In Kite v. Director, Division of Taxation, the Superior Court of New Jersey, Appellate Division, held that a taxpayer must pay state income taxes on a qui tam award under the New Jersey Gross Income Tax Act (Act), and that attorneys' fees and portions paid to co-plaintiffs were not deductible from this tax liability.
The plaintiff, a financial consultant, discovered fraudulent Medicare billing practices by some of his clients. After filing a qui tam action with two additional plaintiffs, he obtained a settlement with the hospital defendants. The federal government paid the qui tam award to the plaintiff's attorneys, who then distributed contractually agreed shares to themselves, the plaintiff's co-plaintiffs in the qui tam action, and the plaintiff himself.
The plaintiff did not report his qui tam recovery to the New Jersey Division of Taxation, and in 2012 the Division issued a tax deficiency notice. The plaintiff argued at trial that the qui tam award did not fall under the Act—which taxes prizes and awards—and that if it did, he was entitled to deduct the amounts he was contractually obligated to pay to his attorneys and co-plaintiffs. The trial and appellate courts both disagreed, stating that damages recovered in a lawsuit fall within the definition of "Award" in the Act, making them taxable as gross income. Both courts also refused to allow the plaintiff to deduct the portions of the award he paid to his attorneys for their services and to his co-plaintiffs in the qui tam action. The courts explained that the Act distinctly defines some income sources as gross income and others as net income, and that "awards" are defined as gross income. Therefore, the plaintiff was assessed taxes even on the portions of the qui tam award that went to his attorneys and co-plaintiffs.
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