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Public Statements

Statements on Introduced Bills and Joint Resolutions

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Date:
Location: Washington, DC


STATEMENTS ON INTRODUCED BILLS AND JOINT RESOLUTIONS -- (Senate - March 08, 2007)

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By Mr. SPECTER:

S. 813. A bill to amend the Internal Revenue Code of 1986 to allow an above-the-line deduction for attorney fees and costs in connection with civil claim awards; to the Committee on Finance.

Mr. SPECTER. Mr. President, the first bill which I am introducing, and that is to permit attorneys to deduct payment of litigation costs as ordinary and necessary business expenses. In litigation, illustratively on a personal injury claim, the plaintiff frequently is without funds and can only move forward with the litigation on a contingency fee basis. In these situations, it is customary for the attorney to advance the costs of filing fees, depositions, and other costs there may be. The Internal Revenue Service has taken the position that those are loans from the attorney to the client, so the attorney cannot immediately deduct litigation payments as ordinary business expenses. If the litigation costs are treated as ordinary business expenses, the attorney would be able to deduct the expenses as they are incurred.

The Ninth Circuit has held that the Internal Revenue Service is wrong. As a result, attorneys in States within the Ninth Circuit can deduct as ordinary and necessary expenses advances on litigation. This legislation would make it explicit under the Internal Revenue Code that these advanced costs could be deducted by attorneys across the country.

Again, I ask that the Record contain my extemporaneous comments and the explanation as to why there is some repetition in the formal statement which I now ask unanimous consent be printed in the Record, as well as the two bills which follow these two pieces of legislation which I am introducing.

There being no objection, the material was ordered to be printed in the RECORD, as follows:

Senator Arlen Specter

STATEMENT ON LEGISLATION TO PERMIT ATTORNEYS TO DEDUCT PAYMENT OF LITIGATION COSTS AS ORDINARY AND NECESSARY BUSINESS EXPENSES

Mr. SPECTER. Mr. President, I have sought recognition to introduce legislation amending the Internal Revenue Code to permit attorneys to deduct payments of litigation expenses on behalf of contingency fee clients as an ordinary and necessary business expense. The IRS deems these advances to be loans, so the attorney cannot immediately deduct litigation related payments as ordinary expenses. If the payments are treated as ordinary and necessary business expenses, the attorney receives the benefit of being able to deduct the expenses as they are incurred, and to recognize the income associated with those expenses if and when damages are recovered, which may be years later.

In part because the IRS deems these payments to be loans, and State canons of legal ethics--based on common law of medieval England--prohibited loans to clients, contingency fee lawyers for many years were not able to pay these expenses. In the latter part of the 1800s States began permitting attorneys to advance client expenses as long as the client remained obligated to repay the advances. Even for their indigent clients, if there ultimately was not an award, attorneys were required to seek repayment. The ABA Model Rule has been updated to state that ``a lawyer may advance court costs and expenses of litigation, the repayment of which may be contingent on the outcome of the matter.' Many States model their rules on these Model Rules, and their ethics rules have been updated, but the Internal Revenue Code has not. Because my bill appropriately treats payments of costs under contingency fee arrangements as ordinary business expenses, attorneys may structure their fee contracts in ways that do not run afoul of State ethics rules.

In addition, I note that tax treatment of these payments is not consistent across all jurisdictions. In Boccardo v. Commissioner, 56 F.3d 1016 (9th Cir. 1995) the Ninth Circuit disagreed with the IRS and held that advances on behalf of clients were ``ordinary and necessary expenses' in contingency cases with ``gross fee' contracts. So the rule is different in States in the Ninth Circuit; the IRS continues to take the position that expense advances are not deductible as ordinary and necessary business expenses in other jurisdictions. This different treatment is neither logical nor equitable.

This change will encourage lawyers to represent those who may not otherwise be able to pay an attorney for his work. This is good policy and common sense.

S. 813

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By Mr. SPECTER.

S. 814. A bill to amend the Internal Revenue Code of 1986 to allow the deduction of attorney-advanced expenses and court costs in contingency fee cases; to the Committee on Finance.

Mr. SPECTER. Mr. President, I have sought recognition to introduce two bills relating to tax deductibility which impact unfairly on claimants and plaintiffs in litigation and on attorneys. The second bill relates to permitting a taxpayer to deduct expenses for attorney's fees in contingency fee cases. For example, if a plaintiff secures punitive damages of $15,000 and the attorney collects one-third contingency, $5,000 goes to the attorney. Under current law, the plaintiff is required to pay taxes on the full $15,000 without an above the line deduction for the $5,000 paid on attorney's fees. This is a result of technicalities of the Internal Revenue Code. My bill would clarify the tax law and will ensure consistent and fair treatment of taxpayers.

Mr. President, I have just made an extemporaneous statement on the essence of the floor statement, and I now ask unanimous consent that the full floor statement be printed in the Record and that there be included the segue of why there is some repetition of what I have just said and the written formal statement itself.

There being no objection, the material was ordered to be printed in the RECORD, as follows:

Senator Arlen Specter

STATEMENT ON LEGISLATION TO PERMIT TAXPAYER DEDUCTIONS FOR ATTORNEYS' FEES IN AN AWARD OF DAMAGES OR SETTLEMENT OF LEGAL CLAIMS

Mr. SPECTER. Mr. President, I have sought recognition to introduce legislation that will allow taxpayers to subtract from their gross income, in arriving at adjusted gross income, the attorneys fees and court costs paid by, or on behalf of, the taxpayer in connection with any income from any settlement of legal claims or award of damages. This is known as an ``above the line' deduction.

This change does not affect the requirement that attorneys pay federal income tax on legal fees they receive. What it does eliminate is the inequity of the client also paying tax on those same fees, when the client not entitled to, and did not receive that money under the terms of a contingency fee contract.

The tax treatment of these contingency fees is determined through a patchwork of rules that are confusing and inequitable. The legislation would ensure more uniform treatment of contingency fees in all types of litigation and across jurisdictions. In particular, it will eliminate situations in which a plaintiff's recovery may be diminished, primarily as a result of the Alternative Minimum Tax (AMT), by taxation at a rate of approximately 60 percent on the taxpayer's net recovery, after contingency fee.

This change is common sense and will ensure consistent and fair treatment of taxpayers. Congress never intended that the attorneys' portion of recoveries should be included in taxable income--whether for regular income or alternative minimum tax purposes.

Section 61(a) of the Code requires taxpayers to include in their gross income ``all income from whatever source derived,' absent a contrary provision in the Code. Awards for physical personal injury, other than punitive damages, are not taxable (26 U.S.C. 104(a)(2)). Awards of fees in cases primarily related to employment may be deducted ``above the line' as a result of the American Jobs Creation Act.

With these exceptions noted above, the Code treats taxpayers as having received the entire amount of any award or settlement (including any contingency fee portion). This means that for awards based on certain claims or for punitive damages, the taxpayer must include in adjusted gross income the entire award, even though the true benefit or income to the taxpayer after contingency fees and costs may be only 50 percent or 60 percent of the award. This ``net' then is reduced by what many believe are unfair taxes because, even though the fees may be taken as a miscellaneous itemized deduction under Section 212, which provides for deduction for expenses incurred for the production of income, this category of deductions is subject to disallowance under the AMT, and a phase out of itemized deductions under the regular tax code.

Accordingly, the current tax structure, when coupled with the compensation arrangement found in contingency fee contracts, generally (1) creates an enormous tax burden, especially for lower income individuals who often have contingency fees as their only avenue of obtaining legal counsel; and (2) may drive up settlement costs as a result of the serious diminution of the plaintiffs actual award after taxes.

An illustration of the tax inequities and inconsistencies follows: an individual/client who obtains $500,000 in a legal settlement on a fraud claim, who incurs $200,000 in legal fees and costs, and nets only $300,000, still may owe AMT on $500,000, and would have to pay approximately $160,000, or about 60 percent of the damage award, in federal and state taxes. This leaves the client with only $140,000 of an award intended to compensate the client in the amount of $500,000.

This clarification of tax law is common sense and will ensure consistent and fair treatment of taxpayers, especially those who can get representation only on a contingency fee basis. I encourage my colleagues to consider this legislation and join me in helping to correct this unfair situation.

S. 814

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