the number of hours they
worked on Gadlow’s case. Therefore, the fee was
Gadlow’s debt due and owing from Gadlow to his
attorneys without regard to the outcome of the
litigation.
26
See supra note 20.
 - 54 -

whether the Tax Court can and should apportion the respective

gross incomes of client and attorney pursuant to a contingent fee

agreement under which the client gives up substantial control

over the prosecution and recovery of his claim.

3. Another Reason for Reexamination: Repeal of Statutory
Spreadback and Averaging Provisions

The history of the statutory spreadback provisions is

instructive in another respect.27 In 1964, those provisions were

repealed in favor of general income averaging.28 In 1970,

Congress enacted the 50-percent maximum tax on earned income,

which was in turn repealed in 1981, when the top income tax rate

27
Under the 1954 Code, taxpayers were afforded six targeted
spreadback (or averaging) provisions that were intended to
mitigate the harsh effects of progressive tax rates on income
earned unevenly over the years. See secs. 1301-1307 (1954 Code).
These relief provisions applied only to particular types of
income (e.g., employment compensation, back pay, breach of
contract damages, income from inventions or artwork, antitrust
damages) earned or received over specified periods of time.
28
Congress amended the targeted averaging provisions in the
Revenue Act of 1964, stating that “A general averaging provision
is needed to accord those whose incomes fluctuate widely from
year to year the same treatment accorded those with relatively
stable incomes.” S. Rept. 830, 88th Cong., 2d Sess. (1964),
1964-1 C.B. (Part 2) 505, 643, 644. Congress explained that the
former targeted averaging provisions were inadequate because they
were (1) limited to a relatively small proportion of situations
and (2) unduly complicated. See id. at 644. Accordingly,
Revenue Act of 1964, Pub. L. 88-272, sec. 232(a), 78 Stat. 19,
105 replaced the old provisions (subject to transitional relief)
with an averaging device that was available to individual
taxpayers generally, regardless of the source of income. See id.
 - 55 -

was reduced to 50 percent.29 In 1986, Congress repealed general

income averaging.30 All these provisions were tools Congress had

used to ameliorate the top marginal income tax rates that went as

high as or higher than 70 percent during most of the relevant

periods. After 1986, under the new flatter rate structure, with

a top rate of substantially less than 50 percent, these

provisions were no longer needed. Against the background of

Congressional concerns about ameliorating a high and steeply

progressive rate structure, I don’t believe Congress expected or

intended that the interplay of the newly enacted itemized

deduction and AMT provisions could result in effective rates of

tax substantially exceeding 50 percent up to more than 100

percent of a net recovery.

29
Congress granted another type of relief from the punitive
effects of historically high marginal rates when it enacted the
50 percent maximum tax on personal service income for tax years
beginning after Dec. 31, 1970. Tax Reform Act of 1969, Pub. L.
91-172, sec. 804(a), 83 Stat. 487, 685 (codified as sec. 1348).
However, such relief subsequently was considered no longer
necessary when Congress reduced the highest marginal tax rate on
all types of income to 50 percent, for taxable years beginning
after Dec. 31, 1981. Economic Recovery Tax Act of 1981, Pub. L.
97-34, sec. 101(c)(1), 95 Stat. 172, 183. (repealing sec. 804(a)
of the Tax Reform Act of 1969).
30
In 1986, Congress repealed the income averaging
provisions almost entirely (exception carved out for farming
income). Tax Reform Act of 1986, Pub. L. 99-514, sec. 141(a),
100 Stat. 2085, 2117. Congress believed that changes to the
individual income tax provisions, which provided wider brackets,
fewer rates, and a flatter rate structure with a top marginal
rate substantially less than 50 percent, reduced the need for
complicated income averaging. See H. Rept. 99-426 (1986), 1986-3
C.B. (Vol. 2) 114.
 - 56 -

Contrarywise, the purpose of the AMT is to prevent

individuals with substantial economic income from avoiding

significant tax liability.31 Although we have held that the

itemized deduction limitations and the AMT can apply to low and

middle-income taxpayers,32 that doesn’t mean that Congress

expected or intended that these provisions could result in

effective tax rates exceeding 50 percent. Where their interplay

with contingent fees has that potential, courts are entitled to

ask whether the plaintiff-claimant’s retained control--vis-a-vis

the control acquired and exercised by the attorney--is sufficient

to justify including in the claimant’s gross income the

contingent fee the attorney pays himself out of the recovery

proceeds.

4. Cotnam and Estate of Clarks

The inquiry continues with a review of the opinions of the

Court of Appeals for the Fifth Circuit in Cotnam v. Commissioner,

263 F.2d 119 (5th Cir. 1959), affg. in part and revg. in part 28

T.C. 947 (1957). The handling of the matter by the Court of

Appeals discloses both a narrow ground and a broader ground for

its decision. The numerous occasions we have distinguished

Cotnam on the narrow ground have obscured the broader ground and

31
See S. Rept. 99-313, at 518, 1986-3 C.B. (Vol. 3) 1, 518.
32
See, e.g., Huntsberry v. Commissioner, 83 T.C. 742
(1984); Lickiss v. Commissioner, T.C. Memo. 1994-103.
 - 57 -

contributed to our failure to grapple with the issue in a broad-

gauged, principled way under the Federal common law of taxation

as adopted by the Supreme Court. Instead, we’ve been beguiled by

“attenuated subtleties” and “refinements” into treating the

problem as one of determining the claimant’s retained legal

rights in his cause of action under State law.

The taxpayer in Cotnam had rendered housekeeping services to

an elderly individual during the years 1940-44 in consideration

of his promise to bequeath her one-fifth of his estate.

Following his death without a will, she entered a contingent fee

agreement with attorneys who successfully prosecuted her claim to

judgment against the estate. The check for the $120,000 recovery

(plus approximately $5,000 in interest), which was received in

1948, was made payable to the taxpayer and her attorneys. After

endorsement by the payees, the check was deposited in the

attorneys’ bank account. Retaining their fee of $50,000, the

attorneys gave the taxpayer their check of $75,000 for the

balance (amounts rounded off).

The Commissioner determined that the recovery was

compensation income rather than a nontaxable bequest and

apportioned the gross recovery under section 107 of the 1939 Code

over the 4-1/2-years the services were rendered. In applying

section 107, the Commissioner allowed the legal fee as a

deduction only in the year paid, in which the taxpayer had
 - 58 -

otherwise negligible income against which to deduct the fee,

resulting in a deficiency of more than $36,000.33

The Tax Court first held that the recovery was compensation

income rather than a nontaxable bequest; on this issue the Court

of Appeals for the Fifth Circuit unanimously affirmed. On the

second question, whether the contingent legal fee was excluded

from the compensation to be spread back or merely a useless

deduction in the year of receipt by the attorneys, Judge Wisdom,

writing for the panel, made clear that he disagreed with the

outcome in the taxpayer’s favor, stating as follows:

A majority of the Court, Judges Rives and Brown,
hold that the $50,365.83 paid Mrs. Cotnam’s attorneys
should not be included in her gross income. This sum
was income to the attorneys but not to Mrs. Cotnam.

* * * * * * *

The facts in this unusual case, taken with the
Alabama statute, put the taxpayer in a position where
she did not realize income as to her attorneys’
interests of 40% in her cause of action and judgment.
[Cotnam v. Commissioner, 263 F.2d at 125.]

33
Because of the high marginal rates of Federal income tax
in effect in 1940-44 and 1948, inclusion of the gross recovery in
1948 income and allowance of the deduction in that year would
have resulted in a greater deficiency than that arising under the
apportionment of the gross income over the prior years under 1939
Code sec. 107, even if the fee were treated as a deduction or
offset for 1948. The taxpayer was arguing for even greater
relief, that the compensation received in 1948 and apportioned
under sec. 107 over the earlier years should be reduced by the
legal fee.
 - 59 -

This is the narrow holding of the Court of Appeals’ decision

in Cotnam, discussed below in subpart i.34

There then followed a statement of the broader ground of the

panel’s decision, introduced by the following statement: “Judges

RIVES and BROWN add to the foregoing, the following”, 263 F.2d at

125, and concluding: “Accordingly, the attorneys’ fee of

$50,365.83 should not have been included in the taxpayer’s gross

income”, 263 F.2d at 126. Then came the dissenting opinion of

Judge Wisdom, who had written the opinion for the panel embodying

the narrow holding.35 The disagreement between the additional

34
Although the Tax Court noted that the attorneys “only had
a lien on the fund” payable to Mrs. Cotnam and that the attorneys
“had no right in or title to” Mrs. Cotnam’s recovery sufficient
to justify treating them as the owners for tax purposes of any
portion of that recovery, it is not clear that the peculiar
provisions of Alabama law that provided the narrow holding of the
Court of Appeals decision were brought to the attention of the
Tax Court. See Cotnam v. Commissioner, 28 T.C. 947, 954 (1957),
affd. in part and revd. in part 263 F.2d 119 (5th Cir. 1959).
The Tax Court, in sustaining the Commissioner’s treatment of the
fee as a deduction, did not address the significance (or even
advert to the existence) of those provisions (discussed infra pp.
60-66).
35
Cotnam is a close-to-home example of a judge (Wisdom, J.)
writing both the majority opinion and a dissent. Although only
rarely does the judge who writes the majority opinion also write
separately in concurrence or dissent, it has happened in this
Court, Haserot v. Commissioner, 46 T.C. 864, 872-878 (1966)
(Tannenwald, J., “speaking separately”), affd. sub nom.
Commissioner v. Stickney, 399 F.2d 828 (6th Cir. 1968), and in
other courts, see, e.g. City of Baton Rouge v. Ross, 654 So.2d
1311, 1326 (La. 1995) (Calogero, C.J., concurring); Santa Clara
County Local Transp. Auth. v. Guardino, 902 P.2d 225, 256 (Cal.
1995) (Werdegar, J. dissenting); Dawkins v. Dawkins, 328 P.2d
346, 353 (Kan. 1958) (Jackson, J., concurring), no less than the
(continued...)
 - 60 -

statement of Judges Rives and Brown and Judge Wisdom’s dissent is

a disagreement about the application of traditional assignment of

income principles. The broader holding, which, the majority and

I agree, frames the issue on which the case at hand and other

contingent fee cases should be decided, is discussed below in

subpart ii. Of course, the majority agree with Judge Wisdom and

I agree with Judges Rives and Brown.

i. Narrow Ground--Significance of State Law

In deciding Cotnam v. Commissioner, supra, the majority of

the Court of Appeals, in the portion of the panel’s opinion

written by Judge Wisdom (hereinafter majority opinion), relied

heavily on two unusual characteristics of attorney’s liens under

Alabama law. The majority opinion noted that the Alabama

35
(...continued)
Supreme Court of the United States, see, e.g., Logan v. Zimmerman
Brush Co., 455 U.S. 422, 438-442 (1982) (separate opinion of
Blackmun, J.); Abbate v. United States, 359 U.S. 187, 196-201
(1959) (separate opinion of Brennan, J.); Wheeling Steel Corp. v.
Glander, 337 U.S. 562, 574-576 (1949) (separate opinion of
Jackson, J.); cf. Helvering v. Davis, 301 U.S. 619, 639-640
(1937) (opinion of Cardozo, J.); Andrew Crispo Gallery, Inc. v.
Commissioner, 16 F.3d 1336, 1343-1344 (2d Cir. 1994) (opinion of
Van Graafeiland, J.), affg., vacating and remanding in part T.C.
Memo. 1992-106; In re Estate of Sayre, 279 A.2d 51, 52 n.2 (Pa.
1971) (opinion of Bell, C.J.). As Justice Jackson said in
Wheeling Steel Corp. v. Glander, supra at 576: “It cannot be
suggested that in cases where the author is the mere instrument
of the Court he must forego expression of his own convictions.
Mr. Justice Cardozo taught us how justices may write for the
Court and still reserve their own positions, though overruled.
Helvering v. Davis, 301 U.S. 619, 639.” For discussions of the
practice, see Aldisert, Opinion Writing, 168-170 (1990);
Llewellyn, The Common Law Tradition: Deciding Appeals 494 (1960).
 - 61 -

attorney’s lien statute gave an attorney an interest in the

client's suit or cause of action, as well as the usual security

interest in any judgment or settlement the client might

eventually win or receive. See Cotnam v. Commissioner, 263 F.2d

at 125; United States Fidelity & Guar. Co. v. Levy, 77 F.2d 972,

975 (5th Cir. 1935) (cited by the majority opinion in Cotnam).

The majority opinion also noted that under the Alabama statute

"Attorneys have the same rights as their clients." Cotnam v.

Commissioner, 263 F.2d at 125. The majority opinion did not

explain in detail the sense in which attorneys' and clients'

rights were the same. However, the cases cited to support this

point make clear the majority opinion was referring to an

attorney's right, under Alabama law, to prosecute his client's

suit to a final judgment, even after the client has settled the

suit with the adverse party. See Denson v. Alabama Fuel & Iron

Co., 73 So. 525 (Ala. 1916); Western Ry. v. Foshee, 62 So. 500

(Ala. 1913).36

When we have not followed Cotnam, we have usually relied on

differences between the attorney’s lien law for the State in

issue and Alabama law. See, e.g., Estate of Gadlow v.

36
We recently followed the decision of the Court of Appeals
in Cotnam v. Commissioner, supra, where Alabama law applied. See
Davis v. Commissioner, T.C. Memo. 1998-248 (Tax Court constrained
to follow Court of Appeals’ Cotnam decision under rule of Golsen
v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th
Cir. 1971)), affd. per curiam F.3d (11th Cir. 2000). See
also Foster v. United States, F. Supp.2d (N.D. Ala. 2000).
 - 62 -

Commissioner, 50 T.C. 975 (1968) (distinguishing Pennsylvania

law); Petersen v. Commissioner, 38 T.C. 137 (1962) (Nebraska and

South Dakota law); Benci-Woodward v. Commissioner, T.C. Memo.

1998-395 (California law); Sinyard v. Commissioner, T.C. Memo.

1998-364 (Arizona law); Srivastava v. Commissioner, T.C. Memo.

1998-362 (Texas law); Coady v. Commissioner, T.C. Memo. 1998-291

(Alaska law). But see O'Brien v. Commissioner, 38 T.C. 707

(1962) (dictum that State law makes no difference), affd. per

curiam 319 F.2d 532 (3d Cir. 1963).37

Wisconsin law governed the attorney-client relationship

between Fox & Fox and Mr. Kenseth. Wisconsin law arguably gives

attorneys the two unusual interests in their clients' lawsuits

relied on by the majority opinion in Cotnam v. Commissioner, 263

37
Other Federal courts, in concluding that taxpayer-
plaintiffs are taxable on contingent fees paid to their
attorneys, have also noted that the State laws in issue do not
give attorneys proprietary or equitable interests in their
clients’ recoveries or causes of action. See Baylin v. United
States, 43 F.3d 1451, 1455 (Fed. Cir. 1995) (commenting on
Maryland attorney’s lien statute); Estate of Clarks v. United
States, 98-2 USTC par. 50,868, 82 AFTR 2d 7068 (E.D. Mich. 1998)
(distinguishing Cotnam v. Commissioner, supra, on the ground of
differences between Michigan and Alabama law), revd. 202 F.3d 854
(6th Cir. 2000)). My view that the tax effects of contingent fee
agreements should be decided on the broader ground makes it
unnecessary for me to take a position on the view of the Court of
Appeals for the Sixth Circuit that the Michigan common law
attorney’s lien is the equivalent of the proprietary interest of
the attorney in the cause of action under Alabama law.
 - 63 -

F.2d 119 (5th Cir. 1959).38 Although the narrow ground issue need

not detain us indefinitely, a few observations are in order.

Respondent argues that Wisconsin ethical rules prohibit an

attorney from acquiring a "proprietary interest" in a cause of

action he is pursuing for his client. See Wis. Sup. Ct. R.

20:1.8(j) (1998). That rule actually states, however, that "A

lawyer shall not acquire a proprietary interest * * * except that

the lawyer may: (1) acquire a lien granted by law to secure the

lawyer's fee or expenses; and (2) contract with a client for a

reasonable contingent fee in a civil case." Id. (Emphasis

added.) Therefore, the rule clearly permits an attorney to

acquire the interests in his client's cause of action

contemplated by the Wisconsin attorney’s lien laws; it also

suggests that those interests are proprietary interests.

38
See Smelker v. Chicago & N. W. Ry., 81 N.W. 994, 994
(Wis. 1900), which quoted the Wisconsin attorney’s lien statute
as originally enacted in 1891. Although Smelker is an old case,
diligent research has not disclosed any authority reversing it or
declaring it obsolete. It is cited and summarized as standing
for the propositions described in the text in 146 A.L.R. 67, 69
(1943) (“ANNOTATION. Merits of client’s cause of action or
counterclaim as affecting attorney’s lien or claim for his
compensation against adverse party, in case of compromise without
attorney’s consent”) and 7 Am. Jur. 2d, Attorneys at Law, sec.
323 (1997) (“Right to continue action client has settled”). Our
opinions distinguishing the decision of the Court of Appeals in
Cotnam v. Commissioner, supra, on the basis of differences in
State law have relied on Pennsylvania cases from 1852 and 1919,
and on Texas cases from 1913 and 1920. See Estate of Gadlow v.
Commissioner, 50 T.C. 975, 980 (1968) (distinguishing
Pennsylvania law); Srivastava v. Commissioner, T.C. Memo. 1998-
362 (Texas law).
 - 64 -

The majority respond with two observations in support of

respondent’s position: First, Wis. Stat. 757.36 has been revised

to give the attorney a lien “upon the proceeds or damages” as

well as “upon the cause of action.” The majority suggest that it

is no longer necessary to keep the underlying cause of action

alive in order effectively to assert an attorney’s lien under

Wisconsin law.

The majority also point to Wis. Sup. Ct. R. 20.1.16 and

20.1.2(a) (1998), which include the ethical rules that a client

may discharge an attorney at any time and that “a lawyer shall

inform a client of all offers of settlement and abide by a

client’s decision whether to accept an offer of settlement of a

matter.” The majority suggest that these rules mean that a

Wisconsin attorney cannot acquire an interest in a lawsuit that

would enable the attorney to continue to press it in the face of

the client’s expressed desire to settle, or at least that it

would be an ethical violation for the attorney to continue to

press a case that the client had settled or desired to settle.

Admittedly, the matter is unclear, bearing in mind that Section

III of the contingent fee agreement entered by Mr. Kenseth and

other class members with Fox & Fox provide that the client can

not settle his case without the consent of Fox & Fox, and that

the Preamble to the Rules of the Wisconsin Supreme Court

governing professional conduct for attorneys says that the rules
 - 65 -

are for disciplinary purposes; they are not supposed to affect

the substantive legal rights of lawyers and are not designed to

be a basis for civil liability.39

The Wisconsin courts have recognized the tension between the

client’s rights to terminate representation and the attorney’s

rights under contingent fee agreements and the statutory lien.

See Goldman v. Home Mut. Ins. Co., 126 N.W.2d 1 (Wis. 1964),

cited by respondent and the majority for the proposition that the

claim belongs to the client, not the attorney. However, what

Goldman actually said was more balanced:

it is not against public policy for a client to settle
his claim with the tortfeasor or his insurer without
participation and consent of the attorney before action
is commenced even though the client has retained
counsel. * * * The claim belongs to the client and
not the attorney; the client has the right to
compromise or even abandon his claim if he sees fit to
do so. * * *

We do not hold by inference that a contract
between client and attorney whereby the attorney is to
control the procedure of the prosecution of the claim,
nor that an agreement for a lien upon the cause of
action for attorney’s fees is against public policy
and, therefore, void. On the contrary, by virtue of
the attorney lien statutes and the common law we
recognize their validity. [Id. at 5.]

39
Compare Estate of Newhouse v. Commissioner, 94 T.C. 193,
232-233 (1990), regarding effect on valuation of a right of the
necessity of bringing a lawsuit to enforce it; presence of such
uncertainty equates with a reduction in claimant-assignor’s
degree of control; see also Estate of Mueller v. Commissioner,
T.C. Memo. 1992-284, on effects of threatened litigation on
possible nonconsumation of a stock acquisition as affecting value
of the stock.
 - 66 -

The Wisconsin courts have also recognized that although a

client may have the ultimate power to discharge an attorney or

settle a claim, the attorney has rights and remedies when the

client breaches or terminates a contingent fee agreement. For

example, in Tonn v. Reuter, 95 N.W.2d 261 (Wis. 1959), the

Wisconsin Supreme Court held that an attorney who had been

discharged without cause could sue his client for breach of

contract; the measure of damages was the contingent fee

percentage applied to the client’s ultimate recovery, less the

value of the services the attorney was not required to perform as

a result of the breach. And in Goldman v. Home Mut. Ins. Co.,

supra, the Wisconsin Supreme Court held that a plaintiff’s

attorney could sue the defendant for third-party interference

with contract rights, where the defendant settled with the

plaintiff, without the knowledge of the attorney.40

ii. Broader Ground--Federal Standard

I now turn to the broader ground of the decision of the

Court of Appeals in Cotnam v. Commissioner, supra, as announced

by Judges Rives and Brown, and as opposed by Judge Wisdom, and

40
If, on appeal of the case at hand to the Court of Appeals
for the Seventh Circuit, the Court of Appeals should wish to
obtain answers to any questions of Wisconsin law that the parties
have not resolved to its satisfaction, and which it regards as
bearing on the outcome, the Wisconsin Supreme Court has power
(not obligation) to entertain any such questions put to it by the
Court of Appeals under Wis. Stat. sec. 821.01 (1999) (Uniform
Certification of Questions of Law Rule).
 - 67 -

recently adopted by the Court of Appeals for the Sixth Circuit in

Estate of Clarks v. United States, supra. The primary point made

by Judges Rives and Brown was that in a practical sense the

taxpayer never had control over the portion of the recovery that

was retained by her attorneys. In my view, this broader ground

disposes of the case at hand in petitioners’ favor, independently

of the narrow ground.

Judge Wisdom’s dissent was very much in the vein that the

transaction was governed by the classic assignment of income

cases that he cited and relied upon: Helvering v. Eubank, 311

U.S. 122 (1940); Helvering v. Horst, 311 U.S. 112 (1940); and

Lucas v. Earl, 281 U.S. 111 (1930). After quoting at length from

Helvering v. Horst, supra, Judge Wisdom concluded:

This case is stronger than Horst or Eubank, since
Mrs. Cotnam assigned the right to income already
earned. She controlled the disposition of the entire
amount and diverted part of the payment from herself to
the attorneys. By virtue of the assignment Mrs. Cotnam
enjoyed the economic benefit of being able to fight her
case through the courts and discharged her obligation
to her attorneys (in itself equivalent to receipt of
income, under Old Colony Trust Co. v. Commissioner,
1929, 279 U.S. 716 * * *. [Cotnam v. Commissioner, 263
F.2d at 127.]

The majority in Cotnam also rejected the Commissioner’s and

Judge Wisdom’s reliance on Old Colony Trust Co. v. Commissioner,

279 U.S. 716 (1929), because a contingent fee agreement creates

no personal obligation. The only source of payment is the

recovery; if there is no recovery, the client pays nothing and
 - 68 -

the attorney receives nothing. I agree with this additional

point of the Court of Appeals majority in Cotnam.41

The points made by the Courts of Appeals in Cotnam and

Estate of Clarks v. Commissioner, supra, are not in complete

agreement, but their differences don’t invalidate the essential

on which they do agree. The Courts of Appeals in Cotnam and

Clarks agree that the value of the claim was speculative and

dependent on the services of counsel who was willing to take it

on a contingent fee basis to try to bring it to fruition. They

also agree that the only benefit the taxpayer could obtain from

his or her claim was to assign the right to receive a portion of

it (the contingent fee percentage) to an attorney in an effort to

collect the remainder and that such benefit does not amount to

full enjoyment that justifies including the fee portion in the

assignor’s gross income. The Courts of Appeals in Cotnam and

Clarks also agree that the proper treatment is to divide the

gross income between the client and the attorney, rather than to

41
Regarding the reliance of the Commissioner and Judge
Wisdom on Old Colony Trust Co. v. Commissioner, 279 U.S. 716
(1929), I observe, as did Judges Rives and Brown, that the
contingent fee was not one that the claimant (Mr. Kenseth) was
ever personally obligated to pay, even if there should be a
recovery. Under Sections IV and VIII of the contingent fee
agreement (unlike Section II, which personally obligated the
client to pay litigation expenses, as defined), the attorneys’
right to receive the fee was secured solely by the lien that
would attach to any recovery, which was the sole contemplated and
actual source of payment of the fee.
 - 69 -

include the entire recovery in the client’s income and to

relegate the client to a deduction that is not fully usable.

I am in complete agreement with Judges Rives and Brown and

the panel in Estate of Clarks that the assignment of income

doctrine should not apply to contingent fee agreements. A

contingent fee agreement is not an intrafamily donative

transaction, or even a transaction within an economic family,

such as parent-subsidiary, see United Parcel Serv. of Am., Inc.

v. Commissioner, T.C. Memo. 1999-268, or the doctors’ service

partnership and related HMO in United States v. Basye, 410 U.S.

441 (1973). Notwithstanding the attorneys’ fiduciary

responsibilities to their client, a contingent fee agreement is a

commercial transaction between parties with no preexisting common

interest that sharply reduces or eliminates the client’s dominion

and control over both the cause of action and any recovery. Our

decisions distinguishing (or just not following) the decision of

the Court of Appeals in Cotnam v. Commissioner, supra, have not

adequately considered the characteristics of contingent fee

agreements or the effect those characteristics should have in

deciding whether such agreements should be treated as assignments

of income to be disregarded for Federal income tax purposes.

I now address the points of the Court of Appeals for the

Sixth Circuit in Estate of Clarks v. United States, supra, that

go beyond the points of Judges Rives and Brown in Cotnam v.
 - 70 -

Commissioner, supra: that the contingent fee arrangement is (1)

like a partnership or joint venture or (2) a division of property

or transfer of a one-third interest in real estate, thereafter

leased to a tenant.

We rejected the first point in Bagley v. Commissioner, 105

T.C. 396, 418-419 (1995), affd. on other issues 121 F.2d 393 (8th

Cir. 1997), in holding that a contingent fee agreement does not

create a partnership or joint venture under section 7701(a)(2)

(see further discussion infra part 10).

The citation by the Court of Appeals for the Sixth Circuit

of Wodehouse v. Commissioner, 177 F.2d 881, 884 (2d Cir. 1949),

raises doubts about the second point. Wodehouse is just another

case that illustrates the proposition, see Chirelstein, Federal

Income Taxation 203 (8th ed. 1999), that interests in self-

created property rights, such as paintings, patents, and

copyrights, “are effectively assignable for tax purposes despite

the elements of personal services on the part of the assignor.”

Id.42

5. Significance of Control in Supreme Court’s
Assignment of Income Jurisprudence

The transfers of income or property at issue in the classic

cases on which the dissent of Judge Wisdom and this Court have

relied–-cases such as Lucas v. Earl, supra, and Helvering v.

42
A recent case that illustrates the proposition is Meisner
v. United States, 133 F.3d 654 (8th Cir. 1998).
 - 71 -

Horst, supra–-were intrafamily donative transfers.43 If given

effect for tax purposes, such intrafamily transfers would permit

family members to “split” their incomes and avoid the progressive

rate structure (a less pressing concern these days). In

addition, because the transferred item never leaves the family

group, the transferor may continue to enjoy the economic benefits

of the item as though the transfer had never occurred. See

Commissioner v. Sunnen, 333 U.S. 591, 608-610 (1948) (husband

transferred patent licencing contracts to wife; husband’s

indirect post-transfer enjoyment of royalty payments and other

benefits received by wife a factor favoring decision that

transfer was an invalid assignment of income); Helvering v.

Clifford, 309 U.S. 331 (1940) (husband created short-term trust

for wife’s benefit; intrafamily income-splitting possibilities

required special scrutiny of arrangement, and husband’s continued

43
The statement of facts in the third Supreme Court
decision relied on by the majority and the dissent of Judge
Wisdom, Helvering v. Eubank, 311 U.S. 122 (1940), does not reveal
whether the transfer at issue was intrafamily. However, the
majority opinion in Eubank contains no independent analysis; it
rests entirely on the reasoning of the Supreme Court’s opinion in
the intrafamily transfer companion case of Helvering v. Horst,
311 U.S. 112 (1940). In addition, in Commissioner v. Sunnen, 333
U.S. 591, 602-603 (1948), the Supreme Court described Eubank,
along with several other classic assignment of income cases, as
part of the “Clifford-Horst line of cases”, all involving
transfers within the family group. The Supreme Court in Sunnen
further stated that “It is in the realm of intra-family
assignments and transfers that the Clifford-Horst line of cases
has peculiar applicability.” Commissioner v. Sunnen, 333 U.S. at
605.
 - 72 -

indirect enjoyment of wife’s benefit a factor in decision to

treat husband as owner of trust). Contingent fee agreements

between client and attorney do not present these problems.

Equally importantly, in Lucas v. Earl, supra, and Helvering

v. Horst, supra, the transferor–-in part due to the family

relationship–-was found to have retained a substantial and

significant measure of control after the transfer over the income

rights or property transferred. The presence of such continuing

control is undoubtedly important in deciding whether a transfer

should be treated as an invalid assignment of income. As the

Supreme Court stated in Commissioner v. Sunnen, 333 U.S. at 604:

The crucial question remains whether the assignor
retains sufficient power and control over the assigned
property or over receipt of the income to make it
reasonable to treat him as the recipient of the income
for tax purposes. * * *

Or, as the Supreme Court wrote in Corliss v. Bowers, 281 U.S.

376, 378 (1930) (revocable trust created by husband for benefit

of wife and children treated as invalid assignment of income):

taxation is not so much concerned with the refinements
of title as it is with actual command over the property
taxed * * *. * * * The income that is subject to a
man’s unfettered command and that he is free to enjoy
at his own option may be taxed to him as his income,
whether he sees fit to enjoy it or not. * * *

I acknowledge, with 3 Bittker & Lokken, Federal Taxation of

Income, Estates, and Gifts 75-2 (2d ed. 1991), that efforts to

shift income have extended beyond the family to other economic

units. Courts have been alert, whatever the motivation of the

taxpayers before them, to forestall the tax success of
 - 73 -

arrangements that, if successful, would be exploited by others.

As a result, legislative and judicial countermeasures “have come

to permeate the tax law so completely that they sometimes

determine which of several parties to an ordinary business

transaction must report a particular receipt or can deduct a

liability.” Id. However, those observations don’t answer the

question. They just remind us that the taxpayer’s arguments

deserve strict scrutiny.

I also acknowledge that the assignor’s lack of retained

control may be trumped if the subject of the assignment is

personal service income.44 Unlike the trust and property cases,

Lucas v. Earl, supra, can be rationalized not so much on the

service provider’s retained control over whether or not he

works,45 “but on the more basic policy to ‘tax salaries to those

who earned them’”.46

My response is that Mr. Kenseth’s claim did not generate

personal service income. Even though the loss of past earnings

44
3 Bittker & Lokken, Federal Taxation of Income, Estates,
and Gifts 75-7 (2d ed. 1991).
45
The Court of Appeals in Estate of Clarks v. United
States, supra, misstates Lucas v. Earl, 281 U.S. 111 (1930), in
saying that in that case, as in Helvering v. Horst, supra, “the
income assigned to the assignee was already earned, vested and
relatively certain to be paid to the assignor”. As a matter of
fact, the assignment document in Lucas v. Earl had been executed
in 1901, long before the effective date of the 16th Amendment;
the taxable years in issue were 1920 and 1921. See Lucas v.
Earl, supra at 113.
46
Bittker & Lokken, supra, at 75-11; see also Chirelstein,
Federal Income Taxation 194-195, 214-216 (8th ed. 1999).
 - 74 -

as well as future income and benefits were taken into account in

computing his settlement recovery, Mr. Kenseth’s claim had its

origin in the rights inhering in a constitutionally or

statutorily protected status (e.g., age, sex, race, disability)

rather than a free bargain for services under an ongoing

employment relationship or personal service contract. Such

rights are no less alienable than other types of property rights

that may be bought and sold and otherwise compromised by payments

of money.47 Indeed, where a claim based on status, such as an

ADEA claim, is the subject of a contingent fee agreement, the

amount paid the attorney as a result of his successful

prosecution of the claim is much more personal service income of

the attorney than personal service income of the claimant,

however the claimant’s share of the income might be characterized

for tax purposes. Again, quoting Bittker & Lokken, supra at 75-

13, in a slightly different context: “If a metaphor is needed,

one could say that the pooled income is the fruit of a single

grafted tree, owned jointly by the parties to the agreement.”48

47
Perhaps, contrary to Maine, Ancient Law 100 (Everyman ed.
1931), more recent developments, which, in “progressive societies
has hitherto been a movement from Status to Contract,” have
shifted back to a greater emphasis on status as a source of
personal and property rights.
48
See discussions infra at 80-81 of the “two keys” simile
and at 90-97 of the cropsharing analogy.
 - 75 -

6. Substantial Reduction of Claimant’s Control by
Contingent Fee Agreement

When Mr. Kenseth executed the contingent fee agreement, he

gave up substantial control over the conduct of his age

discrimination claim. He also gave up total control of the

portion of the recovery that was ultimately received and retained

by Fox & Fox.

The contingent fee agreement provided that Mr. Kenseth could

not settle his case without the consent of Fox & Fox. It further

provided that, if Mr. Kenseth had terminated his representation

by Fox & Fox, that firm would still have a lien for the

contingent fee called for by the agreement, and all costs and

disbursements would become due and payable within 10 days.

Moreover, Mr. Kenseth was just one member of the class of

claimants represented by Fox & Fox. All these factors

contributed, as a practical matter, to the creation of

substantial barriers to Mr. Kenseth’s ability to fire Fox & Fox

and to hire other attorneys or to try to settle his case

himself.

Mr. Kenseth instead relied on the guidance and expertise of

Fox & Fox, and Fox & Fox made all strategic and tactical

decisions in the management and pursuit of Mr. Kenseth’s age

discrimination claim. Fox & Fox negotiated a net recovery (after

reduction by the contingent fee) that substantially exceeded the

settlement that the EEOC had recommended.
 - 76 -

i. “Contract of Adhesion”

For all these reasons it is clear, when Mr. Kenseth signed

the contingent fee agreement, that he gave up substantial

control-–perhaps all effective control–-over the future conduct

of his age discrimination claim. This is not surprising; a

contingent fee agreement in all significant respects amounts to a

“contract of adhesion”,49 defined by Black’s Law Dictionary 318-

319 (7th ed. 1999) as: “A standard-form contract prepared by one

party, to be signed by the party in a weaker position, usu. a

consumer, who has little choice about the terms”.50

I’m not suggesting that the contingent fee agreement would

be unenforceable;51 contracts of adhesion are prima facie

enforceable as written. See Rakoff, “Contracts of Adhesion: An

49
See Rakoff, “Contracts of Adhesion: An Essay in
Reconstruction”, 96 Harv. L. Rev. 1174, 1176-1177 (1983), which
sets forth seven characteristics that define a “contract of
adhesion”; all these characteristics are present in the
contingent fee agreement between Mr. Kenseth and Fox & Fox.
50
The landmark article that coined and gave currency to the
appellation “contract of adhesion” is, of course, Kessler,
“Contracts of Adhesion–-Some Thoughts About Freedom of Contract”,
43 Colum. L. Rev. 629 (1943). The less inflammatory term found
and used in Restatement, Contracts Second, sec. 211 (1979), is
“standardized agreement”. But see Corbin on Contracts, secs.
559A-559I (Cunningham & Jacobson, Cum. Supp. 1999).
51
Other than the uncertainty regarding enforceability of
the provision in Section III of the agreement that Mr. Kenseth
and the other claimants in the class action could not settle
their cases without the consent of Fox & Fox.
 - 77 -

Essay in Reconstruction”, 96 Harv. L. Rev. 1174, 1176 (1983).52

Nor do I suggest that the contingent fee agreement in the case at

hand operated unfairly so as to make it unenforceable. I do

suggest that the character of the agreement as a contract of

adhesion supports my ultimate finding that Mr. Kenseth as the

adhering party gave up substantial control over his claim, which

was the subject matter of the agreement.

ii. American Bar Foundation Contingent Fee Study

My ultimate finding in this case is not just the sympathetic

response of a “romantic judge”53 or an idiosyncratic reaction

divorced from the practical realities of the operation of

contingent fee agreements. My findings on Mr. Kenseth’s reduced

control over the prosecution and recovery of his claim are

supported by the recurring comments to the same effect in the

study by MacKinnon, Contingent Fees for Legal Services: A Study

of Professional Economics and Liabilities (American Bar

Foundation 1964). What is striking about the MacKinnon study,

which makes no mention of any tax questions, are its repeated

52
In a departure from traditional analysis, Rakoff, supra
at 1178-1179, asserts that adhesive contracts may exist in
otherwise competitive markets. This would appear to be the case
with respect to that segment of the market for legal services in
which contingent fee agreements are customarily used. There is
no reason to believe that much if any bargaining occurs with
respect to the other terms of contingent fee agreements
concerning the attorney’s lien and the contractual provisions for
its enforcement. So it appears in the case at hand.
53
See Glendon, A Nation Under Lawyers 151-173 (1994).
 - 78 -

references54 to the high degree of practical control that

attorneys acquire under contingent fee agreements over the

prosecution, settlement, and recovery of plaintiffs’ claims.

After Mr. Kenseth signed the contingent fee agreement, he

had absolutely no control over the portion of the recovery from

his claim that was assigned to and received by Fox & Fox as its

legal fee. The agreement provided that, even if Mr. Kenseth

fired Fox & Fox, Fox & Fox would receive the greater of 40

percent of any recovery on Mr. Kenseth’s claim or their regular

hourly time charges, plus accrued interest of 1 percent per

month, plus a risk enhancer of 100 percent of their regular

hourly charges (not exceeding the total recovery). The agreement

also stated that Mr. Kenseth gave Fox & Fox a lien on any

recovery or settlement. The agreement also provided that Mr.

Kenseth would not settle the claim without first obtaining the

approval of Fox & Fox.

As noted above, the contingent fee agreement between Mr.

Kenseth and Fox & Fox was not an intrafamily donative transaction

and did not occur within an economic group of related parties.

In addition, Mr. Kenseth’s control of his claim (and of any

recovery therefrom) was sharply reduced or eliminated by the

54
See MacKinnon, Contingent Fees for Legal Services: A
Study of Professional Economics and Liabilities 5, 21-22, 29, 62,
63, 64, 70, 73, 77, 78-79, 80, 196, 197, 211 (American Bar
Foundation 1964).
 - 79 -

contingent fee agreement. For all these reasons, the broader

ground of the decisions of the Courts of Appeals in Cotnam v.

Commissioner, 263 F.2d 119 (5th Cir. 1959), and Estate of Clarks

v. United States, 202 F.3d 854 (6th Cir. 2000), applies to the

case at hand. The contingent fee agreement did not effect an

assignment of income that must be disregarded for income tax

purposes under Helvering v. Eubank, 311 U.S. 122 (1940),

Helvering v. Horst, 311 U.S. 112 (1940), and Lucas v. Earl, 281

U.S. 111 (1930).

This conclusion provides an independent and sufficient

ground for the holding, decoupled from the narrow ground of

Cotnam and Estate of Clarks regarding attorneys’ ownership

interests in lawsuits under State law, that Mr. Kenseth’s gross

income in the case at hand does not include any part of the

settlement proceeds paid to the Fox & Fox trust account and

retained by Fox & Fox as its contingent fee.

The application of the decisions of the Courts of Appeals in

Cotnam and Estate of Clarks is not limited to situations in which

local law allows a transfer of a “proprietary” interest in the

claim to the attorney. These holdings apply to situations in

which the attorney obtains only the usual security interest in

the claim and its proceeds that is provided in most States.

It is noteworthy that neither the additional statement of

the Cotnam majority nor the dissent of Judge Wisdom referred to
 - 80 -

the Alabama law that provides for the transfer of a proprietary

interest in the claim to the attorney. The language of the

additional statement supports the offset approach in all

contingent fee situations in which the proceeds of the settlement

or judgment are pursuant to prearrangement paid directly to the

attorney (or to attorney and client as joint payees) with the

understanding that the attorney will calculate and pay himself

the fee and pay the balance to the client. To make the result

depend upon whether a technical ownership interest was

transferred under State law would make the outcome depend on

“attenuated subtleties” and “refinements” that, as Justice Holmes

said in Lucas v. Earl, supra at 114, and Judge Raum said in

O’Brien v. Commissioner, supra at 712, should be disregarded.55

iii. “Two Keys” Simile

The contingent fee situation is much like that in Western

Pac. R.R. Corp. v. Western Pac. R.R. Co., 345 U.S. 247, 277

(1953) (Jackson, J. dissenting), which concerned the respective

interests of former parent corporation and subsidiary in the tax

55
It also appears, notwithstanding that petitioners did not
argue the point in the case at hand, that plaintiffs in a class
action, such as Mr. Kenseth, in a legal and practical sense have
less control over the prosecution of their claims than a sole
plaintiff who has signed a contingent fee agreement. See Newberg
on Class Actions, sec. 5.25--Individual Settlements More
Difficult after Commencement of Class Action (3d ed. 1992).
Compare Eirhart v. Libbey-Owens-Ford Co., 726 F. Supp. 700 (N.D.
Ill. 1989), with Sinyard v. Commissioner, T.C. Memo. 1998-364,
and Brewer v. Commissioner, T.C. Memo. 1997-542, affd. without
published opinion 172 F.3d 875 (9th Cir. 1999).
 - 81 -

benefits of net operating losses arising in consolidated return

periods:

Each corporation then had a bargaining position.
The stakes were high. Neither could win them alone,
although each had an indispensable something that the
other was without. It was as if a treasure of
seventeen million dollars were offered * * * to whoever
might have two keys that would unlock it. Each of
these parties had but one key, and how can it be said
that the holder of the other key had nothing worth
bargaining for?

The tax position of Mr. Kenseth is stronger than that of

either claimant in the Western Pac. R.R. case. Justice Jackson’s

reference to the “treasure” is to a static, fixed, pre-determined

amount, the tax benefit from the net operating losses. When

attorney and client enter a contingent fee agreement, the amount

of the ultimate recovery is unknown; the recovery is determined

in a dynamic process in which the exercise of the experience and

skill of the attorney results both in some recovery and in an

increase in the value of that recovery. The attorney creates and

adds value; the efforts of the attorney contribute to--indeed he

may be solely responsible for--both the recovery and its

augmentation. Attenuated subtleties and refinements of title

have nothing to do with the practical realities of contingent fee

agreements and the relative interests of attorney and client in

any recovery that may ultimately be realized.
 - 82 -

7. Omissions and Distortions: the Majority Opinion

The majority opinion makes a caricature of the findings it

purports to adopt by ignoring some and distorting others.56

Some examples:

First, on the meaning and application of the term “control”:

neither “control” nor “lack of control” is a monolithic concept,

nor do they occupy opposite sides of the same coin. Many

elements or strands are braided into the ownership and control of

a claim or cause of action. The question is whether enough

elements of control over all or part of the claim are given up by

the client who enters into a contingent fee agreement to make it

inappropriate to include the entire amount of the recovery in the

client’s gross income. The correct answer is to allocate the

recovery in the first instance between attorney and client as

their interests may appear in accordance with the terms of the

contingent fee agreement.

Petitioner gave up substantial control over his claim, and

all control over the portion attributable to the contingent fee.

Even if Smelker v. Chicago & N.W. Ry., 81 N.W. 994, 994 (Wis.

1900) is no longer good law under the Wisconsin attorney’s lien

law and the Wisconsin ethical rules require an attorney to abide

by a client’s decision to accept an offer of settlement, the

56
In so doing, the majority opinion creates a mismatch
between findings of fact and opinion that is reminiscent of the
centaur in Greek mythology.
 - 83 -

contrary provision in the contingent fee agreement substantially

dilutes the control retained by the client, as shown by Tonn v.

Reuter, 95 N.W.2d 261 (Wis. 1959), and Goldman v. Home Mut. Ins.

Co., 126 N.W.2d 1 (Wis. 1964). Even if that provision of the fee

agreement should not be enforced in strict accordance with its

terms if it came to a lawsuit between the client and the first

attorney, that provision of the agreement creates considerable

uncertainty. That uncertainty means the client has far less

retained control over the prosecution of the claim than the

assignor of an interest in the income from his own future

services to third parties. Further, the client’s ability to fire

the attorney and hire another is severely limited by the

likelihood that liability for two sets of fees will result. So

much for the practical substance of the “ultimate control”

retained by the client who signs a contingent fee agreement.

The majority opinion distorts the taxpayer’s position by

stating, p. 26: “There is no evidence supporting petitioner’s

contention that he had no control over his claim.” First, there

is substantial evidence that petitioner suffered a substantial

reduction in his control over his claim; it’s right there in the

findings. Second, petitioners aren’t arguing that they had no

control; they’re just saying that their control was substantially

reduced. We’re not called upon to come up with relative

percentages of control; that would be a sterile exercise in
 - 84 -

trying to create an unnecessary appearance of certainty. The

substantial impediments petitioners subjected themselves to in

entering into the contingent fee agreement are enough to take

this case out of the traditional assignment of income situation,

where the assignor’s retained control is absolute and unfettered.

On page 27, the majority opinion uses the gross misnomer

“details” to characterize what Mr. Kenseth entrusted to Fox &

Fox. How can it be accurate to say that Fox & Fox was only

responsible for the “details of his [Mr. Kenseth’s] litigation”?

Mr. Kenseth and the other class members were able with the advice

of Fox & Fox to sign the severance agreement and receive

severance pay, as well as press their ADEA claims; this is

because APV and its attorneys had made a mistake in preparing the

severance agreement that was spotted by Fox & Fox. The findings

also note that EEOC had recommended that the claims be settled

for an amount 2.5 times smaller than what Fox & Fox was able to

negotiate. To quote from the findings:

Petitioner and the other members of the class
relied on the guidance and expertise of Fox & Fox in
signing the separation agreements tendered to them by
APV and then seeking redress against APV. Commencing
with the advice to petitioner that he could sign the
separation agreement with APV without giving up his age
discrimination claim, Fox & Fox made all strategic and
tactical decisions in the management and pursuit of the
age discrimination claims of petitioner and the other
class members against APV that led to the settlement
agreement and the recovery from APV. [Majority op. p.
12.]
 - 85 -

Further, Fox & Fox factored into the settlement an amount for

their fee that was grossed up in the total, so that the total net

recovery was still $1.9 million, almost twice EEOC’s original

valuation of the claim.

All this supports my conclusions that Fox & Fox added

substantial value to the raw claim as it existed immediately

prior to execution of the contingent fee agreement(s) and that

Fox & Fox was responsible for much more than mere “details”.

At page 25, the majority opinion says: “The entire ADEA

award was ‘earned’ by and owed to petitioner, and his attorney

merely provided a service and assisted in realizing the value

already inherent in the cause of action.” Is the majority

opinion saying that, at the time immediately prior to

petitioner’s entry into the contingent fee agreement, the claim

had the same value as the amount ultimately recovered? Of course

not; the uncertain speculative front end value had to be

discounted to reflect the time value of money and the risks of

litigation. Fox & Fox added substantial value to the claims of

Mr. Kenseth and his colleagues. Under the terms of the

contingent fee agreement, Fox & Fox’s shares of the recovery

should be taxed to them directly and not run through petitioner

and the other members of the class who never even had the chance

to kiss goodbye what they never became entitled to receive.
 - 86 -

8. Majority Opinion’s Handling of Authorities

The majority misstate the Alexander, Baylin, Brewer, and

O’Brien cases (majority op. pp. 14, 17-18, and 21, respectively)

and what they stand for.

The majority opinion at page 14 creates a misleading

impression about the significance of Alexander v. IRS, 72 F.3d

938, 948 (1st Cir. 1995), affg. T.C. Memo. 1995-51. The Court of

Appeals for the First Circuit did affirm the Tax Court, and the

Court of Appeals did say that applying the AMT to the itemized

deductions “smacks of injustice”, as indeed it did--the sum of

the legal fees and the additional tax liability exceeded the

taxpayers’ net taxable recovery. What the majority opinion omits

is that the taxpayer in Alexander did not argue, as petitioners

argue in the case at hand, that the legal fee should be excluded

from petitioner’s gross income because the assignment of income

rules don’t properly apply.57 There was both a taxable recovery–-

$250,000–-and a concededly non-taxable recovery–-$100,000–-and

the taxpayer deducted an allocable part of his legal fees

(computed on a disproportionate time basis, which the

Commissioner did not dispute) from the taxable recovery. The Tax

Court and the Court of Appeals for the First Circuit held,

57
Alexander v. IRS, 72 F.3d 938, 948 (1st Cir. 1995), affg.
T.C. Memo. 1995-51, lacked any findings as to whether the legal
fee in question was a contingent fee or a fee based on hourly
rates for which the taxpayer was personally liable.
 - 87 -

because the recoveries related to taxpayer’s wrongful termination

as an employee, that the fees so deducted by the taxpayer were

employee business expenses properly treated as itemized

deductions subject to the 2-percent floor and the AMT. In so

doing, the courts rejected the taxpayer’s argument that the

deductible legal fees were Schedule C expenses because,

notwithstanding his wrongful termination as an employee, he had

thereafter gone into the management consulting business as an

independent contractor. The settlement proceeds were

compensation ordinary income and did not represent amounts

received on the disposition of intangible assets. Consequently,

the legal fees were not incurred in a disposition and could not

be netted against the settlement proceeds received.58

58
Respondent argues in the alternative in the case at hand
that if Mr. Kenseth was able to assign an interest in his cause
of action to Fox & Fox, that assignment was itself a taxable
transaction. Mr. Kenseth entered into the contingent fee
agreement in 1991; that year is not before us. Therefore, we are
not required to consider the tax consequences, if any, of the
signing of the contingent fee agreement. See Schulze v.
Commissioner, T.C. Memo. 1983-263 (assignment of claim in 1975 by
husband to wife in connection with divorce shifted burden of
taxation on amounts recovered on that claim in 1976; we found it
unnecessary to consider the Commissioner's alternative argument
that the assignment was a taxable event in the earlier year,
because that year was not before us).

The Justice Department in its brief on appeal to the Court
of Appeals for the Eleventh Circuit in Davis v. Commissioner,
T.C. Memo. 1998-248, affd. per curiam F.3d (11th Cir.
2000) (see supra note 36), also made the alternative argument--
not raised by the Commissioner in the Tax Court--that the
contingent fee agreement is a transfer of an interest in the fee
(continued...)
 - 88 -

With respect to Baylin, the majority opinion says: “The

Court of Appeals for the Federal Circuit sought to prohibit

taxpayers in contingency fee cases from avoiding Federal income

tax with ‘skillfully devised’ fee agreements.” Majority op. p.

18. This language from Lucas v. Earl, which had to do with

protecting the progressive rate structure, obviously has no

bearing on latter-day contingent fee arrangements. I also

disagree with Baylin’s in effect applying Old Colony Trust Co. to

treat the fee, which becomes the lawyer’s share of the realized

claim, as an amount realized by the client that is properly

included in the sum of satisfactions procured by the client.

Even though the lawyer may not obtain legal ownership of the

claim, there is no denying that the lawyer acquires a substantial

economic interest in the ultimate recovery.

The majority opinion cites Brewer v. Commissioner, 172 F.3d

875 (9th Cir. 1999), affg. without published opinion T.C. Memo.

1997-542, as if it were substantial authority. Both the

unpublished opinion of the Court of Appeals and this Court’s

58
(...continued)
with a zero basis on which the taxpayer realized deferred income
or gain in the year of the recovery under the open transaction
theory. This argument really is nothing more than a restatement
of the anti-assignment of income argument that begs the question.
The question unanswered by the Justice Department and the
Commissioner is whether the taxpayer is entitled to treat the
contingent fee as a cost of obtaining the total recovery or an
offset that must be taken into account in computing gross income,
rather than including the entire recovery in gross income and
taking a separate deduction for the fee.
 - 89 -

memorandum opinion--the taxpayer was pro se--provide no more than

a lick and a promise on this point. The taxpayer in Brewer was a

member of a class of hundreds (women who had been discriminated

against in the recruiting, hiring, and training of sales agents

by the State Farm insurance companies). I find it incredible

that those claimants were all required to gross up their

recoveries and then deduct their respective shares of the legal

fees. I doubt that any member of such a large class had a

scintilla of control over the conduct of the class action.

The majority opinion’s quotations from O’Brien v.

Commissioner, 38 T.C. at 710, particularly, “Although there may

be considerable equity to the taxpayer’s position, that is not

the way the statute is written” (majority op. p. 21), ignore that

O’Brien and its antecedents and descendants were construing

statutory spreadback provisions, not applying the assignment of

income doctrine under section 22 of the 1939 Code, section 61 of

the 1954 or 1986 Code, or the 16th Amendment.

9. Preventing Tax Avoidance by Other Transferors

The majority state at page 14: “We perceive dangers in the

ad hoc modification of established tax law principles or

doctrines to counteract hardship in specific cases, and,

accordingly, we have not acquiesced in such approaches”.

Although the majority opinion does not spell out those dangers,

concerns have been expressed that adoption of my findings and
 - 90 -

conclusion would open the door to tax avoidance. My response to

such concerns is that the contingent fee agreement is a peculiar

situation, far removed from the intrafamily and other related

party transfers, including commercial assignments within economic

units, that generated and continue to sustain the assignment of

income doctrine. The result I espouse can be confined to the

contingent fee situation; the tools of legal reasoning remain

alive and well to enable the Commissioner and the courts to

defend the fisc against transferors who in other contexts might

seize upon my proposed result in this case to try to extend it

beyond its proper limits.

10. Cropsharing as Alternative to Joint
Venture/Partnership Analogy

The suggestion of the Court of Appeals in Estate of Clarks

v. United States, supra, that the contingent fee arrangement is

like a partnership or joint venture has intuitive appeal.

Posner, Economic Analysis of Law 624-626 (5th ed. 1998),

describes the contingent fee agreement not only as a high

interest rate loan that compensates the lawyer for the risk he

assumes of not being paid at all if the claim is unsuccessful and

for the postponement in payment,59 but also as a kind of joint

59
See also Garlock, Federal Income Taxation of Debt
Instruments 6-10 (1998 Supp.): “Thus, rights to wholly
contingent payments would be treated in accordance with their
economic substance”. Garlock also comments p. 6-33:

(continued...)
 - 91 -

ownership “(and a contingent fee contract makes the lawyer in

effect a cotenant of the property represented by the plaintiff’s

claim)”, id. at 625, which could also lead to partnership/joint

venture characterization.

Adoption of the partnership/joint venture analogy could

create problems that would require attention. It has been

suggested that partnership or joint venture characterization

would open the door to tax avoidance by attorneys who enter into

contingent fee agreements.60 Examples include the possibility

that attorneys would contend that partnership characterization

entitles them to distributive shares of the tax-free recoveries

in personal injury actions and to current deductions for the

59
(...continued)
Because many contracts for the sale of property that
call for contingent payments involve principal payments
that are wholly contingent, it is doubtful that these
contracts would be viewed as debt instruments and
accordingly would be subject to section 483 rather than
section 1274. * * *

It seems likely that a contingent fee contract would be treated
under a debt analysis as contingent as to both principal and
interest; both the principal and interest amounts could be
determined only when and if the claim is satisfied so as to give
rise to the lawyer’s entitlement to a fee, see Garlock supra at
4-21 and 22, and would not satisfy the form or substance
requirements of debt. As a result, there is obvious similarity
in substance if not in form to a partnership or joint venture
between attorney and client.
60
Kalinka, “A.L. Clarks’ Est. and the Taxation of
Contingent Fees Paid to an Attorney”, 78 Taxes 16, 18-20 (Apr.
2000).
 - 92 -

advances of costs they make to their clients.61 In addition,

local law and ethical rules prohibiting the assignment of claims

to attorneys would be obstacles to the making of the capital

contribution that is the prerequisite to the formation of a

partnership.62 See Luna v. Commissioner, 42 T.C. 1067 (1964), and

Estate of Smith v. Commissioner, 313 F.2d 724 (8th Cir. 1963),

affg. in part, revg. in part, and remanding 33 T.C. 465 (1959),

which rejected arguments by service providers that they had

entered into partnership agreements that entitled them to capital

gain treatment of what was held to be compensation income.63

Although I agree with our rejection in Bagley v.

Commissioner, 105 T.C. 396 (1995), of the partnership/joint

venture analogy, we did not go far enough in exploring the

consequences of other arrangements that don’t amount to

partnerships or joint ventures and yet result in the division of

61
See, e.g., Canelo v. Commissioner, 53 T.C. 217 (1969),
affd. 447 F.2d 484 (9th Cir. 1971).
62
Although secs. 1.721-1(a) and 1.707-1(a), Income Tax
Regs., contemplate arrangements in which a partner makes property
available for use by the partnership without contributing it to
the partnership, such arrangements are considered to be
transactions between the partnership and a partner who is not
acting in his capacity as a partner. If this were the only
transaction between the putative capital partner and the putative
partnership, it would appear that no contribution of property to
the partnership would have occurred.
63
Other examples of unsuccessful efforts by assignment to
transmute ordinary income into capital gain may be found in
Commissioner v. P.G. Lake, Inc., 356 U.S. 260 (1958), and Hort v.
Commissioner, 313 U.S. 28 (1941).
 - 93 -

the proceeds or income from an activity. Although section

301.7701-1(a)(2), Proced. & Admin. Regs., provides that certain

joint undertakings may give rise to entities for federal tax

purposes “if the participants carry on a trade, business,

financial operation, or venture and divide the profits

therefrom,” the examples that follow illustrating such

arrangements, also distinguish them from mere joint undertakings

to share expenses or arrangements by sole owners or tenants in

common to rent or lease property, such as cropsharing

arrangements.

One way to think of the contingent fee agreement, which

brings us back to the metaphor about fruits and trees, is to

analogize it to a cropsharing arrangement.64 Cropsharing is

strikingly similar to the contingent fee agreement. The attorney

is in the position of the tenant farmer, who bears all his direct

and overhead expenses incurred in earning the contingent fee (and

64
To adopt another agricultural metaphor, a claim, lawsuit,
or cause of action is, see Compact Oxford English Dictionary 1838
(1971), a “monocarp”, “a plant that bears fruit but once * * *.
Annuals and biennials, which flower the first or second year and
die, as well as the Agave, and some palms which flower only once
in 40 or 50 years and perish, are monocarpic. * * * The plant
itself is also completely exhausted, all its disposable formative
substances are given up to the seed and the fruit, and it dies
off (monocarpous plants)”. So the unsuccessful lawsuit dies off
without bearing fruit, but, with the successful husbandry of an
attorney who has entered into a contingent fee agreement with the
client, the lawsuit may come to fruition in a recovery, which is
shared by the client and attorney under the terms of the
agreement.
 - 94 -

the contingent fees under all such arrangements to which he is a

party with other clients). The client is in the position of the

landowner (lessee-sublessor), who bears none of the operating

expenses, but is responsible for paying the carrying charges on

his land, such as mortgage interest and real estate taxes. These

charges are analogous to court costs, which the client under a

contingent fee agreement is usually responsible for, and which

the attorney can only advance to or on behalf of the client.

It is apparently so clear that there is no direct authority

that cropsharing arrangements result in a division of the crops

and the total gross revenue from their sale in the agreed upon

percentages. See IRS Publication 225, Farmer’s Tax Guide 15-16

(1999). This income is characterized as rental income to the

owner or lessee of the land and farm income to the tenant-farmer.

See id.65

The analogy of contingent fee agreements to crop sharing

arrangements is suggestive and helpful. It solves the problem

under the attorney’s ethics rule that says the attorney is not

65
Probably the most litigated issue has been whether, under
the facts of each particular case, there has been “material
participation” by the owner or lessee so as to obligate him or
her to pay self-employment tax and to be entitled to Social
Security benefits. See, e.g., Davenport, Farm Income Tax Manual
sec. 303, “Rents Received in Crop Shares”, particularly “Material
Participation Trade-off”, pages 203-204 (1998 ed.); ALI-ABA,
Halstead, ed., Federal Income Taxation of Agriculture, ch. 2
Social Security and the Farmer, particularly 16-27 (3d ed. 1979).
 - 95 -

supposed to acquire an ownership interest in the cause of action

that is the subject of such an agreement. The client, like the

owner or lessee of farmland who rents it to the tenant farmer,

transfers to the attorney an interest in the recovery that is

analogous to the tenant farmer’s share of the crop generated by

his farming activities on the land leased or made available to

him by the non-active owner or sublessor.

1 McKee et al., Federal Taxation of Partnerships and

Partners, par. 3.02[5], at 3-15-16 (3d ed. 1997), cites Smith v.

Commissioner, supra, and Luna v. Commissioner, supra, among

others, for the following propositions:

A profit-oriented business arrangement is not a
partnership unless two or more of the participants have
an interest in the partnership as proprietors. Thus an
agreement to share profits is not a partnership if only
one party has a proprietary interest in the profit-
producing activity. For example, the owner of a
business may agree to compensate a hired manager with a
percentage of the income of the business, or a broker
may be retained to sell property for a commission based
on the net or gross sales price. Even though both
arrangements culminate in the division of profits,
neither constitutes a partnership unless the
arrangement results in the parties becoming
coproprietors.

The Culbertson intent test has its greatest
continuing viability in connection with the elusive
distinction between coproprietorship arrangements and
other arrangements for the division of profits. A
number of objective factors may be taken into account
in determining whether participants intend to operate
as coproprietors or to share profits as third parties
dealing at arm’s length.
 - 96 -

McKee et al. go on to discuss the characteristics of proprietary

profits interests, and other factors evidencing proprietary

interests, such as agreement to share losses, ownership of a

capital interest, participation in management, performance of

substantial services, and the intention to be a partnership,

which includes not only the intention to share profits as

coproprietors, but can also be evidenced by more mundane factors,

such as entry into a partnership agreement and the filing of

partnership returns. See Commissioner v. Culbertson, 337 U.S.

733 (1949); Luna v. Commissioner, supra at 1077-1078; Estate of

Smith v. Commissioner, supra.

McKee et al. at par. 5.03[2] n.120 again cite Estate of

Smith and other cases for the proposition that, if a service

provider obtains only an interest in future profits, the courts

have been reluctant to recognize the service provider as a

partner; instead they treat him as an employee or independent

contractor who has received nothing more than a promise of

contingent compensation in the future. Given the nature of the

attorney-client relationship, independent contractor is the

relationship that obtains under the contingent fee agreement.

Under this arrangement, as in Estate of Smith v. Commissioner,

supra, the profits are divided between the parties in the agreed

upon percentages. But the decision not to treat the arrangement

as a partnership assures that the income of the service provider
 - 97 -

retains its character as compensation ordinary income. The

service provider’s income does not take its character from the

property that belongs to the other party who made it available to

be worked on by the service provider.

Conclusion

The assignment of income cases decided by the Supreme Court

for the most part have arisen in intrafamily donative transfers.

Assignment of income cases arising in commercial contexts have

concerned attempts at income tax avoidance between related

parties. The touchstone of these cases has been the retained

control over the subject matter of the assignment by the

assignor.

The control retained by Mr. Kenseth in this case was much

less than the control retained by the assignor in any of the

cases in which the assignment of income doctrine has been

properly applied. Indeed, the control retained by Mr. Kenseth

was so much less as to make it unreasonable to charge him with

the full amount of his share of the total settlement, without

offset of the attorney’s fee apportioned against his share. From

the inception of the contingent fee agreement, a substantial

portion of any recovery that might be obtained was dedicated to

Fox & Fox, who through the mixture of their labor with the claims

of Mr. Kenseth and his colleagues, first, caused the claims to be
 - 98 -

realized under a settlement agreement, and, second, added

substantially to whatever speculative value those claims might

have had when the contingent fee agreements were entered into.

The Bankruptcy Court for the Middle District of Alabama said

it very well in recently applying Cotnam in Hamilton v. United

States, 212 Bankr. 212 (Bankr. M.D. Ala. 1997), a case that would

have been appealable to the Court of Appeals for the Eleventh

Circuit: “This decision does not limit taxation of the total

amount of the judgment as income. It merely apportions the

income to the proper entities”.

In conclusion, there should be no concern that giving effect

to my findings and conclusion will open the door to tax

avoidance. They are confined to a peculiar situation, far

removed from the intrafamily and other related party transfers

that generated and sustain the assignment of income doctrine.

The case at hand is not an appropriate occasion for application

of that doctrine. The gross income realized and received by Mr.

Kenseth and his colleagues should not be inflated to include the

contingent fee paid to their attorneys.