A Tax Break for Trial Lawyers

The House Democrats’ 2,100-page budget bill is chock full of goodies for liberal special interests, and one of the worst is a tax break for their dear friends in the plaintiffs bar. While raising taxes on businesses, Democrats want to subsidize more frivolous lawsuits against business.

The IRS generally bars lawyers working on contingency-fee cases from deducting expenses such as depositions, expert testimony and discovery until a case resolves. In contingency-fee arrangements, attorneys front the costs of a lawsuit in return for some share—usually 30% to 40%—of the client’s eventual settlement or award.

Under longstanding IRS rules, these expenses are treated like non-deductible loans to clients since they may eventually get reimbursed at the end of a case when their client settles or wins. In the rare case there’s no recovery, they can write them off like a bad loan.

Tax courts and federal appellate courts have consistently upheld this interpretation dating to the 1930s. The Ninth Circuit Court of Appeals in 1995 created a carve-out for a certain type of contingency contract. But the IRS has limited this interpretation to states in the Ninth Circuit, which is a mecca for contingency-fee lawsuits.

Under the House bill, trial attorneys nationwide would be allowed to deduct contingency-fee expenses “disregarding the possibility that such amount will be repaid.” The bill also says “income attributable to any related recovery shall not be reduced by such amount.’’ The deduction would cost $2.5 billion over a decade, according to the Joint Committee on Taxation.

By reducing trial lawyers’ legal costs, it would effectively subsidize contingency-fee cases. Lawyers will be more likely to file dubious lawsuits and drag out cases if they can immediately deduct their expenses. This is a direct income transfer to plaintiffs’ lawyers, who will turn around and finance Democratic election campaigns. It’s the definition of a corrupt political bargain.