The only realistic hope for people of limited means to establish a legal claim is a lawyer who will work on a contingency fee. The Build Back Better legislation approved by the House of Representatives on November 19, 2021 authorizes a change in accounting for personal injury lawyers, at no loss of tax revenues to the government, which will allow them to more easily support their clients. That is good public policy.
In “A Tax Break for Trial Lawyers” editorial on November 8th, the Wall Street Journal’s contempt for trial lawyers presented a distorted view of tax accounting by contingency fee lawyers who provide needed services to the average person who cannot pay the fees charged by lawyers representing corporations and insurance companies. For those who chide me for subscribing to the WSJ, aside from its editorial policies, the Journal covers an array of topics not touched by the NYT, Washington Post, San Francisco Chronicle and the San Jose Mercury, the other papers that I read.
The expected and common war cry of “frivolous lawsuits” by the Journal’s editors on November 8th was a dog whistle for corporate interests who hate having to foot the bill for negligence, defective products, and profiteering at the expense of consumers. On the other hand I love forcing the bastards to pay when they are responsible for avoidable harm and this particular tax issue deserves an honest report, which the WSJ did not provide. As it turns out, I was on the ground floor of dealing with this subject and can write with authority. Here is the full undistorted story.
For decades contingency fee attorneys on an annual basis would deduct as expenses against income the costs incurred on behalf of their clients in prosecuting a contingency fee case. When eventually the case settled, the lawyer paid income tax on both the fee and the recovered case costs. Paying income tax in the year the case settled was a sensible way to run a law practice, i.e., pay the tax when funds are at hand.
In 1985 the IRS imposed a new rule that case costs could not be deducted as an expense against income in the year paid but instead had to be capitalized. That required plaintiff’s attorneys to pay the expenses of litigation with after-tax dollars.
Everyone running a business understands the cost of spending after-tax dollars and suffer the penalty of making a capital expenditure out of current income. Business owners, including myself, loathe having to pay tax on income spent on capital equipment, and after giving up the cash then be restricted by IRS regulations to taking a small portion of the expenditure as a deduction against current income.
The goal of IRS depreciation schedules is simple: increase the government’s tax revenues. The result for our economy has been the spawning of leasing companies which allow for deducting the cost of leasing capital equipment and avoiding the tax depreciation headache for outright purchases of capital equipment.
In 1985 my law partner, James Boccardo, and I concluded that the capitalization penalty could be avoided in our personal injury practice by instituting a gross fee contingency fee contract. The client would pay a percentage, which included the expenditures the law firm paid for investigators, filing fees, purchasing of medical records, court reporters, travel, and experts, which are expenditures necessary to obtain the proof to secure a recovery for a personal injury client. That contract change made the case cost expenditures pure expenses for tax purposes. The Ninth Circuit upheld the firm’s use of a gross fee contract in 1995 in Boccardo v. Commissioner.
Unfortunately, the gross fee contract was financially unsustainable in major personal injury cases involving defective products, collapsing buildings and bridges, exploding gas tanks, widespread consumer frauds, and the like. In catastrophic cases, case costs are substantial. They include multiple experts, who are expensive, to prove liability, medical professionals to evaluate serious injuries, residual skills, future lifetime medical care, and life care planners, plus economists to calculate wage losses, and the present value of future care. In catastrophic lawsuits against billion-dollar manufacturers, six-figure case costs are typical. One side effect of the IRS capitalization rule has been the growth of bankers lending for case costs, akin to the leasing industry growth, albeit at rates that are eye-popping.
Major personal injury and wrongful death lawsuits commonly require working for years without pay, while paying the salaries of law firm staff and office overhead that demand monthly expenditures. No other profession provides sustained services for years without regular prompt payment. Serious lawsuits for serious injuries require a fee agreement that provides for the payment of case costs in addition to a contingency fee for legal services, so that is what we do. It is a financial fact of life.
The current budget bill’s provisions for the tax treatment of case costs by contingency lawyers will cancel the penalty of capitalization on cash flow imposed by the IRS and re-established a common-sense approach that will not impact the taxation of income. It will allow the expensing of case costs and treating the recovery of those costs as taxable income.
Restoring the previous practice denies the government no tax. What is deducted in one year eventually results in tax in a later year. The change will also promote the ability of plaintiff’s law firms to risk holding wrongdoers accountable, which is good for consumers and good for responsible businesses that operate safely and strive to prevent injuries.
The Wall Street Journal does not see it that way, which I understand, but it could not resist lambasting plaintiff’s lawyers with the usual “frivolous lawsuit” epithet. A few words about that.
In fifty years of personal injury law practice, I have not known any plaintiff’s lawyer who has thrown away time and money on a frivolous lawsuit. Prosecuting a baseless case is financial idiocy and worse, incurs the risk of being sued for punitive damages for malicious prosecution and abuse of process. With very few exceptions, wholesale, frivolous lawsuits are a myth.
Nobody likes being sued and held accountable for misconduct that is against the law, ergo the popularity of lets “kill all the lawyers.” In my experience, no wrongdoer loves a lawyer until they need one, and then they never want justice. They want to get away paying as little as possible. The fact that a jury will find that the law abhors wrongdoing that harms others provides a solid reality check that prevents continued misconduct and promotes safety, no matter what the anti-social opinions of the editors of the Wall Street Journal. That is purposeful and beneficial public policy that promotes our common welfare and a just society.
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