                      T.C. Memo. 1998-395



                    UNITED STATES TAX COURT



  IVOR F. AND DEBRA A. BENCI-WOODWARD, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



    Docket Nos. 3769-96, 4185-96,        Filed November 9, 1998.
                8265-96.


         In these consolidated cases, R determined
    deficiencies in Ps' Federal income taxes for their 1992
    taxable year due to their failure to include in gross
    income certain punitive damages and interest arising
    out of a State court lawsuit. (Ps now concede that all
    amounts received as punitive damages, plus interest,
    are includable in gross income as determined by R. See
    O'Gilvie v. United States, 519 U.S. 79 (1996).) R
    allowed Ps miscellaneous itemized deductions for legal
    fees and costs attributable to their punitive damages
    awards pursuant to sec. 67, I.R.C. However, in
    computing Ps' alternative minimum tax (AMT)
    adjustments, R disallowed their miscellaneous itemized
    deductions pursuant to sec. 56(b)(1)(A)(i), I.R.C.



     1 Cases of the following petitioners are consolidated
herewith: Laurentz J. and Barbara Mangum, docket No. 4185-96,
and Jose and Dianne M. Ragatz, docket No. 8265-96.
                               - 2 -

          1. Held: Ps' deductions for legal expenses
     attributable to punitive damages are miscellaneous
     itemized deductions, deductible to the extent they
     exceed 2 percent of adjusted gross income. Sec. 67,
     I.R.C; sec. 1.67-1T(a)(1)(ii), Temporary Income Tax
     Regs., 53 Fed. Reg. 9875 (Mar. 28, 1988).

          2. Held, further, miscellaneous itemized
     deductions for legal expenses related to punitive
     damage awards are not allowed for purposes of
     calculating AMT. Sec. 56(b)(1)(A)(i), I.R.C.;
     Alexander v. Commissioner, 72 F.3d 938 (1st Cir. 1995),
     affg. T.C. Memo. 1995-51, applied.

          3. Held, further, Ps' gross income includes their
     punitive damage awards unreduced by attorney's fees
     (and costs). Cotnam v. Commissioner, 263 F.2d 119 (5th
     Cir. 1959), affg. in part and revg. in part 28 T.C. 947
     (1957), distinguished.



     Philip Garrett Panitz, for petitioners.

     Mark A. Weiner, for respondent.



                        MEMORANDUM OPINION

     NIMS, Judge:   In these consolidated cases, respondent

determined the following deficiencies with respect to the Federal

income taxes of petitioners Ivor F. and Debra A. Benci-Woodward

(the Benci-Woodwards), Laurentz J. and Barbara Mangum (the

Mangums), and Jose and Dianne M. Ragatz (the Ragatzes):

                         Docket No. 3769-96
                       (the Benci-Woodwards)

               Year                      Deficiency
               1992                      $321,002
                                - 3 -

                          Docket No. 4185-96
                             (the Mangums)

                  Year                    Deficiency
                  1992                    $314,873

                          Docket No. 8265-96
                            (the Ragatzes)

                  Year                    Deficiency
                  1992                    $316,965

     Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect for the year in

issue.   All Rule references are to the Tax Court Rules of

Practice and Procedure.    All dollar amounts are rounded to the

nearest dollar.

     After concessions by petitioners, the issues remaining for

decision are:   (1) Whether legal expenses attributable to

petitioners' receipt of punitive damages constitute miscellaneous

itemized deductions within the meaning of section 67(b); if so,

(2) whether such deductions are subject to disallowance for

purposes of computing petitioners' alternative minimum tax (AMT)

liability; and (3) whether attorney's fees and costs may be

excluded from gross income under the facts of this case.

     These cases were submitted fully stipulated.      The

petitioners resided in California at the time they filed their

petitions.
                                - 4 -

                             Background

     Ivor F. Benci-Woodward (Benci-Woodward), Laurentz J. Mangum

(Mangum), and Jose Ragatz (Ragatz) (collectively referred to

herein as the plaintiffs) filed a lawsuit (lawsuit) against

Dayton-Hudson, Inc. (Dayton-Hudson), and Dana Pereau (Pereau)

(collectively referred to herein as the defendants).   Plaintiffs

brought the following causes of action, among others, against the

defendants:    False imprisonment, fraud, defamation, intentional

infliction of emotional distress, wrongful discharge, and breach

of contract.

     In connection with the lawsuit, Benci-Woodward, Mangum, and

Ragatz each entered into a Retainer Agreement (Agreement) with

John H. Howard, an attorney, which empowered him to "handle any

and all legal proceedings arising out of said incidents", and

further provided, among other things, that

          Client agrees to pay Attorney for services a sum equal
     to forty percent (40%) of any amounts received or recovered
     in this matter on behalf of Client. Attorney may retain his
     share out of the amount finally collected by settlement or
     judgment, herein termed "recovery", in full for the services
     and any advanced costs.

          Attorney is given a first lien and assignment on any
     recovery however procured to the extent of this contract and
     such amounts may be retained therefrom. Attorney is given a
     further lien and assignment on any sums recovered herein for
     fees incurred for all legal work performed for client
     whatsoever and such amounts shall be in addition to the
     contingent fee and costs provided for in this agreement.
                               - 5 -

     A jury trial was held before Judge Melinda A. Johnson of the

Superior Court of California, County of Ventura, on April 23,

1990.   Verdict was entered on July 11, 1990.   In addition to

awards for compensatory damages, each plaintiff was awarded

punitive damages in the amount of $1,190,000, plus interest, from

Dayton-Hudson.   Furthermore, Ragatz and Mangum were each awarded

punitive damages in the amount of $16,000 from Pereau, plus

interest, and Benci-Woodward was awarded $12,000 in punitive

damages, plus interest, from Pereau.   Dayton-Hudson paid its

portion of both the compensatory and punitive damage awards in

full to Howard's trust account.

     According to a Breakdown dated October 8, 1992, supplied by

Howard to Benci-Woodward, the latter was entitled to receive a

net combined amount from Dayton-Hudson and Pereau of $915,097,

consisting of judgment amounts, interest, and costs paid by

Dayton-Hudson, less attorney's fees and certain costs advanced by

Howard and another.   The $915,097 was disbursed by Howard to

Benci-Woodward out of the trust account.

     According to a Breakdown dated October 8, 1992, supplied by

Howard to Ragatz, the latter was entitled to receive a net

combined amount from Dayton-Hudson and Pereau of $881,226,

consisting of judgment amounts, interest, and costs paid by

Dayton-Hudson, less attorney's fees, costs advanced by Howard,
                               - 6 -

and certain other miscellaneous items.   The $881,226.03 was

disbursed by Howard to Ragatz out of the trust account.

     The details of the disbursement to Mangum are not in the

record.

     Petitioners did not report their punitive damages awards as

taxable income on their respective 1992 tax returns, although the

Benci-Woodwards and the Mangums disclosed the awards on their

returns.   In addition, petitioners did not report in full their

interest on punitive damages on their respective 1992 returns.

     Respondent timely issued notices of deficiency to

petitioners.   Among other adjustments, respondent determined that

punitive damages and related interest were fully includable in

petitioners' gross income pursuant to section 61.   Petitioners

have since conceded that their punitive damages, and related

interest, are includable in gross income in the amounts

determined by respondent.   See O'Gilvie v. United States, 519

U.S. 79 (1996).

     Respondent also determined that the Benci-Woodwards, the

Mangums, and the Ragatzes were entitled to miscellaneous itemized

deductions, subject to the 2-percent floor provided by section

67(a), for attorney's fees and costs attributable to the punitive

damages awards in the amounts of $670,135, $626,448, and

$609,767, respectively.   However, for AMT purposes, respondent
                                - 7 -

disallowed petitioners' miscellaneous itemized deductions for

legal fees completely, and determined AMT liability for the

Benci-Woodwards, the Mangums, and the Ragatzes in the respective

amounts of $85,009, $73,787, and $75,694.

     Howard reported on Schedule C, Profit or Loss From Business

(Sole Proprietorship), attached to his 1992 individual tax return

as gross receipts from his legal practice all of the attorney's

fees he received from plaintiffs.

                             Discussion

     The dispute here concerns the appropriate treatment for the

legal fees and costs attributable to punitive damages that the

plaintiffs incurred in pursuing their lawsuit against the

defendants.   Section 67(a) imposes a 2-percent floor on the

miscellaneous itemized deductions of individuals for all taxable

years beginning after December 31, 1986.    In other words,

miscellaneous itemized deductions may be taken only to the extent

that they exceed 2 percent of an individual taxpayer's adjusted

gross income.    Miscellaneous itemized deductions are defined in

section 67(b) as those itemized deductions that are not

specifically enumerated therein.    Legal expenses related to the

production or collection of income and thereby deductible under

section 212(1), as here, are not specifically enumerated in

section 67(b).
                              - 8 -

     Petitioners argue that Congress never intended legal

expenses attributable to punitive damages to fall within the

category of miscellaneous itemized deductions.   In that

connection, petitioners maintain that

     Since punitive damage awards were not definitively
     determined to be taxable until recently, there was no
     prior need for a determination that attorney fees
     should be allowed as an itemized deduction excluded
     from the miscellaneous itemized deduction "catch-all"
     of section 67(b).

     Petitioners cite no authority in support of their

proposition, and their argument is, in fact, untenable.    The

treatment of legal expenses attributable to punitive damages as

miscellaneous itemized deductions results from the purely

mechanical application of section 67.   Moreover, such treatment

accords with the treatment of legal fees attributable to damages

awarded in, or settlements connected with, contractual disputes,

for example, which have always been subject to tax.   Alexander v.

Commissioner, 72 F.3d 938 (1st Cir. 1995), affg. T.C. Memo. 1995-

51; see also Brewer v. Commissioner, T.C. Memo. 1997-542 (holding

that a deduction for legal fees attributable to settlement of

Title VII gender discrimination suit is a miscellaneous itemized

deduction subject to the 2-percent floor); Glassman v.

Commissioner, T.C. Memo. 1997-497 (holding that section 212
                                 - 9 -

deduction for legal fees is a miscellaneous itemized deduction

subject to section 67(a)).

     Had Congress intended to except legal fees attributable to

taxable punitive damages from the 2-percent limitation of section

67(a), it easily could have done so.     It did not, and we must

interpret the statute as it is written.     See United States v. Ron

Pair Enters., Inc., 489 U.S. 235, 241 (1989); see also Estate of

Young v. Commissioner, 81 T.C. 879, 890 (1983) (Chabot, J.,

concurring), where it is observed that "our task is to interpret

the statute that the Congress enacted and not to guess at what

the Congress would have done had it faced the matter we deal with

in the instant case".

     We hold that legal expenses incurred in connection with the

receipt of punitive damages constitute miscellaneous itemized

deductions within the meaning of section 67(b).     Having so held,

we must also decide whether miscellaneous itemized deductions for

legal expenses related to receipt of punitive damages are subject

to disallowance pursuant to section 56(b)(1)(A)(i) for purposes

of computing petitioners' AMT.

     Since 1969, the Internal Revenue Code has included minimum

tax provisions for both corporate and individual taxpayers.     Tax

Reform Act of 1969, Pub. L. 91-172, 83 Stat. 487.    Congress

enacted the minimum tax to prevent corporate and individual
                              - 10 -

taxpayers from aggregating deductions to the point where they pay

either no tax or a "shockingly low" tax.    First Chicago Corp. v.

Commissioner, 842 F.2d 180, 181 (7th Cir. 1988), affg. 88 T.C.

663 (1987).

     The post-1986 AMT rules, codified as sections 55 through 59,

were enacted to achieve one overriding objective:   To establish a

floor for tax liability, so that a taxpayer pays some tax

regardless of the tax benefits available to him under the regular

income tax (RIT).   See S. Rept. 99-313 (1986), 1986-3 C.B. (Vol.

3) 515, 518.   The AMT is paid only if, and to the extent that, it

exceeds the taxpayer's RIT.   Sec. 55(a).   Computing AMT liability

begins with determining alternative minimum taxable income

(AMTI).   AMTI is computed in the same manner as regular taxable

income except that the adjustments provided in sections 56 and 58

are taken into account for AMTI, and so-called tax preference

items set forth in section 57 are not permitted to reduce AMTI.

Sec. 55(b)(2).

     Section 56(b) provides as follows:

          (b) Adjustments Applicable to Individuals.--In
     determining the amount of the alternative minimum
     taxable income of any taxpayer (other than a
     corporation), the following treatment shall apply (in
     lieu of the treatment applicable for purposes of
     computing the regular tax):

               (1) Limitations on deductions.--

                   (A) In general.--No deduction shall be
               allowed--
                              - 11 -

                      (i) for any miscellaneous itemized
                   deduction (as defined in section 67(b))
                   * * * [Emphasis added.]

     Thus, since we have already concluded that the legal

expenses at issue are miscellaneous itemized deductions within

the meaning of section 67(b), it follows that they are not

allowed for purposes of computing petitioners' AMT liability.

Alexander v. Commissioner, supra; sec. 56(b)(1)(A)(i); sec. 1.67-

1T(a)(1)(ii), Temporary Income Tax Regs., 53 Fed. Reg. 9875 (Mar.

28, 1988).

     Petitioners acknowledge that section 56(b)(1)(A)(i)

expressly disallows miscellaneous itemized deductions for

purposes of computing AMT.   However, petitioners alternatively

assert that the application of the AMT in the instant cases

unfairly creates "a circumstance of double taxation", inasmuch as

petitioners and attorney Howard must pay tax on the same amount

recovered from the defendants.   Petitioners' argument on this

score is unavailing.   See, e.g., Alexander v. Commissioner, supra

at 947 ("It is well established that equitable arguments cannot

overcome the plain meaning of the statute.").

     We hold that petitioners' legal expenses are miscellaneous

itemized deductions subject to disallowance pursuant to section

56(b)(1)(A)(i) for purposes of computing petitioners' AMT

liability for their 1992 taxable years.
                              - 12 -

     Petitioners argue in the alternative that they are in the

"identical position as the taxpayers in Cotnam and Davis."     See

Cotnam v. Commissioner, 263 F.2d 119 (5th Cir. 1959), affg. in

part and revg. in part 28 T.C. 947 (1957); Davis v. Commissioner,

T.C. Memo. 1998-248.   While as to the salient facts this may be

true, petitioners' legal position is not the same.

     In Cotnam v. Commissioner, supra at 125, the Court of

Appeals for the Fifth Circuit concluded that under 46 Ala. Code

sec. 64 (1940), attorneys have the same right over "suits,

judgments, and decrees for money" as their clients, so the

taxpayer in that case did not realize income as to her attorneys'

interests of 40 percent in her cause of action and judgment.

Davis v. Commissioner, supra, involving the case of a taxpayer

who was a resident of Alabama, followed Cotnam.   See Golsen v.

Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir.

1971).

     The law of Alabama, as analyzed in Cotnam, is not the law of

California, the State of petitioners' residence during all times

relevant here.   The parties have not brought to our attention any

statute of California regulating attorney's liens, and we are

aware of none.   Nevertheless, the case law of California is clear

that liens for attorney's fees, whether created expressly or

implied from a retainer agreement, do not transfer to the

attorney an ownership or proprietary interest in the client's
                              - 13 -

cause of action.   In an en banc opinion, Isrin v. Superior Court

of Los Angeles County, 403 P.2d 728, 732 (Cal. 1965), the Supreme

Court of California concluded that contingent fee agreements "do

not operate to transfer a part of the cause of action to the

attorney but only give him a lien upon his client's recovery."

     Petitioners also argue that cases which have addressed the

taxability of punitive damages have consistently analyzed those

damages net of attorney's fees and costs.   Petitioners cite

Hawkins v. United States, 30 F.3d 1077 (9th Cir. 1994); O'Gilvie

v. United States, 66 F.3d 1550 (10th Cir. 1995), affd. in part,

revd. on the issue of taxability of punitive damages 519 U.S. 79

(1996); and Commissioner v. Miller, 914 F.2d 586 (4th Cir. 1990),

revg. and remanding 93 T.C. 330 (1989), supplemented by T.C.

Memo. 1993-49.

     In both Hawkins v. United States, supra, and O'Gilvie v.

United States, supra, the respective Courts appear to have

accepted, without further consideration or discussion, the

premise that the question to be resolved was the taxability of

punitive damages, net of attorney's fees and costs.   In

Commissioner v. Miller, supra, the Court of Appeals for the

Fourth Circuit reversed a prior Tax Court decision holding that

punitive damages are exempt from tax.   The taxpayer had obtained

a jury verdict awarding $500,000 in compensatory damages and

$450,000 in punitive damages, which was settled for an overall
                               - 14 -

amount of $900,000, the taxpayer receiving a net of $525,000

after attorney's fees and costs.    On remand, the Court of Appeals

provided the Tax Court with instructions on possible methods of

valuing the punitive damage portion of the settlement, stating

that "It is appropriate for the case to be remanded to the Tax

Court to permit a determination as to what portion of the

$900,000 gross amount in settlement (reduced to $525,000 net) was

attributable to punitive damages."      Id. at 592.   (Emphasis

added).    The Court of Appeals does not explain its reason for

reducing the $900,000 gross amount to the $525,000 net amount,

before the directed allocation between punitive and compensatory

damages.

     With the exception of Cotnam v. Commissioner, supra, and

Davis v. Commissioner, supra (which, as noted, followed Cotnam

under the Golsen rule), courts, when directly confronted with the

question, have uniformly rejected the contention that taxpayers

may exclude the amount of their legal fees and costs from gross

income in cases such as the one before us.     Since the courts in

the 3 cases cited by petitioners were not so confronted, and

therefore did not have the occasion to focus directly on the

issue, we decline to accept those cases as precedent for the

proposition that petitioners' gross income is to be determined

net of their attorney's fees (and costs).     For examples of recent
                             - 15 -

cases which have distinguished Cotnam, see Sinyard v.

Commissioner, T.C. Memo. 1998-364; Srivastava v. Commissioner,

T.C. Memo. 1998-362; and Coady v. Commissioner, T.C. Memo. 1998-

291, and additional cases cited therein.   We hold that

petitioners' gross income includes their punitive damage awards

unreduced by their attorney's fees (and costs).

     To reflect the foregoing and petitioners' concessions,



                                   Decisions will be entered

                              for respondent.
