Civil Rights Settlements and Taxation: When Attorney’s Fees Are Deductible Under IRC §62

By Zaher Fallahi, Tax Attorney & CPA

In the context of litigation recoveries, one of the most consequential—and frequently misunderstood—tax issues is whether attorney’s fees are deductible “above the line.” This determination can dramatically affect a taxpayer’s net recovery.

For plaintiffs involved in civil rights litigation, Congress has provided a critical safeguard under IRC §62(a)(20) and §62(e) allowing qualifying attorney’s fees to be deducted in arriving at adjusted gross income (AGI). Proper classification of the underlying claim is therefore essential.

This article provides a structured overview of what constitutes a “civil right” or “unlawful discrimination” claim for purposes of §62, with practical guidance for taxpayers and advisors.

1. Employment Discrimination (The Most Common Category)

Employment-related discrimination claims are the clearest and most frequent examples of qualifying civil rights actions.

Common Examples:

• Race discrimination
• Gender discrimination
• Sexual harassment / hostile work environment
• Pregnancy discrimination
• Age discrimination
• Disability discrimination
• National origin discrimination
• Religion-based discrimination

Governing Statutes:

• Title VII of the Civil Rights Act of 1964
• Americans with Disabilities Act
• Age Discrimination in Employment Act

These claims fall squarely within the definition of “unlawful discrimination” under IRC §62(e).

2. Retaliation Claims

Retaliation is often pled alongside discrimination and is independently recognized as a qualifying claim.

Typical Scenarios:

• Termination after reporting discrimination
• Adverse action following an HR complaint
• Retaliation for cooperating with an EEOC investigation
• Whistleblower retaliation

Courts and the IRS generally treat retaliation claims as part of the civil rights framework.

3. Whistleblower Protection Cases

Employees who report illegal conduct may be protected under several federal statutes, many of which fall within §62(e).

Examples:

• Financial fraud
• Securities violations
• Healthcare fraud
• Government contract fraud

Relevant Laws:

• Sarbanes-Oxley Act
• False Claims Act
• Dodd-Frank Act

These claims are often treated as “civil rights-type” claims for tax purposes.

4. Police Misconduct & Constitutional Violations

Claims against government actors for violations of constitutional rights are classic civil rights cases.

Examples:

• Excessive force
• Unlawful arrest
• Illegal search and seizure
• Wrongful imprisonment

Legal Basis:

• 42 U.S.C. § 1983

5. Housing Discrimination

Housing-related discrimination claims are also covered under civil rights law.

Examples:

• Refusal to rent based on race
• Disability discrimination
• Denial of reasonable accommodations
• Discriminatory lending practices

Governing Law:

• Fair Housing Act

6. Education Discrimination

Discrimination in educational settings may qualify under §62(e).

Examples:

• Gender discrimination in schools
• Denial of equal educational opportunity
• Disability discrimination in education

Statutes:

• Title IX
• Section 504 of the Rehabilitation Act

7. Immigration / National Origin Discrimination

Discrimination based on nationality or immigration status may fall within the civil rights framework.

Examples:

• Refusal to hire due to nationality
• Discriminatory employment verification practices
• Harassment based on immigration status

These claims are typically addressed under Title VII’s national origin provisions.

8. Other Civil Rights Violations

Additional qualifying claims may include:

• Voting rights violations
• Freedom of speech violations (government actors)
• Religious discrimination
• Gender identity discrimination

Why This Matters: Tax Consequences of Civil Rights Settlements

Proper classification of a claim under IRC §62(e) has substantial tax implications:

✔ Attorney’s fees are deductible above the line
✔ Prevents taxation on the gross settlement amount
✔ Reduces exposure to the “phantom income” problem

Authority:

• Internal Revenue Code §62(a)(20)
• Internal Revenue Code §62(e)

Without this treatment, plaintiffs may be taxed on the full recovery—including amounts paid directly to attorneys—resulting in inequitable outcomes.

Practical Guidance for Clients and Advisors

When analyzing a settlement or pending claim, a critical threshold question is:

“Under what law was the claim brought?”

If the answer includes:

• EEOC complaint
• Title VII claim
• ADA claim
• Age discrimination claim
• Retaliation or wrongful termination tied to discrimination

Then the claim will generally qualify under IRC §62(e).

Final Observations

From a tax controversy perspective, the classification of a legal claim is not merely academic—it directly determines the economic outcome for the client.

Careful structuring of pleadings, settlement agreements, and allocations is essential to preserve favorable tax treatment. Failure to do so may result in unintended and avoidable tax liabilities.

About the Author

Zaher Fallahi, Attorney at Law, CPA
Dual-licensed Tax Attorney and Certified Public Accountant with extensive experience in federal and international tax controversy, civil rights–related settlement taxation, and complex litigation support.

Offices:
Los Angeles (Downtown Financial District)
Orange County (South Coast Plaza Area)

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