A new law enacted in October 2004 will make it easier for attorneys to settle civil rights and employment discrimination cases. The American Jobs Creation Act of 2004 (AJCA) incorporates a portion of the Civil Rights Tax Relief Act (CRTRA) relating to the taxability of attorney’s fees in certain cases. The Act was supported by pro-employer groups, such as the US Chamber of Commerce, as well as the plaintiffs bar. The AJCA changed a provision of a law enacted in 1996 that sometimes made it difficult for employment lawyers to settle cases.

In the Small Business Job Protection Act of 1996, Congress made taxable all damage awards not based on “physical injuries or physical sickness. ” This meant that employment discrimination awards involving back pay or non-physical injuries, including emotional distress claims not stemming from physical injuries or sickness, were taxable. Therefore, when a plaintiff received a verdict or a settlement in an employment discrimination case, the portion that was designated attorney’s fees was “double-taxed,” as both the plaintiff and the attorney had to pay taxes on the fee award. An award of attorney’s fees and costs was includible in income and was treated as a miscellaneous itemized deduction (“below the line” deduction), subject to the 2% of adjusted gross income on such deductions. If the plaintiff did not itemize deductions or was subject to the alternative minimum tax, then no portion of the attorney’s fees was deductible. The IRS took this position, even though the plaintiff was never in possession of the attorney’s fees portion of the judgment. The result was that plaintiffs could owe more in taxes than they received from the judgment or settlement. This was burdensome for settlement purposes as it sometimes significantly increased the amount needed by plaintiffs. Both parties had to consider tax co