The U.S. Department of Treasury may issue an order giving plaintiffs’ lawyers a substantial tax break allowing them to deduct costs upfront in contingency fee lawsuits. These costs are typically fronted as a loan to the client; the client promises to repay the loan, sometimes with interest, at the end of the litigation. Under this arrangement, the cost is a loan to the client and not an expense of the lawyer. Consequently, a plaintiffs’ lawyer cannot deduct these loaned costs until after the litigation has ended and the client has failed to repay the loans.
An exception exists in the Ninth Circuit. In Boccardo v. Commissioner, 56 F.3d 1016 (9th Cir. 1995), the court held that the loans may be treated as “deductible ordinary and necessary business expenses.” No other circuit has adopted Boccardo, and the Internal Revenue Service’s field service advice limits Boccardo’s applicability to the Ninth Circuit. Plaintiffs’ lawyers have lobbied without success for legislation allowing them to deduct these loaned costs upfront as the Boccardo decision allows. In 2008 and 2009, bills to permit upfront deductions were introduced but failed to pass in Congress.
Now, it appears that plaintiffs’ lawyers may have found a way to circumvent the legislative process. Legal Newsline reported that, in a speech at the American Association for Justice’s (“AAJ”) convention last month, John Bowman, AAJ’s director of federal relations, told delegates that the Treasury Department would soon be issuing an order permitting upfront deductions. Legal Newsline also reported that “Bowman cautioned AAJ members not to go public with the news [that] the order would soon be issued for fear of raising public ire to the proposal.” The Treasury Department refused to comment; however, it is expected that the referenced order would extend the Ninth Circuit’s ruling in Boccardo to all circuits.
On July 22, Senator Chuck Grassley and Representative Dave Camp sent a letter to Secretary Tim Geithner noting that “[n]either other Circuits nor Congress have validated the Ninth Circuit decision” and urging the Treasury Department “not to make such changes in the government’s enforcement of the tax laws absent a clear direction from Congress or to comply with court decisions.” On July 29, Senator John Thune, joined by 23 of his Senate colleagues, sent a similar letter “express[ing] … concern about possible Treasury actions to provide a new tax break for trial lawyers.” Both letters requested information about the change in tax policy reportedly being considered.
Allowing plaintiffs’ lawyers to deduct their loaned costs upfront will increase litigation at taxpayer expense. The current system acts as a check on frivolous lawsuits. A complex case can easily cost several hundred thousand dollars to litigate. That cost is significant, particularly for an attorney who will recover nothing if he loses. Many attorneys do not have the financial ability to front those costs, and those who do are likely to think twice before investing that amount in speculative litigation. Given the slow pace of litigation, a plaintiffs’ lawyer may have to front the costs for many years without deduction.
Speculative litigation becomes less risky and more profitable, however, if plaintiffs’ attorneys can deduct their costs upfront. The Wall Street Journal writes that treating loans as deductible expenses “would subsidize as much as 40% of the initial cost of litigation, reducing the financial risk of taking on dubious suits and almost certainly encouraging more legal marauding.”
As the Heritage Foundation states, “[i]f a change like this can’t get through the front door of Congress, it shouldn’t sneak through the back door by way of private administrative action.”
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