25 T.C. 767">*767 The respondent determined a deficiency in income tax for the years 1948 and 1949 in the amounts of $ 8,683.84 and $ 9,609.18, respectively. The sole issue is whether the legal fees received by Michael M. Phillips in 1948 and 1949, under a contingent fee contract, are reportable as income in the years of receipt, where it develops that the lower State court decree in 1948 which led to the payment of such fees was reversed in 1949 by the highest court of the State.

FINDINGS OF FACT.

Petitioners are husband and wife residing at Chicago, Illinois. They timely filed joint Federal income tax returns with the collector of internal revenue for the first district of Illinois. Petitioners kept their books and records and filed their returns for the years in1956 U.S. Tax Ct. LEXIS 298">*299 question on the cash basis. (Hereafter the word "petitioner" shall refer to Michael M. Phillips.)

Michael M. Phillips is an attorney at law duly licensed and admitted to practice in the State of Illinois.

In the State of Illinois, under the Retailers' Occupational Tax, persons engaged in the sale of goods, wares, or merchandise at retail were, at all times material herein, subject to a tax measured by a percentage of gross receipts. A dispute arose as to whether the gross receipts of night clubs, cabarets, and other forms of entertainment 25 T.C. 767">*768 business were properly subject to the Retailers' Occupational Tax, commonly known as the sales tax, the contention being that such gross receipts were received primarily by virtue of intangibles rather than tangible personal property.

The procedure in the State of Illinois for testing the applicability of any taxing measure or revenue measure as it applies to any person or class of persons is generally to pay the tax claimed by the State of Illinois under protest and to bring injunction proceedings in a proper court of the State to obtain a judicial determination as to the applicability of the taxing measure or revenue law. Funds so 1956 U.S. Tax Ct. LEXIS 298">*300 paid under protest are held separate and apart by the State treasurer until final determination by the court.

Certain persons engaged in the night club, cabaret, or entertainment business, employed the services of Milton Raynor and Thomas Rosenberg, attorneys at law duly licensed and admitted to practice in the State of Illinois, to contest the application of the Retailers' Occupational Tax Act to the gross receipts of such entertainment enterprises. The attorneys, Milton Raynor and Thomas Rosenberg, were retained on a contingent fee basis, to receive as a fee an amount equal to 33 1/3 per cent or 50 per cent of any amounts recovered by them from the State treasurer, depending on the contract signed with the particular client.

Petitioner was engaged by Milton Raynor and Thomas Rosenberg as co-counsel to assist in the matter concerning the taxability of gross receipts. In the fee arrangement entered into among themselves petitioner was to receive for his services 22 per cent of the total amount of any refund obtained from the State.

After the tax demanded by the State of Illinois was paid by the clients, under protest, a proceeding was filed on November 14, 1945, in the Circuit Court1956 U.S. Tax Ct. LEXIS 298">*301 of Cook County, Illinois, to test the determination of the State taxing authorities that the clients were subject to the Retailers' Occupational Tax Act. Said proceeding was entitled "Byron Massell -- Moe Henry Weiss, doing business as 51 Hundred Club, a limited partnership, et al., Plaintiffs, v. Paul C. Rosenquist as Acting Director of Revenue of the Department of Revenue of the State of Illinois; Richard Yates Rowe as State Treasurer of the State of Illinois, and George F. Barrett, Attorney General of the State of Illinois, Defendants, No. 45 C 9061."

On December 1, 1948, the Circuit Court of Cook County, Illinois, entered a decree in favor of the plaintiffs. A supplemental order specifying the amounts to be refunded to each plaintiff was entered by the court on December 20, 1948. Prior to December 31, 1948, pursuant to the decree and supplemental order of the court, the State treasurer of Illinois issued negotiable warrants payable to the several 25 T.C. 767">*769 plaintiffs in the circuit court action to effect the refund of the amounts paid in protest under the Retailers' Occupational Tax Act. These warrants were delivered by the State treasurer to the attorney general of Illinois1956 U.S. Tax Ct. LEXIS 298">*302 (or one of his representatives), who in turn delivered the warrants to petitioner as one of the attorneys for the payees.

Petitioner opened a checking account in his own name at the Exchange National Bank in Chicago, Illinois, on December 31, 1948, and together with a letter of direction dated December 30, 1948, he forwarded the negotiable warrants to the bank. Pursuant to the letter of direction, the Exchange National Bank obtained the endorsements of virtually all of the payees of the warrants and paid to such persons the proceeds of the warrants less the one-third withheld as a fee and credited to the petitioner's account. On December 31, 1948, petitioner's account was credited with an initial deposit of $ 33,047.07. There was never any restriction on petitioner's use and disposition of the amounts in the checking account either in 1948 or in 1949.

Endorsements on all but a few of the remaining warrants were obtained by the Exchange National Bank prior to January 28, 1949. The credits to petitioner's account were made as follows:

1956 U.S. Tax Ct. LEXIS 298">*303 The remaining unendorsed warrants were returned by the Exchange National Bank to petitioner, who secured the endorsement himself and deposited, on January 20, 1949, his share of the proceeds, $ 1,496.25, in his regular bank account at the American National Bank.

On December 31, 1948, the petitioner paid, by checks drawn against his account at the Exchange National Bank, the sum of $ 10,000 in counsel fees to associate attorneys, Milton Raynor, Thomas Rosenberg, and Max Satt. In 1949, the petitioner paid, also by check, the following amounts in counsel fees:

Petitioner drew upon the balance in his checking account at the Exchange National Bank throughout the year 1949. At the end of July 1949, the balance in petitioner's checking account at the Exchange National Bank was $ 11.61.

25 T.C. 767">*770 On January 21, 1949, the State filed an appeal from the decree of the Circuit Court of Cook County, and on November 21, 1949, the Supreme Court of the State of Illinois reversed the decree of the lower court, 1956 U.S. Tax Ct. LEXIS 298">*304 (rehearing denied January 12, 1950), and did not remand said cause for further hearings.

When the decree of the lower court was reversed by the Supreme Court of Illinois on November 21, 1949, petitioner in that same year acknowledged to several of the clients who had obtained refunds that he felt indebted to them for the fees he had received. No portion of the fees was repaid to the clients in 1949. On April 27, 1954, petitioner made out a promissory note for $ 20,000, payable in three installments, to the order of the Hotel Sherman, Inc., one of petitioner's clients in the refund matter. The installments did not bear interest, but if unpaid at the due date, a rate of 7 per cent per annum was imposed. As collateral for the note, the petitioner deposited with the Hotel Sherman, Inc., stock evidencing a half interest, worth $ 20,000, in certain real property in Chicago. Also on April 27, 1954, petitioner, together with Milton Raynor and Thomas Rosenberg, assigned to the Hotel Sherman, Inc., the first $ 37,563.65 of a certain contingent fee which would become payable to them by the hotel if certain litigation then pending were successful.

On January 22, 1950, the State of Illinois1956 U.S. Tax Ct. LEXIS 298">*305 commenced an action in the Circuit Court of Cook County against Byron Massell, et al., Docket No. 50 Cow. 598, for recovery of moneys wrongfully paid. In this action, the defendants were substantially all of the persons who had obtained refunds under the Circuit Court decree of December 1, 1948. Judgment was entered in favor of the State on May 5, 1953. Only one defendant appealed from this judgment, and on March 17, 1954, the Illinois Supreme Court affirmed the judgment and award of the Circuit Court.

No part of the legal fees received by petitioner in this matter in 1948 and 1949 was reported by him in his individual income tax returns filed for 1948 and 1949. The respondent determined deficiencies in the petitioner's income tax for the years 1948 and 1949 by including these fees in the petitioner's income, $ 33,047.07 in 1948 and $ 45,072.23 in 1949. In his determination of the deficiencies, the respondent allowed the petitioner a deduction in 1948 for the $ 10,000 paid in that year by the petitioner, out of the fees collected, to associate counsel, and the respondent was allowed a deduction in 1949 for the $ 15,000 similarly paid by the petitioner in that year to associate 1956 U.S. Tax Ct. LEXIS 298">*306 counsel out of the fees collected.

25 T.C. 767">*771 OPINION.

The sole question in this case is whether attorney's fees paid to petitioner under a contingent fee contract, after favorable adjudication in the State trial court, without any restriction as to their disposition or use, are income taxable to the petitioner in the year of receipt.

Petitioner, an attorney, was retained under a contingent fee contract to secure refunds of the Illinois State sales tax paid by certain clients under protest. Under the agreement, petitioner was to be paid a percentage of the tax refunds recovered from the State. Petitioner was successful in the State trial court; the tax refunds were made in the form of warrants. The warrants were turned over to a bank, and the payees, the clients, came to the bank, endorsed the warrants and received the amount, less the percentage due petitioner. The bank credited petitioner's share to a separate checking account in his name. In this manner, petitioner received a portion of his contingent fee in December 1948, and the balance in January 1949. Petitioner did not include any portion of the contingent fee received in 1948 and 1949 in his income tax returns for those1956 U.S. Tax Ct. LEXIS 298">*307 years. Some time before the month of August 1949, petitioner had withdrawn and spent practically the entire balance in the special checking account derived from his share of the tax refund warrants. In January 1949, the State taxing authority served notice of an appeal to the Supreme Court of Illinois. In November 1949, the Supreme Court of Illinois reversed the trial court, holding that the decree of the lower court was void. Petition for rehearing was denied by the Supreme Court of Illinois in January of 1950. Subsequently, in litigation consummated in later years, the State collected the refunded taxes from petitioner's clients.

Respondent argues the fees paid in 1948 and 1949 were compensation for services rendered and constitute income in the years paid and any deduction for repayment could be taken in the years of repayment. We agree with the respondent that the portion of the fee received by the petitioner in December 1948 was taxable income for that year. In , the Supreme Court explained the doctrine which we believe is applicable here:

If a taxpayer receives earnings under a1956 U.S. Tax Ct. LEXIS 298">*308 claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent. * * *

Here, the money was received by the petitioner under a claim of right, after the favorable lower court decree, and there was no restriction 25 T.C. 767">*772 as to the disposition of such money once it was credited by the bank to petitioner's checking account. It is true that the possibility still existed of an appeal by the State, but the possibility that, upon reversal by the higher court, the money would at some future date have to be returned, in no way diluted petitioner's claim to the money and to its unrestricted use in 1948. Such future uncertainties cannot be allowed to determine the taxability of moneys in the year of their receipt by a taxpayer. There was no promise of repayment in 1948 and no recognition by petitioner in that year that he was under any duty to repay the fees he had collected. He held the fees throughout the year 1948 under a claim of right. It is immaterial that the petitioner was1956 U.S. Tax Ct. LEXIS 298">*309 mistaken in his claim. , rehearing denied . Petitioner also argues that the State of Illinois at all times had retained "special title" in the protested taxes, paid by the petitioner's clients from the time of the deposit with the State treasurer until the State either acquired full title by court order, or the special title was divested by a final order in the protesting taxpayer's favor, and that such title in the State prevents the receipts in 1948 and 1949 from being taxable income. We do not believe that refinements of title can overcome the "readily realizable economic value" ¹ and the practical use and benefit of the money enjoyed by petitioner in 1948. Petitioner cites , as support for this argument; but that case, which we do not consider governing the situation here, has been limited to its facts in a subsequent Supreme Court opinion. , rehearing denied . We conclude, on the above1956 U.S. Tax Ct. LEXIS 298">*310 facts, that the petitioner's receipts in 1948 were under a claim of right and unrestricted as to use, and that they were taxable income in that year.

In January 1949, credits to petitioner's checking account equaled $ 43,575.98. Again there was no restriction on the use of these receipts. The same month, the State filed an appeal from the decree of the lower court, and on November 21, 1949, the Supreme Court of Illinois reversed the decree, declaring it to be void, and did not remand the cause for further hearings. The petitioner makes the contention that the fees received by him in 1949 were not taxable in that year because after the nullification of the lower court decree he held conversations with several of his clients and told them he "felt indebted" to them for the fees he had received. Although there were more than 20 clients involved in the litigation, the petitioner identifies only one, the Sherman Hotel, as participating 1956 U.S. Tax Ct. LEXIS 298">*311 in these conversations. The petitioner argues that the claim of right doctrine is defeated by these admissions to some of the clients. We do not agree. By August of 1949, the petitioner had spent all but $ 11.61 of the fees received by 25 T.C. 767">*773 him. The conversations with the few clients were based apparently on the action of the Supreme Court of Illinois in , nullifying the lower court decree. This case did not establish the right of the State to recover the refunds made to the petitioner's clients. At best, the petitioner was making a surmise as to an eventual liability to repay the money received by him. It is significant that a petition for rehearing in , was denied in the following year, 1950, so the matter was still open until then. Moreover, the Illinois Supreme Court in 1949 in , did no more than nullify the lower court decree. It did not rule upon the question of the repayment of the refunds by the taxpayer to the State. Indeed, the State instituted an action in 1950 in the Circuit Court of 1956 U.S. Tax Ct. LEXIS 298">*312 Cook County for recovery of the money from the petitioner's clients, and it was not until May 5, 1953, when judgment was entered by that court in favor of the State, that these clients were obliged to repay the tax refunds erroneously received by them some years before. This judgment was affirmed by the Illinois Supreme Court in , where the court pointed out that in its prior decision in 1949 in , where the lower court decree authorizing the refunds had been declared void, "No opinion was expressed * * * on the right of the State to restitution for the sums refunded pursuant to the invalid decrees."

The petitioner's clients contested, in , the right of the State to recover the refunded taxes paid by the State in 1948 and 1949. The nature of their arguments appears in a quotation from the opinion of the Illinois Supreme Court in this case:

the defendants in the case at bar appeal from a similar judgment against them severally, contending that the1956 U.S. Tax Ct. LEXIS 298">*313 decree appealed from in , was not a consent decree but a judicial determination of rights; and that since it had not been reversed at the time defendants received and cashed the warrants by which the refunds were made, they were "protected" by the decree and not liable to make restitution. It is also argued that the decree, being a judicial determination, had the effect of vesting title to the fund in defendants, that since the State officials then had no right to immediate possession defendants could not have converted the funds; and that the present action by the State must therefore fail.

There was no clear and undisputed liability on the part of the petitioner's clients to repay the tax refunds to the State in 1949, and we do not believe that it has been established that the petitioner was bound to repay the fees to the clients in 1949. Such an obligation to repay arose, if at all, in 1954.

We hold that the legal fees credited to the petitioner in 1949 were received by him under a claim of right, without any restriction as to their disposition or use, and that they were taxable income to him in that year.

Decision1956 U.S. Tax Ct. LEXIS 298">*314 will be entered for the respondent.