Benci-Woodward

The question before us is whether the taxpayers may exclude from gross income the portion of a punitive damages award retained by their attorney pursuant to a contingent fee agreement. The answer is no and is dictated by our recent case of Coady v. Commissioner, 213 F.3d 1187 (9th Cir.2000). Although Coady involved analysis of an attorney lien under Alaska law, the result is the same under California law. We have jurisdiction pursuant to 26 U.S.C. § 7482 (a)(1), and we affirm the decision of the Tax Court.

BACKGROUND

Petitioners, who were employees of Target Stores, filed a lawsuit in California state court against Dayton-Hudson, Inc. (of which Target is a division) and Dana Pereau. The complaint, stemming from events arising out of an employer investigation, alleged false imprisonment, defamation, intentional infliction of emotional distress, wrongful discharge in violation of public policy, breach of an implied-in-fact employment contract, breach of the implied covenant of good faith and fair dealing, constructive discharge, and intentional misrepresentations. In connection with their legal representation, Petitioners entered into a Retainer Agreement with their attorney that…