Legislature(2003 - 2004)
02/09/2004 08:12 AM Senate JUD
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
SB 300-ATTORNEY'S LIEN
SENATOR BERT STEDMAN, prime sponsor of SB 300, told members that
SB 300 is a housekeeping measure to avoid double taxation. He
explained that when court settlements are awarded, the
prevailing party must pay income tax on phantom income - the
gross amount of the award even though part of that income is
paid to the party's attorney. The attorney must then pay tax on
the income received, resulting in double taxation. The structure
of the system in the State of Oregon differs so that if the
proper documents are filed, the court settlement is paid to the
attorney who, after retaining attorney fees, pays the remainder
to the client, thereby avoiding double taxation. Attorneys have
structured trust accounts to hold court settlements, so this
mechanism would pose no danger to the client.
8:16 a.m.
SENATOR HOLLIS FRENCH asked for an example to illustrate the
double taxation problem.
SENATOR STEDMAN said a wrongfully damaged plaintiff might be
awarded $10,000. The plaintiff would have to claim income of
$10,000 and pay tax on that amount, $2,000 if the plaintiff's
tax bracket was 20 percent. The plaintiff must also pay 30
percent of the $10,000 for attorney fees, equaling 3,000. Then,
the attorney must pay tax on his fee of $3,000. SB 300 will
avoid double taxation by paying the attorney off the top, so
that the plaintiff would claim gross revenue of $7,000.
SENATOR FRENCH surmised that two parties would be paying income
tax on the $3,000.
SENATOR STEDMAN said that is correct. He said there is no way an
attorney could avoid paying taxes on his or her fees, so SB 300
will not affect the attorney. It will, however, have a big
impact on the citizen who must pay tax on the attorney fees.
SENATOR GENE THERRIAULT asked if the way to avoid double
taxation is to have the attorney file the proper lien paperwork
so that the jury award becomes the property of the attorney.
Then, once the attorney's lien is paid, the remainder is paid to
the client via contract.
SENATOR STEDMAN said that is correct and that the client would
pay taxes on the actual amount paid to him or her. He clarified
that the award funds paid to the attorney would be protected by
a litany of regulations to provide safety for the client.
SENATOR THERRIAULT asked if SB 300 passes, the plaintiff in the
previous example would receive $7,000 and the attorney would
receive $3,000, while under the current system, the plaintiff
would only receive $5,000.
SENATOR STEDMAN said that is correct.
SENATOR FRENCH asked if any damage award would go directly to
the attorney.
SENATOR STEDMAN said yes, if the attorney has filed the proper
liens, and the attorney would disburse the funds directly to the
client. The plaintiff would then claim only the income received
from the attorney, not the gross amount.
SENATOR FRENCH noted letters of support from attorneys in
members' files but asked if Senator Stedman has heard from any
plaintiffs who are concerned that attorneys might sit on their
money for too long.
CHAIR SEEKINS said that witnesses were available to testify and
might be able to answer that question. He took public testimony.
MR. WILLIAM SCHENDEL, an attorney who has practiced in Fairbanks
for about 30 years, told members that the issue behind SB 300 is
double taxation and is one of the biggest problems that has
faced both employers and employees over the last five years. In
essence, the plaintiff is taxed on the attorney fees that the
plaintiff does not receive. The consequence of that system is
that the plaintiff is prompted to try to recover more from the
defendant, typically the employer, and that drives up the cost
of settlements. SB 300 will do away with double taxation so that
the plaintiff is only taxed on the net award.
MS. JO KUCHLE, a Fairbanks attorney for 17 years, told members
that regarding the trust account issue, the funds do not always
flow through the trust account; sometimes the funds are paid
directly to the prevailing party. She said under the current
scheme this issue not only arises with settlements, it can occur
with judgments or in any case in which the prevailing party has
won damages and pays attorney fees. She pointed out:
This has been primarily the result of rulings by the
Ninth Circuit Court of Appeals, which has basically
determined that for federal tax purposes, the fee
award, though it goes directly to the taxpayer and the
taxpayer has to pay the attorney, gets taxed entirely
to the taxpayer. They carved out an exception in
Oregon on Oregon's lien law. That's why the group
before you has requested, and we're very pleased that
Senator Stedman has introduced this bill, to correct
this disparity with Oregon taxpayers and that all
taxpayers really in the Ninth Circuit - all states in
the Ninth Circuit are affected by this taxpayer
[indisc.].
MR. KEN COVELL, a Fairbanks attorney for 18 years, told members
he focuses on personal injury and employment law, and that he is
concerned that in civil rights actions, a plaintiff will receive
nominal damages of $1. However, attorney fees are often
$100,000. These cases are often very important and involve
racial discrimination. It is conceivable that a plaintiff could
receive a $1 award but have a $30,000 tax liability because of
the $100,000 attorney fee. He pointed out that clients often
take on such cases at great emotional and personal risk.
Therefore, if an attorney has to tell that client he or she is
liable for an additional $30,000 tax, clients will not pursue
important cases. SB 300 would put the citizens of Alaska on
equal footing with citizens of various other states. He repeated
that the current system creates a disincentive for clients to
pursue important issues.
MR. KEVIN WALSH, a certified public accountant in Fairbanks for
25 years, thanked members for considering SB 300. He said this
issue is near and dear to him as he runs into this problem in
his tax practice and must advise potential plaintiffs. It
creates different classes of taxpayers and affects opportunities
that people have to correct injustices changes based on tax
advice. He considers that to be wrong and looks to SB 300 for
resolution. He said this issue is based on federal income tax
law, which is based on taxing the owner of income. A recent
Supreme Court decision basically said, "tax the fruit of the
tree to the tree from which it falls." This lien law is based on
establishing property rights - who owned the case and who owned
what right under the case. Current federal tax law says the
entire case belongs to the plaintiff; therefore all amounts
flowing from that case are taxable to the plaintiff. He
explained:
Then, if the plaintiff is allowed a deduction for the
amount of the attorney fees that they pay, then they
end up [indisc.] income tax only on the net amount.
This is absolutely true for any business that is
successful in a suit. Businesses report the entire
damage amount as income, deduct all of the attorney
fees. They only pay income tax on the net amount.
People that are injured in a personal injury situation
don't pay taxes at all. This is not an issue for them.
So it boils down to the only people impacted on this
are the employees. Employees who bring suit against
their employers for whatever reason and end up
successful, end up having to report the entire amount
of the attorney fees and their own award as income.
They are then allowed a deduction for the amount that
they pay the attorneys.
Unfortunately the deduction is limited to two separate
distinct events: one, it is only allowed as a
miscellaneous itemized deduction and limited to the
amount that exceeds 2 percent of their adjusted gross
income.... Unfortunately, the alternative minimum tax,
which if you have - is a parallel tax system that was
established many years ago to make sure that the rich
paid at least a minimum tax every year, the
consequence of that tax is that no miscellaneous
itemized deductions of any type are allowed for
purposes of computing that tax and then the tax rate
is 25, 28 percent applied to the net income coming
from that.
So let me give you a real live example coming out of
our practice. We had a public interest litigant, an
employee who was [indisc.]. They sued successfully.
The received approximately $105,000. Their attorney's
fees were $100,000 and that was understood to be part
of the award. In other words, their net amount was
about $5,000. They ended up with a tax bill associated
with that of approximately $30,000. In other words,
understand, they got to keep $5,000 and had the
obligation to pay $30[,000], so by taking corrective
action through the judicial system to get a court to
correct an employer's egregious behavior, they had to
reach in their pocket and take out approximately
$25,000. I consider that to be a miscarriage of
justice.
MR. WALSH gave other examples and said that the origin of this
situation is based on property law in Alabama, Michigan and
Oregon. The court reviewed it and found the attorneys in those
cases had a sufficient property right in their piece of that
case so that income was taxed to them and not to the taxpayers.
The Alaska Supreme Court has reviewed this issue and said the
person receiving the award "gets the shaft." He said Alaska's
law should be changed so that a public interest litigant is not
penalized. He noted the Supreme Court has had several
opportunities to correct the disparity between the circuit court
and has basically said it does not care. Similarly, Congress has
had the opportunity to take this matter up several times but
declined to do so. He encouraged the Legislature to take action.
8:37 a.m.
CHAIR SEEKINS asked, "As I understand it, this lien exists until
it is satisfied and only affects the previously agreed upon
fees. Is that correct?"
MR. COVELL said that is correct.
CHAIR SEEKINS asked if SB 300 passes, the prevailing party would
pay taxes only on the award less the attorney fees.
MR. COVELL agreed.
CHAIR SEEKINS asked if SB 300 will correct the current
disparity.
MR. COVELL said it would.
CHAIR SEEKINS asked if it would have any fiscal impact on the
State of Alaska.
MR. COVELL said it would not.
SENATOR THERRIAULT asked if attorney fees and the costs of a
case are categorized separately and whether they would be
treated the same way.
MR. COVELL said he believes so; nothing would change in regard
to cost.
CHAIR SEEKINS said as is the common practice of the committee,
he would hold the bill for a second hearing to see if anyone
else wants to comment. He said he believes SB 300 is good public
policy and thanked all participants.
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