The opinion of the court was delivered by: SHADUR
MILTON I. SHADUR, UNITED STATES DISTRICT JUDGE
Counsel for the plaintiff class (the "Class") in this long-running class action have moved for an order directing defendants (collectively "LOF") not to file information returns with the Internal Revenue Service ("IRS") reporting, as income taxable to the Class members, LOF's payment in 1988 of attorneys' fees awarded to Class counsel. Both sides have their own special tax counsel, and both sets of counsel have argued that the IRS position on the inclusion of attorneys' fees in the taxable income of members of a benefited class is reflected in Rev. Rul. 80-364, 1980-2 C.B. 294 (the "Ruling"). That Ruling describes several situations in which plaintiffs' attorneys' fees were paid as a result of litigation or settlement and states the IRS stance on whether such fees are includable
in plaintiffs' income.
According to the parties, the only question for decision here is whether the situation in the current case is more like that described in Situation 1 or Situation 3 of the Ruling. After taking into consideration the submissions of Class counsel as well as LOF's objections, this Court grants the motion of Class counsel and directs LOF not to file the disputed returns with IRS, but for reasons somewhat different from those urged by Class counsel.
In Situation 1 an individual filed a complaint against a company for back pay on his own behalf and the court awarded him 8x dollars in back pay, 1x dollars in interest and an attorney's fee of 1x dollars. Upon those bare-bones facts IRS held the award of the attorney's fees would be included in the employee's gross income.
In Situation 3 a union filed an action against a company for breach of a collective bargaining agreement. After the union and the company then entered into a settlement agreement that provided for payment to the union of 40x dollars in full settlement of all claims, the union paid 6x dollars to its attorneys for their services and distributed the remaining 34x dollars among the employees for back pay in proportion to the employees' claims. There IRS ruled the amount paid by the union for attorneys' fees was not includable in the gross income of the individual employees. Instead IRS characterized the payment as "a reimbursement for expenses incurred by the union to enforce the collective bargaining agreement."
Class counsel argue the current case is more like Situation 3 than Situation 1, so that IRS would not view the part of the LOF fund paid out as attorneys' fees as income reportable by the Class members. Their P. Mem. 2-3 characterizes the distinction between Situations 1 and 3 this way:
In Situation 1, the individual plaintiff obviously incurred a direct obligation to compensate his or her attorney, and derived a direct benefit from the court's order that the attorney's fee be paid by the defendant.. . . In Situation 3, however, the individual members who shared in the group recovery won by their representative incurred no obligation to compensate the attorneys hired by the representative and, therefore, did not enjoy a comparable direct benefit from having the attorney's fees paid by someone else.
According to Class counsel, the test this Court should use to determine whether or not attorneys' fees would be includable in the income of the Class members is whether the money allocated to attorneys' fees "belonged" to the members of the Class but was paid to discharge an obligation of the Class members to their attorneys. Applying that test, Class counsel urge this Court to find that the funds paid to them did not belong to the members of the Class because (1) no individual Class members incurred a direct obligation to pay the attorneys' fees whether the Class won or lost the case and (2) the amount belonging to the individuals could be determined only after the attorneys' fees were subtracted from the group-wide award.
LOF suggests the distinction between Situations 1 and 3 stems instead from the status of the union as an intervening entity, and it argues the Class in this case is not an analogous entity.
LOF notes that in Situation 1 the plaintiff brought his action on his own account and derived a direct benefit from the payment of his attorneys' fees. He was the party to the lawsuit, and therefore he was reimbursed for the attorneys' fees incurred. In Situation 3, on the other hand, the union apparently brought the action for breach of the collective bargaining agreement on its own behalf and for its own reasons.
In the Title VII scheme of 42 U.S.C. § 2000e-5(k) ("Section 2000e-5(k)"), the union was the party whose attorneys' fees were reimbursed, and therefore the union was the entity that should bear the tax burden (if any) resulting from that reimbursement.
This Court does not agree with either side's explanation of the Ruling as dispositive here. Their respective weaknesses may be examined in turn.
Second, the fact that the amount "belonging" to members of the plaintiff Class cannot be determined until after the attorneys are paid either fails to distinguish this case from any other or begs the question that Class counsel purport to be asking. No victorious plaintiff can ever know how much the judgment or award will actually swell his or her bank account until the bill from his or her attorney is known. That is true of individual as well as class actions, or whether or not a plaintiff is irrevocably obligated to pay his or her attorney, or whether or not the attorney is operating on a contingency fee basis, or whether the fees are paid from defendants to plaintiffs or directly to the attorneys out of a common fund. If, on the other hand, Class counsel are using the term "belonging" as a term of art that conveys the idea that the funds do not belong in a taxable sense to the Class members, they are merely stating an ipse dixit conclusion.
On the other hand, LOF's focus on the union as an entity is not really convincing either. In particular, back pay awards resulting from union litigation are taxed to the union members as income and, because the union is merely acting as the agent of its members, such an award results in no income to the union itself. LOF fails to explain why the other reasons behind the union's bringing of the action outweigh its purpose to act as its members' agent and to obtain a benefit for them -- so much so as to shift the entire tax burden away from the primary beneficiaries. In addition, the Class has some attributes of an entity in common with the union (not the least of which is its obvious ability to sue and be sued), and this ...