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 , 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.