Walter Olson notes that some folks in Congress are pushing a tax break for trial lawyers. Specifically, the proposal would enable plaintiffs' lawyers to deduct loans to clients to cover litigation expenses as made, rather than at the conclusion of the litigation. The estimated value of the tax code revision is $1.6 billion. Yet Victor Schwartz (among other things general counsel of the American Tort Reform Association) and Christopher Appel argue the revision could have broader implications:
Those who practice plaintiffs’ lawyer work learn quickly that it is a business similar to other capital businesses. Capital is placed at risk and a judgment is made whether or not it will bring a profit. Today the costs of litigation act as a curb against marginal and frivolous litigation. This is what makes the plaintiffs’ lawyers’ tax proposal of such great practical importance. While one cannot calculate it mathematically, having the federal government bear 40% of the initial costs allows plaintiff’s attorneys to take more cases with higher risks. The result to industries targeted by plaintiffs’ lawyers will be staggering.
Schwartz and Appel also challenge the argument that this reform would simply treat plaintiffs' attorneys' business expenses like those of other small businesses.
Yeah, I totally don't buy this. The loans are already tax deductible if not repaid? My outrage meter is struggling.
Setting that aside, it is hard to disagree with the logic here. In theory - and as a matter of professional responsibility - these loans are supposed to be paid back. In practice, when dealing with a tort plaintiff of modest means, the lawyer generally assumes the loan will not be repaid unless the plaintiff prevails, and treats it as a cost of doing business.
Treating these pseudo-loans as business expenses the moment they're made is effectively an admission that the lawyer doesn't expect to be repaid. If a bank loans you $1 million to buy a house, you don't see them lobbying to make it a tax-deductible business expenses, because it's a bona fide loan they expect to get back.
MCM, to address your point, the fact that the loans are tax-deductible if they are not repaid is not indicative of some special tax treatment that already exists; it simply means that they can be written off like any bad debt. But you don't get to write off bad debt until you actually know it's bad!
Well, while it's true that a winning lawsuit will take money away from (for example) a financial institution, that does not bother me in the cases of wrongdoing. If the owner of a large company molests all his female employees (or cheats all his customers, etc), then the resulting flood of lawsuits will likely drive him out of business, costing the local economy many job and enriching plaintiffs' attorneys. But what is the alternative? Just allow this (hypothetical) guy to get away with his misdeeds?
I think the article does bring up a very interesting point: How should we treat businesses who act 'on the margins?' Schwartz implies that we should endorse (by eliminating or reducing lawsuits aimed at marginal behavior) these actions. But I think an equally compelling argument could be made that--as a society--we are better off by discouraging businesses from acting in these gray areas. In other words: When in doubt, behave ethically.
I'm not sure which side I am on (I can see significant economic costs associated with businesses having to do this, but also can see significant societal costs associated with protecting shady business practices.), but I think it's a debate worth having in public.
I posted before your comment went up. At least as to this narrow issue, I think you've changed my mind. Nice point, and nicely explained.
Aren't they already factoring in the ability to write these loans when they decide to take a case? Sure, it'll be many months/few years later, but Schwartz seems to be arguing it's a much bigger subsidy than that. Giving them the ability to do it up front doesn't seem to change the calculation that much.
If the client does pay, will this change require the lawyer to go back and refile?
If I understand your point, you're saying something like this:
Current law: The lawyer knows he'll either be paid back, with interest, or he'll at least get a tax deduction a couple years down the road.
Proposed law: The lawyer knows he'll either be paid back, with interest, or he'll at least get a tax deduction - that he can claim right now!
If this is what you're saying, I tend to agree that it's not a big difference. It's not as though lawyers are currently saying, "Wow, I better think hard about whether to make this loan, because if we lose the case the money goes right down the rabbit hole." He'll always be getting a tax deduction at some point, even in the worst-case scenario.
But, like my friend from the Third Street Promenade, I'm not particularly moved by the "lawsuits are evil and we need to reduce them" argument. If it's a legitimate business expense, it ought to be a deduction, regardless of our normative judgment about the business activity; and the converse is true if it's not a legitimate business expense.
To me, the more compelling point is grounded in the rules of professional responsibility. The rules (and maybe they should be changed, but this is how they are) say that you can only advance a client's expenses by means of a bona fide loan, one that gets paid back win or lose. So it ought to be treated just like any other bona fide loan, to my way of thinking: it's not a tax deduction unless and until it becomes a bad debt. And you can reach this conclusion without having to take sides on whether tort lawsuits are good or evil.
Hate lawyers all you want. But in our make-work, service-industry economy, they create jobs. There are a lot of flunkies with B.A.s who'd be out of work if it weren't for plaintiffs' lawyers.
Not for lawyers. Get with the program :-).
This is silliness. The have-nots aren't paying taxes, anyway. So how are you going to cut the taxes of 50% of Americans who pay no income taxes at all?
Most of you losers have a job because someone with vision decided to start a business.
I discount the theory that allowing an earlier write off would lead to more lawsuits. It's not a question of whether the loan gets written off if the lawsuit is unsuccessful, the only issue is the timing. Thus, the benefit to the lawyer is only the time value of getting the deduction in year 1 rather than having to wait until year 1+ to take the deduction. Using a made up number of $50,000 per case in such loans and a made up time frame of 3 years for resolution, the time break is worth, at today's rates of close to zero, somewhat under $5,000... not enough in my mind to lead to more lawsuits being filed than would otherwise be the case.
No. Litigation related expenses are ethical.
As a lawyer, you can ethically front your client $100,000 on depositions and expert witnesses. But if your client need $500 to make rent, don't even think about writing that check.
So, what is the proposal? That they be treated as business expenses up front and deducted? Only to be recouped against income later? Or something like that?
Frankly, I was appalled when ObamaCare didn't even mention or take into account malpractice insurance. And it appears that it would moot much of state malpractice reform through national pooling of policies, etc. But worse, this proposal would to some, maybe small extent, subsidize malpractice suits with federal tax money. That isn't a rational solution to our health care problems.
Can the lawyer make expenses contingient?
1) If this refers to literal loans to the client, the last time I heard those were barred.
2) If it refers to the attorney paying for a deposition, expert witness, etc., why wouldn't he deduct these as a cost of doing business in the year in which they were paid?
re your questions:
1) lawyers can front litigation expenses in contingent-fee cases (filing suit, depositions, etc.) At least in the states I'm aware of, they can also pay for medical expenses such as surgery. You could have over 100k out on a big case.
Further, some states actually do allow loans to clients for necessary living expenses. (So far as I'm aware, the interest you can charge a client is strictly regulated.)
But that is not what the authors are talking about. The "loan" terminology comes about because the IRS views lawyer spending on litigation expenses as a "loan" to the client. These expenses are currently deductible- when the case settles, but not before. A big case could take you 3 or 4 years to resolve, easily. The proposed legislation would allow you to deduct the money you front as you front it.
2) The answer to this is in the paragraph above. The IRS will fight you on that. See here.
The Schwartz/Appel piece is practically hissing invective towards plaintiff lawyers. I'd love to see what actual evidence supports their doomsday scenario.
This doesn't strike me as a bad thing, especially if most loans made to clients are not repaid. I did have a question, though — if the loan IS repaid, does the lawyer have to pay back the taxes that were previously deducted?
This proposal would change the law by allowing them to be deducted at the time the expenses are incurred.
I've never understood why these expenses are not deductible. Here in Texas these aren't loans. You front expenses (tens if not hundreds of thousands in big cases) and the client doesn't owe if you lose. This is just as much a business expenses as rent or salaries. I see no real reason to treat it differently.
When I started doing plaintiff's work, my CPA explained that case expenses aren't immediately deductible. I thought he was an idiot and got a second opinion. I learned I was the one who didn't understand.
Opposing this reform is using the tax code to favor a business you like over one you don't. I personally don't think that's a big deal. But I thought free-market conservatives did.
I utterly reject the argument that tax law should be used to discourage "bad" conduct. Tax laws should be used to raise revenue, not for social engineering. They should be based on whether they treat like situations in a like manner, not on whether they punish bad people or bad actions.
That said, I'm not sure which way is more just. It comes down to how solid their expectation of being repaid is. I'd need to see some statistics, at minimum, to judge that.
I think, though, that it probably would have a material effect of the willingness of lawyers to take on certain contingent cases, particularly those involving complicated medical issues (which require expensive expert witness services early in the process). I don't do personal injury work, but I hav friends who do. My impression is that plaintiff's PI lawyers are extremely capital-constrained, and that because of the nature of their business it is harder for them to raise capital (either through business loans or through equity arrangements) than for most other small businessmen. By making advances tax-deductible when made, you reduce the capital requirements of bringing a contingency suit by the lawyer's marginal tax rate.
Whether this is good or bad depends on your perspective on larger legal systematic issues. My own view is that these larger battles should be fought out in the relevant substantive law, or court rules, rather than by proxy in the tax code. Transparency in politics is good.
The rule is especially bizarre in a class action. How can we be loaning millions of dollars to a group of individuals who we haven't identified and who don't yet know they have extended the loan? But there are lots of expenses before the class notice goes out.
Contingent fee arrangements are simply "payment upon completion" contracts, which are not uncommon in other lines of work. A factory will purchase raw materials and turn them into widgets. The widgets are sold upon completion. The cost of raw materials is not a loan to the customer who might buy a widget the following year. It is a deductible cost of doing business. There's no principled reason that expert witness fees--which will result in revenue in a future year or will be written off--are treated differently.
So alcoholic beverages should be taxed the same as nonalcoholic beverages?
Consider opposition to this reform a tax on the unearned profits that rent-seeking lawyers receive as a result of government subsidies to lawyers (e.g., licensing cartel).
I'm sure you think this is a gotcha!. But, yeah, most clear-thinking people would say, "Yes."
Now, if alcohol has certain externalities that other beverages don't have, then there'd be a case for higher taxes. Those tax dollars, though, should be earmarked to pay for those externalities and should not, instead, go into a general fund.
That alcohol is morally bad, though, is not a justification for higher taxes.
That is what Schwartz/Appel say too, and even they admit there is no way to quantify this.
As a plaintiff's lawyer let me throw in my perspective: the biggest cost in doubtful cases is my TIME. In a case of pretty good liability where I invest $100,000 or so, I don't really worry about the time I have to spend working on the case. In weaker cases, above and beyond the money you spend, you worry about all the time you will waste screwing with it. Even if you end up settling it for something to get your costs back, you expend more effort than on your good cases even before you think about effort vs. dollar returned; and of course, your client is not satisfied with the outcome, and human nature being what it is what do you think they say: (a) "I had a crap case" or (b) "my lawyer did a bad job."
That, to me, is the biggest cost of pursuing a weak case. The tax advantages of deducting costs now, vs. when the case settles 2 years from now, are real but not a world-ending difference. Tax deduction or not, a loser is still a loser. Nobody wants to spend a whole lot of time on a weak case.
That is even setting to one side, the question of "why should we continue to elevate form over substance, and keep lawyers from deducting business expenses at the time they are incurred."
Interestingly, the 9th Circuit allowed the deduction under a gross fee arrangement even though such arrangement violated Cal. State Bar rules (but not the rules of the DC Bar). There was no evidence that the Cal Bar enforced these rules, which meant that Code section 162(c) had no application. [read the opinion to get details on how section 162(c) works]
So what happens tax wise when the client actually pays the costs as those costs are incurred? They MIGHT BE deductible in the year paid, but that depends on the nature of the lawsuit. If the client is suing to recover lost income, the costs will be deductible in the year paid. If the client is suing to recover a valuable asset, like a parcel of real estate, then the costs must be capitalized (i.e., added to the "tax basis" or cost of the asset) and are not deductible ever. They are taken into account when the asset is "sold" for tax purposes.
I have no problems with the law as it stands today, where the deductibility of the costs depends on state law and on the type of fee arrangement. Different outcomes based on different agreements and differing state laws makes sense to me.
But the premise of the highlighted article seems far fetched to me. PI attorneys don't spend their hard earned money on costs to generate a tax break. They spend it because they think that there will be a net recovery in the case. Giving them the tax break in an earlier year does not increase the chances of recovering money from the defendant. Yes, the tax angle might make a difference in a very few cases. But that is no reason to oppose the proposed change in the law.
If the attorney is willing and able to enter into a gross fee agreement, they can get the deduction in the year paid without a change in the tax code. That seems to me to be the best reason for opposing the change in the law. In those states where the State Bar actively disciplines attorneys who enter into gross fee agreements, go to the legislature and get the law changed.
And, in fact, taxing alcohol is probably unjustied on social engineering grounds anyway. The people most likely to be discouraged by an increase in marginal costs are the casual drinkers. The heavy drinkers are least likely to be affected by cost. Most causal drinkers probably extract a health benefit from their drinking. So there is no sensible social engineering reason for punishing them with taxes.
In any event, I don't think taxes are a sensible way to redistribute externalities anyway. But that's another argument entirely.
I'm skeptical. Sure, each plaintiff's lawyer may hire a few people for his office, but on net, I suspect the costs they add to the productive portions of the economy cause a net loss of jobs. Does anyone have any numbers to clear this up?
I suspect that it is not possible to accurately quantify the numbers on either side. I have no doubt that there are numbers out there if you look, but I would expect that the numbers you will find are not "computed" by disinterested parties.
It will always depend on where you draw the line. After all, suits brought by PI attorneys generate jobs in the PI attorneys' firms, in the defense attorneys' firms, for expert witnesses and various consultants, for court reporters, etc. (they might also cause the courts to hire more personnel but that is not clear). And the successful PI attorneys may then spend their contingency fee recoveries in ways that help create jobs. Someone has to make those fancy suits that PI attorneys wear to court.
But there is also no doubt that defending against lawsuits requires spending money that the defendants would put to other uses in the absence of lawsuits. Would the money be spent in ways that create more jobs if the lawsuit had not been brought? For some defendants yes, for some defendants no. I sure don't feel competent to compute the numbers on either side.
Of course, we don't decide who wins and who loses lawsuits based on which side would be able to create more jobs with the funds that are spent on litigation.
According to many VC commenters, yes. In their eyes there is no such thing as a meritorious lawsuit, no matter how plainly intentional or wantonly reckless the conduct was nor how severe the resulting injury was.
The first nuance is that a bad debt is classically a capital loss or a reduction of basis, not a deduction against income. It should be obvious why you would prefer a deduction, particularly since trial lawyers don't have a lot of opportunities to realise capital gains. The reason these loans are treated as expenses and not capital is that the trial lawyers successfully argued that the loans are part of their day-to-day business. This is probably correct.
The other nuance is one of timing. Ordinarily, an expense is deductible once incurred. However, the IRS argues successfully that even in the Texan example the expenses are paid on the lawyer's reasonable expectation that they will be recouped out of the settlement money. Thus, on one view (the IRS's, and presumably the tax court's), the expense is not really incurred until settlement.
On the broader picture, first it can hopefully be seen that this is not really a case of the tax code being discriminatory. It is just that each industry has its own peculiar facts and the tax code necessarily applies differently to each of them.
Secondly, if they do win, they then record more income at that time than they would have previously. So in nominal terms they pay no more nor less tax than they would have anyway. But in 'real' terms they have deferred their tax and thus benefited from the interest and the inflation discount on the tax liability. Before anyone thinks that this is trivial, bear in mind that the single biggest item in Obama's foreign tax plans is to end corporate deferral of taxation on foreign earnings - clearly, someone at least thinks that deferral is a big issue.
With that out of the way a few points should be reasonably capable of forming common ground:
1) Trial lawyers are a major source of Democrat funds and support.
2) It appears highly likely that one of the major causes of America's medical expense inflation is litigation.
3) An aggressive plaintiff bar plays an important role in enforcing existing law and protecting consumers.
From those points some will think that trial lawyers should be 'reined in', others will think that they need to be empowered. Whilst as the fairly libertarian kind, I admire this country's acceptance of litigation funding, class actions and 'law as business', as a pretty conservative lawyer-type I can't help but abhor your forum-shopping, elected judges, overly permissive class rules and simply absurd punitive damage awards (yes, I know that these are almost invariably slashed on appeal, but that hardly makes them sensible). So I am not entirely sure of the best course of action.
However I am sure that someone who wanted to rein in healthcare costs would do things that would hurt trial lawyers, like cap awards, introduce no-fault minor claims and obstetrician's schemes, etc.
The real reason for higher taxes on alcohol is that the demand is not as eleastic, which is also the reason that some claim it is morally bad.
Thinking about it, almost all "sin" taxes are for goods or services whose price is not as elastic as most goods.
You can't get rid of the margins, whether you try to encourage or discourage the currently-marginal behavior. Endorsing currently-marginal behavior just shifts the margin outward: formerly-marginal behavior is now approved, but some formerly-condemned behavior is now marginal. And likewise, discouraging at the margin just shifts the margin inward. No matter where you draw the line, and no matter how you move the line, something's going to fall right on it.
Yes, it worked so well for the San Francisco lawyers involved with Mr. Gian Ferri.
Treating advances as loans, as is currently done, leads to strange tax situations.
Example: In 2007, a law firm collects $5 million. It pays out $3 million for employee salaries and benefits, rent, insurance, etc., and advances $1 million in costs on a contingent fee case. This leaves $1 million left over, which is paid to the partners and shareholders. But because the cost advance is considered a loan and not an expense, the law firm is deemed to have $1 million in income for 2007 ($5 million in receipts, $4 million in expenses), on which it will have to pay income tax.
In 2008, however, the firm again collects $5 million in regular receipts, plus the $1 million cost advance is repaid back when the case settles. The firm still pays $3 million for employee salaries, rent, etc. So in 2008, $3 million is left over to be paid to the shareholders/partners.
But because the firm made $5 million in income, but paid out $6 million in expenses, the firm will have "lost" $1 million that year for tax purposes. Even though its owners actually put three times as much money into their own pockets.
If cost advances remain fairly consistent from one year to the next, this ends up not mattering, because it all evens out. But if costs fluctuate, you can get some weird tax consequences that you wouldn't have if the costs were considered expenses right from the start.
Yet under current law, the law firm earns $1 million in income in 2007, and takes a $1 million loss in 2008.
Is it that there are so many "frivolous" med mal lawsuits; or that there is so much negligence (of which very little results in a lawsuit), and hence a great many meritorious med mal claims; or that it is so expensive to litigate med mal claims; or what?
If all healthcare providers were granted absolute immunity against negligence claims, then how much reduction in it's medical bills would America see?
D lawyers may encourage their clients to settle because they have so much at risk should they lose, though the D lawyers may think theirs is the stronger case. P lawyers have skin (their own) in the game and only eat what they kill, so may push their clients to settle for less than the case's expected value. And more often than not, much more often, it is the Ds who have the deep pockets (their own or insurance company's) and are not above using their financial advantage and other resources to grind Ps down (name many high-priced experts all around the country, forcing Ps to spend heavily before getting to trial) and force them to settle for less than their expected value rather than go to trial.Whose money don't you want to see "hand(ed)...to the plaintiffs' bar? That of losing Ds? Or what the Treasury would lose in interest if P lawyers could deduct their costs when incurred rather than years later?
Sorry, don't understand. You are calling for the English rule rather than the American one? Under what sort of scheme would it be possible for "victorious parties...to deduct these expenses at a greater rate than the loser's"?
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