Applying the federal tax law in effect prior to the 1996 amendments to section 104(a) of the Internal Revenue Code, the Sixth Circuit held in Banks v. CIR that the proceeds from the settlement of plaintiff's claims under 42 U.S.C. 1981, 42 U.S.C. 1983, and Title VII were taxable income (and not for personal injuries), but that the contingent fee part of the settlement was excludable from plaintiff's gross income, in a case settled in California.
The opinion notes that unlike the Sixth Circuit, the Fourth Circuit says contingent fees are not excludable from gross income, citing Young v. Comm’r, 240 F.3d 369 (4th Cir. 2001). This looks like a good case for the Supreme Court, because the issue comes up every day - what are the tax consequences of settling a case?