Tax Equity for Contingent Fee Firms

Senate bill 437 is a new piece of legislation being introduced by Senator Arlin Spector (R-Pa.) and back by numerous Republicans and Democrats alike.  If passed, the Bill would dramatically effect how plaintiffs firm operate, namely how tax write-offs are handled within Firms that operate on contingent fee agreements (e.g. personal injury, employment, civil rights, Social Security, etc.)  The Wall Street Journal ran a  piece last year when the Bill was introduced:

The provision would allow plaintiffs lawyers to deduct the up-front expenses of pursuing contingency-fee lawsuits, even in cases where the lawyer is expecting to be reimbursed for these expenses. The IRS currently considers these costs a loan from the lawyer to his client, and like other taxpayers, the lawyer can only deduct the loan if it isn’t paid back.

Mr. Rangel’s spokesman says, “This is purely a matter of fairness and tax equity. The individuals who would benefit from this provision are already eligible to deduct expenses related to contingency-fee lawsuits, the only question is when.” Not exactly. Attorneys who snare a percentage of the recovery plus expenses today receive no deduction. Allowing these big deductions now would mean that future reimbursements are taxed, but with some monster class-actions, the lawyers could avoid the tax bill for a decade or more.

Simply put, this Bill would allow Firms that operate on contingency fee agreements to deduct costs and expenses on an on-going basis rather than taking one big deduction at the case’s conclusion should the case not be successful.  Firms can take yearly deductions for “costs and expenses” that if at case resolution are recovered, are treated as income for the recovery year.  To me, this seems to put Firms on the same level as other small businesses.  Take the deductions on a yearly basis and treat their recovery as income when the Firm recovers. The current status of costs as “loans” is not accurate, as Firms do not charge interest to the client.  One thing is certain, the tax consequences of this Bill for Firms big and small is gigantic, especially in the realm of class-actions.