Above-the-Line Deduction: Attorney Fees in Discrimination Cases

If you settled or won a discrimination case, federal tax law lets you take an above-the-line deduction for attorney fees in discrimination cases, meaning you subtract the fees directly from gross income on Schedule 1 rather than claiming them as an itemized deduction. The authority is Internal Revenue Code Section 62(a)(20), with a parallel provision at Section 62(a)(21) for whistleblower awards. The deduction is capped at the amount of the settlement or judgment you include in gross income for the tax year.¹

Why This Deduction Exists

The Supreme Court held in Commissioner v. Banks that when a legal recovery counts as income, the plaintiff’s taxable income includes the portion paid to the attorney as a contingency fee.² So a $100,000 discrimination settlement is $100,000 of income to you even if $40,000 goes straight to your lawyer.

Before 2004, the only offset was a miscellaneous itemized deduction subject to a 2% AGI floor and the alternative minimum tax. The American Jobs Creation Act of 2004 replaced that treatment with the above-the-line deduction for discrimination and whistleblower cases.³ That fix became indispensable after the Tax Cuts and Jobs Act of 2017 eliminated miscellaneous itemized deductions, an elimination the One Big Beautiful Bill Act made permanent. Section 62(a)(20) is now the only route to deduct these fees at all.

Which Cases Qualify

Section 62(e) defines “unlawful discrimination” broadly. Common qualifying federal statutes include:

Title VII of the Civil Rights Act of 1964 (race, color, religion, sex, national origin)
The Americans with Disabilities Act
The Age Discrimination in Employment Act⁴
The Family and Medical Leave Act (retaliation)
The Fair Labor Standards Act (wage and hour)
The National Labor Relations Act
The Fair Housing Act
The Rehabilitation Act, the Employee Polygraph Protection Act, the WARN Act, Title IX, ERISA retaliation, and civil rights claims under 42 U.S.C. §§ 1981, 1983, and 1985¹

State and Local Claims

Section 62(e)(18) extends the definition to any federal, state, or local law, or common law, that either enforces civil rights or regulates any aspect of the employment relationship. State-law wrongful termination claims, wage theft claims, workplace retaliation claims, and claims under state human rights laws or local anti-discrimination ordinances qualify on the same footing as a Title VII claim.¹ Tax preparers unfamiliar with employment cases sometimes miss this and route the fees to the wrong line or drop them entirely.

Federal Whistleblower Retaliation

Section 62(e)(17) covers any federal whistleblower protection provision that prohibits retaliation for reporting violations or asserting rights under federal law. Terminations tied to OSHA safety reports, Sarbanes-Oxley disclosures, or any other federal whistleblower statute produce qualifying fees.

Whistleblower Award Programs

Section 62(a)(21) is a separate provision for attorney fees connected to government bounty awards. The qualifying programs are the IRS Whistleblower Program under Section 7623(b), the federal False Claims Act, the SEC Whistleblower Program under Section 21F of the Securities Exchange Act, the CFTC Whistleblower Program under Section 23 of the Commodity Exchange Act, and state false claims acts.¹

How the Cap Works

Your deduction cannot exceed the amount of the settlement or award included in your gross income for the tax year. Report the full recovery as income, then deduct the fees on Schedule 1. On a $100,000 settlement with $40,000 in fees, you report $100,000 and deduct $40,000, leaving $60,000 in AGI from the settlement.¹

The cap can strand part of your fee. Suppose the same $100,000 settlement is split $50,000 in tax-free physical injury damages and $50,000 in taxable emotional distress damages, and the attorney takes $40,000. Only the taxable $50,000 is in gross income, but $40,000 sits below that cap, so the full fee is deductible. Reverse the numbers, with only $20,000 taxable, and you can deduct just $20,000. The remaining $20,000 in fees produces no tax benefit.

Installment payments follow the income. The deduction applies year by year to the amount included in gross income that year; you cannot front-load it.

When the Deduction Does Not Apply

Damages for personal physical injuries or physical sickness are excluded from gross income under IRC Section 104(a)(2). Because that money never enters your taxable income, there is no income to deduct fees against, and the above-the-line deduction is unnecessary. A car accident settlement of $500,000 with $150,000 in fees is fully tax-free on the plaintiff’s side already.

Emotional distress damages that do not stem from a physical injury or physical sickness are taxable.⁵ Most discrimination recoveries fall in this taxable bucket, which is exactly why Section 62(a)(20) matters.

Back Pay and Employment Taxes

The deduction reduces income tax only. It does not reduce Social Security or Medicare taxes. When a discrimination settlement includes back pay, that portion is wages, and the defendant typically withholds the employee’s share of FICA before issuing the check.

How attorney fees interact with FICA turns on the settlement agreement. When the agreement clearly allocates a separate amount to attorney fees, that portion is generally not treated as wages for employment tax purposes. When the agreement is silent and the plaintiff simply pays the lawyer from the gross recovery, the whole recovery can be treated as wages subject to FICA. Language in the settlement is worth negotiating before signing.

Reporting the Deduction

1099 Forms You May Receive

After a settlement, expect one or more information returns:

Form 1099-MISC, Box 3, reports taxable damages paid to the plaintiff.
Form 1099-MISC, Box 10, reports gross proceeds paid to an attorney under Section 6045(f).
Form 1099-NEC, Box 1, reports attorney fees of $600 or more paid as compensation for legal services.

A joint check to plaintiff and attorney typically produces a Form 1099 to each, so the IRS may see what looks like a double payment.⁶ Reconcile every form against the settlement agreement before filing.

Schedule 1

The deduction goes on Schedule 1 (Form 1040), Part II. For the 2025 tax year, attorney fees for discrimination claims go on Line 24h, and attorney fees for IRS whistleblower awards go on Line 24i.⁷ Enter the fees and court costs, capped at the settlement income you reported for the year. The total flows to Line 10 of Form 1040 and reduces your adjusted gross income.⁸

A lower AGI does more than cut this year’s tax. Phase-outs for the premium tax credit, education credits, and the child tax credit key off AGI, so keeping the fee portion out of that number can preserve benefits that would otherwise disappear.

Records to Keep

Retain the settlement agreement, your fee agreement with counsel, every 1099, and any court order allocating damages. If the IRS questions the deduction, you will need to show that the underlying claim falls within Section 62(e) and that the deducted fees do not exceed the settlement income you reported.

1
Office of the Law Revision Counsel. 26 USC 62 – Adjusted Gross Income Defined
2
Legal Information Institute (LII). Commissioner of Internal Revenue v. Banks
3
Congress.gov. American Jobs Creation Act of 2004 – Public Law 108-357
4
Office of the Law Revision Counsel. 29 USC 623 – Prohibition of Age Discrimination
5
Internal Revenue Service. Tax Implications of Settlements and Judgments
6
Internal Revenue Service. Instructions for Forms 1099-MISC and 1099-NEC
7
Internal Revenue Service. 2025 Schedule 1 (Form 1040)
8
Internal Revenue Service. 2025 Instructions for Form 1040