                        T.C. Memo. 1998-364



                      UNITED STATES TAX COURT



     JAMES T. SINYARD AND MONIQUE T. SINYARD, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11056-96.                 Filed October 7, 1998.



     David P. Pearson and Paul W. Markwardt, for petitioners.

     Mary E. Dean, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     SWIFT, Judge:   Respondent determined a deficiency in

petitioners’ Federal income tax for 1992 in the amount of

$115,679.

     The issue for decision is whether $252,608, among other

funds, awarded in class action lawsuits is excludable from

petitioner James T. Sinyard's income.
                              - 2 -

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for 1992.   References to

petitioner are to James T. Sinyard.


                        FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

At the time the petition was filed, petitioners resided in

Scottsdale, Arizona.

     In 1989, petitioner joined two class action lawsuits pending

in the U.S. District Court for the District of Minnesota (namely,

Glass v. IDS Fin. Servs., Inc., Civ. No. 4-89-76 (Glass), and

Stephens v. IDS Fin. Servs., Inc., Civ. No. 4-89-115 (Stephens).

The law firm of Winthrop and Weinstine represented the class

plaintiffs.

     In the original and amended complaints in Glass and in

Stephens, it was alleged that IDS Financial Services, Inc., IDS

Life Insurance Co., and IDS Financial Corp. (IDS):   (1) Engaged

in a pattern and practice of age discrimination against older

division managers employed by IDS in violation of the Age

Discrimination in Employment Act of 1967 (ADEA), Pub. L. 90-202,

81 Stat. 602, the Employee Retirement Income Security Act of 1974

(ERISA), Pub. L. 93-406, 88 Stat. 829, and State law; (2) imposed

illegal chargebacks against its division managers; and (3)

intentionally inflicted emotional distress on certain of its
                              - 3 -

employees; and relief was requested in the form of, among other

things, punitive damages and attorney's fees.

     At the time the classes closed in Glass and Stephens, a

total of 32 class plaintiffs had joined in the lawsuits.

      ADEA class actions generally constitute opt-in class

actions and, after closure of the class, only plaintiffs who have

already elected to do so may be part of the class.   The Glass and

Stephens actions both constituted opt-in class actions of which

petitioner was an opt-in member.

     The class plaintiffs in the Glass and Stephens actions,

including petitioner, entered into contingency fee agreements

with Winthrop and Weinstine under which it was provided that the

class plaintiffs would be obligated to reimburse Winthrop and

Weinstine for out-of-pocket expenses and to pay Winthrop and

Weinstine attorney's fees on a contingency fee basis.   The

agreements provided that out-of-pocket expenses incurred during

pendency of the actions would be billed by Winthrop and Weinstine

to the class plaintiffs on a monthly basis and fees due Winthrop

and Weinstine under the contingency fee agreements would be

billed at the conclusion of the actions.

     Under the specific contingency fee agreement that petitioner

herein entered into on September 18, 1989, with regard to payment

of attorney's fees, it was provided, among other things, as

follows:
                               - 4 -

      in the event of a recovery, Winthrop and Weinstine will
      be paid one-third (1/3) of the monetary amount obtained
      in the lawsuit, whether by settlement or jury award.

and

      In the event that an award of attorney's fees is
      received by you as a plaintiff, then that award will be
      considered as part of your total recovery with one-
      third of the amount to be paid to Winthrop and
      Weinstine and the remainder to be retained by you.


      Under May 29, 1990, amendments to the contingency fee

agreements, it was provided that the amount of attorney's fees

would be "determined from the total monetary award actually

received by each plaintiff."

      Correspondence from Winthrop and Weinstine to class action

plaintiffs dated October 2, 1989, stated:


      Any court-awarded attorney's fees would be part of your
      recovery from which the contingent fee will be
      calculated.


      Correspondence from Winthrop and Weinstine to class action

plaintiffs dated May 24, 1990, stated:


           There are also some other categories of damages
      asserted by all plaintiffs collectively. The first of
      these is attorney's fees. Whether proceeding on a
      contingent basis (as we are here) or on an hourly
      basis, the prevailing plaintiffs in an employment
      discrimination case are entitled to receive an award of
      attorney's fees.

and
                                - 5 -

          After considering these various matters, the Steering
     Committee has unanimously recommended to their fellow
     plaintiffs that attorney's fees, sanctions, costs and
     disbursements and similar awards which are not
     individualized to any particular plaintiff should be awarded
     equally on a pro rata basis to every plaintiff. For
     example, if the plaintiffs collectively receive a $3,200,000
     award for attorney's fees for prevailing in the action, then
     each individual plaintiff would be entitled to $100,000 of
     that award.


     During pendency of the Glass and Stephens class actions,

Winthrop and Weinstine mailed routine billings to class members.

These billings detailed the nature of out-of-pocket legal

expenses incurred.

     The amount of out-of-pocket expenses that, during the

litigation, were billed, charged to, and paid by individual class

plaintiffs varied depending on, among other things, financial

circumstances of the individual plaintiffs.

     During pendency of the class actions, petitioner paid $4,050

to Winthrop and Weinstine in reimbursement of out-of-pocket

expenses incurred by Winthrop and Weinstine.

     On or about April 16, 1990, a motion by the U.S. Equal

Employment Opportunity Commission (EEOC) to intervene in the

Glass and Stephens class actions was granted.    Therein, EEOC

sought a permanent injunction against IDS to prohibit IDS from

engaging in any further discrimination against its employees on

the basis of age.    The EEOC also sought an order requiring IDS to

institute and carry out policies, practices, and programs to
                                - 6 -

provide equal opportunity for individual employees of IDS age 40

and older.

       The injunctive relief sought by EEOC was prospective in

nature and intended to benefit all employees of IDS including

employees who were plaintiffs in the Glass and Stephens class

actions.    Intervention by EEOC in the Glass and Stephens class

actions enhanced the merits of the class action lawsuits against

IDS.

       Legal services of Winthrop and Weinstine on behalf of the

class action plaintiffs complemented the legal services of EEOC’s

attorneys, and vice versa.

       On November 21, 1991, in the Glass and Stephens class

actions, the District Court granted partial summary judgment in

favor of IDS and against the class action plaintiffs dismissing

certain breach of contract, ERISA, and tort claims made against

IDS.    Some of the legal services performed by Winthrop and

Weinstine prior and subsequent to November 21, 1991, were

attributable to the advancement of plaintiffs' contract and ERISA

claims.

       In early August of 1992, a comprehensive settlement in the

Glass and Stephens class actions was entered into in which IDS

agreed to pay $35 million to resolve all remaining claims

relating to the above class actions, including claims for

litigation costs and attorney's fees.
                                - 7 -

     On August 26, 1992, the District Court approved the terms of

the comprehensive settlement.

     Under terms of the settlement, the parties agreed and

stipulated that (based on the total settlement amount of $35

million to be awarded to the class plaintiffs) the amount of

attorney's fees owed to Winthrop and Weinstine was $11,166,666

(one-third of the total settlement amount after deduction of out-

of-pocket expenses).

     The calculation under the settlement agreement of attorney's

fees in the amount of $11,166,666 used the same formula for the

calculation of attorney's fees that was specified in the

contingency fee agreements that the class plaintiffs had entered

into with Winthrop and Weinstine (namely one-third of the total

settlement amount after deduction of out-of-pocket expenses).

     Pursuant to the settlement, out-of-pocket expenses in the

total amount of $1.5 million were first deducted from the total

award of $35 million.   One-third of the $33.5 million balance of

the $35 million award was then allocated to lost wages of the

class plaintiffs; one-third of the $33.5 million balance was

allocated to tort claims of the class plaintiffs; and one-third

of the $33.5 million balance was allocated to attorney's fees.

     With respect to the portion of the settlement award

allocated to lost wages of the class plaintiffs, IDS issued

separate checks directly to the individual class plaintiffs from

which Federal and State income taxes were withheld.
                              - 8 -

     With respect to the portions of the settlement award

allocated to tort claims of the class plaintiffs and attorney's

fees, IDS issued a single check directly to Winthrop and

Weinstine in the total amount of $23,783,333, of which

$12,616,666 represented the portion allocated to tort damages and

$11,166,666 represented the portion allocated to attorney's fees.

The total proceeds from this check were deposited into a trust

account on behalf of the class action plaintiffs.

     In the instant case, the parties have stipulated that the

$862,906 that petitioner received under the above settlement is

allocable as follows:


          $273,573   ---
                       Back wages and taxable as ordinary income;
          $109,429   ---
                       Tort damages and excludable from income;
          $164,144   ---
                       Tort damages and includable in income;
          $ 63,152   ---
                       Attorney's fees attributable to tort
                       damages excludable from income and
                       therefore also excludable from income;
          $252,608 --- Attorney's fees attributable to taxable
                       portion of funds received and the tax
                       treatment of which is in dispute herein.


     On their 1992 individual joint Federal income tax return, of

the total $862,906 in funds that was received from IDS on

petitioner’s behalf, petitioners did not report as income the

$252,608 portion of the funds that was attributable to attorney's

fees allocable to the taxable portion of the funds received.

     On audit, respondent determined that the $252,608 relating

to attorney's fees constituted taxable income to petitioners and
                               - 9 -

is deductible to petitioners only as a miscellaneous itemized

deduction under section 67.


                              OPINION

     Attorney's fees and costs awarded to prevailing parties in

litigation generally are treated as received by the parties, not

by the attorneys, and as items of taxable income to the

prevailing parties.   See Alexander v. Commissioner, 72 F.3d 938,

946-947 (1st Cir. 1995), affg. T.C. Memo. 1995-51; Baylin v.

United States, 43 F.3d 1451, 1455 (Fed. Cir. 1995); Bagley v.

Commissioner, 105 T.C. 396, 418-419 (1995), affd. 121 F.3d 393,

395-396 (8th Cir. 1997); Estate of Gadlow v. Commissioner, 50

T.C. 975, 979-980 (1968); Petersen v. Commissioner, 38 T.C. 137,

151-152 (1962); Coady v. Commissioner, T.C. Memo. 1998-291; Hayes

v. Commissioner, T.C. Memo. 1997-213; Hardin v. Commissioner,

T.C. Memo. 1997-202; Martinez v. Commissioner, T.C. Memo.

1997-126.

     Also, taxpayers generally are treated as realizing taxable

income when their expenses are paid by another.   Sec. 61;

Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955).     The

Supreme Court in Old Colony Trust Co. v. Commissioner, 279 U.S.

716, 729 (1929), stated that "The discharge by a third person of

an obligation to him is equivalent to receipt by the person

taxed."   See also United States v. Boston & Me. R.R., 279 U.S.

732, 734 (1929).
                               - 10 -

     In ADEA cases, it is established that only the prevailing

parties, not the parties' attorneys, have standing to seek

attorney's fees.   Benitez v. Collazo-Collazo, 888 F.2d 930, 933

(1st Cir. 1989); Soliman v. Ebasco Servs., Inc., 822 F.2d 320,

323 (2d Cir. 1987); Brown v. General Motors Corp., 722 F.2d 1009,

1011 (2d Cir. 1983); Rainsbarger v. Columbia Glass & Window Co.,

600 F. Supp. 299, 301-302 (W.D. Mo. 1984).

     We recognize that there is case law treating amounts

received in litigation to cover attorney's fees as not

constituting taxable income.   In Cotnam v. Commissioner, 263 F.2d

119 (5th Cir. 1959), affg. in part and revg. in part 28 T.C. 947

(1957), the taxpayer entered into a contingency fee agreement

with her attorneys under which the taxpayer agreed to pay her

attorneys 40 percent of any funds recovered.   In Cotnam, we held

that the contingency fee agreement did not transfer any interest

in the judgment to the attorneys, and we held that the attorney's

fees that were awarded were to be included in the taxpayer's

income.   Cotnam v. Commissioner, 28 T.C. at 954.

     The Court of Appeals for the Fifth Circuit reversed and held

that under Alabama law the effect of the contingency fee

agreement was to establish in favor of the attorneys an equitable

lien on 40 percent of the funds recovered, and the Court of

Appeals concluded that the portion of the funds allocated to

attorney's fees was to be treated as owned by the attorneys, not

by the taxpayer, and therefore that the funds allocated to
                              - 11 -

attorney's fees did not constitute income to the taxpayer.

Cotnam v. Commissioner, 263 F.2d at 125, citing 46 Ala. Code sec.

64 (1940).

     In Davis v. Commissioner, T.C. Memo. 1998-248, we followed

the Court of Appeals opinion in Cotnam but only because the same

Alabama law and the same appellate venue were involved as in

Cotnam.   See Golsen v. Commissioner, 54 T.C. 742 (1970), affd.

445 F.2d 985 (10th Cir. 1971); see also In re Hamilton, 212

Bankr. 384 (Bankr. M.D. Ala. 1997), applying Alabama law and

following Cotnam.

     Respondent disagrees with the Court of Appeals for the Fifth

Circuit, and respondent continues to assert that, as we held in

Cotnam, notwithstanding the peculiarities of State law, under

contingency fee agreements attorneys do not acquire ownership of

those portions of funds recovered in lawsuits allocable to

attorney's fees, and the attorneys’ clients are taxable on the

full amount of the funds recovered in spite of any lien the

attorneys may have thereon.

     In this case, petitioner resided in Arizona when he filed

his petition herein.   The parties, however, have not cited any

provision of Arizona statutory law, and we have found none, that

pertains to the legal rights of Arizona attorneys in monetary

awards recovered on behalf of their clients.

     Decisions by Arizona courts have addressed this issue only

to a limited extent.   In Skarecky & Horenstein, P.A. v. 3605 N.
                               - 12 -

36th St. Co., 825 P.2d 949, 951 (Ariz. Ct. App. 1991), it was

held that under Arizona Rules of Professional Conduct attorneys

are not permitted to acquire proprietary interests in funds

recovered on behalf of their clients until after the judgments

are rendered.    17A Ariz. Rev. Stat. Sup. Ct. Rules, 42 Prof.

Conduct, ER 1.8(j)(1985); see also State Farm Mut. Ins. Co. v.

St. Joseph's Hosp., 489 P.2d 837, 840-841 (Ariz. 1971), which

held that Arizona attorneys have no right to attorneys' liens

against funds recovered on behalf of their clients until after

judgments are rendered or settlements are entered into.

     It thus appears that, in Arizona, attorneys do not have the

same substantive rights in funds recovered on behalf of their

clients as do attorneys in Alabama.     In Arizona, the total funds

recovered constitute property of the clients.    Based on the

foregoing, this case is distinguishable from Cotnam v.

Commissioner, supra, decided by the Court of Appeals for the

Fifth Circuit.

     In the Glass and Stephens class actions, the documentation

is extensive to the effect that petitioner was entitled to and

received an award of $862,906, one-third of which was then used

to pay the $273,573 portion of the attorney's contingency fees

for which petitioner was obligated.

     Petitioners rely on Eirhart v. Libbey-Owens-Ford Co., 726

F. Supp. 700 (N.D. Ill. 1989), in which it was held that the

defendant need not file information returns with respondent
                                - 13 -

reporting as taxable income the portion of funds awarded that was

allocable to attorney's fees.    The court based its holding on a

common fund theory that would appear to be applicable only to

opt-out class actions in which, as of the time fees are awarded,

not all members of a class have become identified or

contractually obligated to compensate the attorneys who perform

legal services for the members' benefit.   This may occur where

members of a class are unknown until the conclusion of the

lawsuit and in opt-out class actions.

     In opt-out class actions, persons must affirmatively decline

to be a member of the class or they are automatically members of

the class.   In these opt-out class actions, there may be policy

reasons to treat funds recovered and used to pay attorney's fees

as nontaxable to the class members (namely, additional members of

the class may later be identified and held responsible for a

portion of the legal fees).

     On the other hand, in opt-in class actions such as the Glass

and Stephens class actions against IDS, members must

affirmatively join the class to be considered class members.    The

consequence of not specifically joining opt-in class action is

that the person not joining the class is not entitled to share in

the funds recovered by settlement or judgment.

     Thus, in the opt-in class action lawsuits against IDS, when

the class closed, all class plaintiffs were identified, and
                              - 14 -

current and former employees of IDS who did not join were

notified that they were not entitled to share in any recovery.

     Petitioner asserts that the attorney's fees were not awarded

to him personally, but rather that they were awarded directly to

Winthrop and Weinstine.   Petitioner points to the fact that

Winthrop and Weinstine was the sole payee on the $23,783,333

check that included the portion of the funds recovered allocable

to attorney's fees, and petitioner argues that under ADEA an

award of attorney's fees is authorized directly to the

plaintiffs' attorneys.

     We note that the $23,783,333 check included the $12,616,666

portion of the award allocated to tort damages awarded to the

class action plaintiffs and that the total amount of this check

was deposited into a trust account in favor of the class action

plaintiffs.   Presumably, if the class action plaintiffs had no

interest in the portion of the funds allocable to attorney's

fees, two checks would have been requested, and each check would

have been deposited into separate accounts -- one for the class

action plaintiffs in the amount of $12,616,666 representing the

tort damages received and one for Winthrop and Weinstine in the

amount of $11,166,666 representing the attorney's fees.

     The relevant documentation in the Glass and Stephens class

action lawsuits against IDS repeatedly acknowledges that

attorney's fees would be owed by the class plaintiffs and that
                              - 15 -

amounts allocated and to be used to pay attorney's fees were to

be awarded to the class plaintiffs, not to the attorneys.

     Petitioners argue that because the class action lawsuits

provided benefits to persons other than the class plaintiffs, the

attorneys acted as private attorneys general.    We note that

Winthrop and Weinstine never sought relief on behalf of unnamed

plaintiffs.   Injunctive relief on behalf of all employees of IDS

was sought by the EEOC.   Correspondence mailed by Winthrop and

Weinstine to potential class members explained that employees of

IDS not joining the class would not receive any damages.    It was

EEOC, not Winthrop and Weinstine, that requested broader relief

that would extend beyond the class plaintiffs.

     In summary, the $252,608 portion of the total award received

by petitioner from IDS in the class action lawsuits that is

allocable to attorney's fees and that is in dispute herein is to

be included in the taxable income of petitioner.



                                    Decision will be entered

                               for respondent.
