Legislature(2003 - 2004)
03/23/2004 09:04 AM Senate FIN
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* first hearing in first committee of referral
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= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
SENATE BILL NO. 300
"An Act relating to an attorney's lien, to court actions, and
to other proceedings where attorneys are employed."
This was the first hearing for this bill in the Senate Finance
Committee.
Co-Chair Wilken stated this bill sponsored by Senator Stedman,
"addresses a ruling by the Ninth Circuit Court of Appeals. The
Court held that Alaskans who win an award in court must pay federal
income tax on the award, including attorney fees, and then when the
plaintiff pays the attorney, the income is taxes a second time."
SENATOR BERT STEDMAN read the sponsor statement into the record as
follows.
SB 300 eliminates an unfair and potentially disastrous federal
income tax issue affecting Alaskan taxpayers and prevents the
IRS [U.S. Internal Revenue Service] from taxing two Alaskans
on the same income. SB 300 corrects this unjust treatment of
Alaskans under current 9th Circuit rulings.
Because of a peculiarity in Alaskan law, Alaskans who win in
court may pay federal income tax on phantom income. When
Alaskans file their federal tax return, they must report any
litigation recovery allocated to attorney fees as gross
income, even though they receive no economic benefit from
those fees. The federal government taxes that portion of the
prevailing side's award twice; once as income to the client
and again as income to the client's attorney. Incredibly,
there is no federal tax deduction to offset this inequity.
It's even possible for someone to win in court but come out
with a net loss after paying legal bills and taxes.
Under current Alaska lien law <AS 34.35.430>, attorneys have a
"subordinate lien" or ownership interest in the "cause of
action". Other states, Including Oregon, use different
language to specify that as long as an attorney has filed an
appropriate lien and is owed money by the winning client, all
fee awards or payments made to the client belong exclusively
to the attorney. In so vesting the attorney with the property
interests of the award, those states avoid the unfair tax
burden currently imposed on Alaskans. Instead, any portion of
an award retained to pay attorney costs, is not income to the
client.
SB 300 changes Alaskan law to prevent the IRS from taxing
Alaskans on income they don't receive. This bill recognizes
that court awarded fees which pass through to one's attorney
is income to the attorney. And as such, the attorney is
responsible for paying federal income tax on that portion of
their income.
Senator Stedman noted that when drafting statutes for the legal
system, Alaska mirrored the state of Oregon statutes in many ways
and that Oregon has this same inequity. He gave an example of a
case involving the wrongful termination of an employee, in which
that employee prevailed and received a "small" award in addition to
attorney fees. Under current statute, Senator Stedman pointed out
this employee would receive a net loss because the employee would
be required to claim the attorney fees as income and pay federal
taxes on that amount.
SFC 04 # 54, Side B 09:52 AM
Senator Stedman continued that many plaintiffs do not have adequate
resources to absorb the tax burden of this additional income, which
they did not receive.
Co-Chair Green referenced a letter dated February 6, 2004 to
Senator Stedman from Kevin Walsh, of Walsh, Kelliher and Sharp. She
asked if this legislation would only apply to cases heard in the
Alaska Court System or to cases before the Human Rights Commission
as well.
Senator Stedman understood this legislation applies only to the
award of attorney fees from court cases.
KEVIN WALSH, Certified Public Accountant, Walsh, Kelliher and
Sharp, testified via teleconference from Fairbanks in support of
this bill and about his 25 years experience and service as chair of
the IRS/CPA Liaison Committee and chair of the Tax Committee of the
Alaska Society of CPAs. He emphasized this bill was not sponsored
at the request of the Alaska Bar Association (ABA). He stated he
supports this bill because he was "tired of" the IRS becoming the
prime beneficiary of court settlements.
Co-Chair Green restated her question.
Mr. Walsh affirmed this legislation only relates to awards issued
as a result of a court case.
Senator Olson asked how this legislation would affect federal IRS
rules.
Mr. Walsh replied that the IRS considers property rights as
described in state laws. He stated that the Ninth Circuit Court of
Appeals held that the property rights were such that plaintiffs
must pay tax on their attorney fees under California law, Arizona
law and Alaska law. However, he noted that the Court found that the
state of Oregon laws were somewhat different and therefore provided
that the plaintiff's attorney is the only party liable for the
property rights taxes.
Senator Bunde clarified that the impetus of this bill is not the
Alaska Bar Association and asked the ABA position.
Mr. Walsh affirmed the ABA did not initiate this legislation,
commenting that all credit or blame falls to him. He qualified that
he asked the Association for assistance in drafting this
legislation; however, noted that the ABA does not take positions on
legislation. He relayed that the president of the Association has
indicated interest in the matter. He also informed that he
requested the opinion of the Alaska Legal Services Corporation,
which represents disadvantaged parties, but had not received a
reply. He wanted to ensure this legislation would not benefit
attorneys at the expense of taxpayers. He referenced an article
published in the Wall Street Journal [copy on file] regarding the
National Taxpayer Advocate, Nina Olson's attempt to have the US
Congress address the matter through federal law, although he stated
these efforts have been unsuccessful. However, he remarked that the
Alaska Legislature has the ability to change statute in a manner
that the federal Ninth Circuit Court of Appeals could affirm.
Senator Bunde never mind other discussion re tort reform they say
in it for benefit of the people.
Co-Chair Wilken referenced letters in support of this bill from the
Windfree Law Office and Cook Schuhmann and Groseclose, Inc.
Attorneys at Law [copies on file].
Senator Olson asked the reason for the language contained in the
bill as opposed to language changing existing statutes governing
property rights.
Mr. Walsh replied that he had requested the ABA provide him with
language identical to that adopted by the state of Oregon and ruled
adequate by the Ninth Circuit Court of Appeals.
Senator Olson cautioned this "remedy" might inadvertently provide a
loophole relating to property rights.
Co-Chair Wilken asked if the Senate Judiciary Committee had
discussed this possibility.
Senator Stedman replied it did not.
Co-Chair Wilken asked if Senator Olson wanted this bill held in
Committee to address this concern.
Senator Olson deferred to the sponsor and the co-chair.
Co-Chair Wilken suggested highlighting the issue with intent it be
addressed when the bill is considered in the House of
Representatives.
Co-Chair Green wanted assurance that in remedying the tax
consequence, this legislation would place the attorneys "in front
of" of plaintiffs regarding receipt of settlement payments.
Senator Stedman assured it would not allow such "front-running". He
stressed that the laws governing attorney's trust accounts are
"extremely tight" and this legislation would not grant the attorney
additional claim to a settlement.
Co-Chair Green asked if this requires that a client who receives a
settlement make payment to an attorney.
Senator Stedman described the "flow of funds" to a trust account
governed by the attorney then distributed to the client.
Co-Chair Green surmised if 100 percent of an award amount were paid
to the client who then fails to pay the attorney fees, the client
would not be required to pay taxes on that amount. She asked how
this could be justified.
Mr. Walsh responded that the individual receiving funds would be
taxed for the entire amount that person is entitled to. He
explained that an attorney could file a lien against the client if
not paid for services. He also noted that if an attorney chooses to
not collect a fee, the client would be liable for taxation on the
entire amount of a settlement.
Co-Chair Wilken noted this bill does not specify an effective date
and asked whether the sponsor would support an immediate effective
date.
Senator Stedman supported this.
AMENDMENT #1: This conceptual amendment adds a new Section 3 to the
bill providing for an immediate effective date of the provisions of
Sections 1 and 2.
Co-Chair Green moved for adoption.
Without objection the amendment was ADOPTED.
Co-Chair Green offered a motion to report the bill from Committee
as amended with individual recommendations and accompanying fiscal
notes.
There was no objection and CS SB 300 (FIN) MOVED from Committee
with zero fiscal notes #1 from the Department of Natural Resources,
#2 from the Alaska Court System, and #3 from the Department of Law.
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