As of Friday afternoon, with key holdout Republicans announcing their support, U.S. Senate appeared to be on its way to approving epic tax reform legislation. We still don’t know exactly what the final version of the Senate legislation will look like, nor, for that matter, how the House and Senate will reconcile differences between their bills. All kinds of important constituencies -- real estate professionals concerned about preserving tax deductions on home mortgages; Medicare recipients worried about program cuts; universities afraid their graduate programs will take a hit if students have to pay taxes on tuition waivers – will undoubtedly step up lobbying to mitigate the impact of the final law.
One group you haven’t heard from, although the House legislation takes direct aim at them, is trial lawyers. The House version of tax reform, the Tax Cuts and Jobs Act, includes a provision that bars contingency fee lawyers from deducting case-related expenses before cases are resolved. (Specifically, the provision says, “No deduction shall be allowed … for any expense paid or incurred in the course of the trade or business of practicing law, and resulting from a case for which the taxpayer is compensated primarily on a contingent basis, until such time as such contingency is resolved.”)
The latest Senate proposal includes the same provision, explaining in plain language that it “denies attorneys an otherwise-allowable deduction for litigation costs paid under arrangements that are primarily on a contingent fee basis until the contingency ends.” The Senate Finance Committee said the provision will save an estimated $500 million over 10 years.
As you know, plaintiffs lawyers can spend hundreds of thousands -- or even, in complex antitrust, securities or mass tort litigation, millions of dollars – working up cases that take years to be resolved. Other businesses, of course, are entitled to deduct business expenses. But assuming the House provision survives the legislative process intact, trial lawyers’ upfront costs to develop their cases aren’t considered business expenses.
The House Ways and Means Committee Report on the tax reform bill explains why. The upfront cost of developing a contingency fee case, according to the report, is akin to a loan or advance, rather than a business development cost, because it can be recouped when plaintiffs’ lawyers collect their contingency fees. “The committee believes that amounts advanced by attorneys in ‘gross fee’ cases are loans and therefore should not be treated as deductible expenses,” the report said.
As the House report acknowledged, the Internal Revenue Service already disallows deductions for expenses in contingency fee cases in almost every jurisdiction. But there’s a big carve-out for lawyers in the 9th U.S. Circuit Court of Appeals. In 1995, the 9th Circuit bucked decades of precedent in other circuits to hold in Boccardo v. Commissioner of the IRS (56 F.3d 1016) that up-front costs in contingency fee litigation can be deductible as “reasonable and necessary business expenses.”
The House Ways and Means report said the new tax bill’s provision barring contingency fee lawyers from deducting their upfront costs will override the 9th Circuit’s holding and provide nationwide uniformity. I’ve been told the provision was pushed by Virginia Republican Bob Goodlatte, chair of the House Judiciary Committee, but his press shop did not immediately respond to my email request for comment.
If you have a long memory, you’ll recall that Pennsylvania Republican-turned-Democratic Senator Arlen Spector years ago introduced legislation to allow trial lawyers across the country to deduct their upfront costs. Spector argued that his proposed bill would merely treat contingency fee law firms like every other business. His legislation, however, never even made it to a committee vote.
I emailed the American Association for Justice to see if it intended to lobby against the no-deduction provision in the final version of tax reform. No word back.