This is one of those hidden gems. One I missed when I read the Tax Cuts and Jobs Act. (Now you know why my monograph on the law hasn’t been published yet. I’m still re-reading the verbiage to see if there are other “gems” (a.k.a. fecal deposits) hidden between the lines.)

Now, I have a way around this- I think. But, for now, I’m just sharing with y’all the sad news.

Let’s assume I have a client who didn’t pay his bill. (Let’s hope this is a terrible assumption, OK.) And, my firm sues the creep. And, we collect the bill, interest, and legal fees. Under the new law, nothing has changed. If the lawyer collects the whole amount, s/he turns over our now-collected fees and the interest; the lawyer keeps the legal fees. If the lawyer also gets a percentage of the collection, then the lawyer keeps the portion to which we all agreed (hopefully), and we get the rest. We each pay taxes on the revenue we recognized.

(No, you can’t quite claim you don’t recall getting that $ 122,000 collection. Recognition here simply means the funds that were deposited into your bank account.)

If the lawsuit involved physical injury, then the lawyer pays taxes on the fees it receives for its efforts. And, the injured party gets to keep its portion of the recovery tax-free.  Again, no change.

What about if you are suing your employer? Each of you (the law firm and you) pays taxes on the funds received. Unless, of course, the case involves sexual harassment or abuse. Well, not in all those cases- only when there is a non-disclosure clause or agreement. (Oh, by the way. Have you ever seen one of those decisions that DOESN’T have a non-disclosure clause? Yeah. Neither have I.)  This new law also affects what happens if you bring suit for invasion of privacy? defamation? or, claims related to divorce or child support?

Here’s the big surprise. In all these cases, we (the plaintiffs) get taxed on 100% of the decision. And, there is NO deduction for legal fees. Yes, this does mean that the IRS will be collecting taxes on some money TWICE.  The lawyer still is responsible to pay taxes on the money it receives- and we pay taxes on the money we collect and money we don’t (the money that ends up in our lawyer’s (or lawyers’) pockets).

It’s not just those items. Trespass, bad investment or tax advice (stockbrokers or tax advisers), bad faith insurance company torts, wrongful arrest or imprisonment, emotional distress, legal malpractice, or punitive damages from a trucking firm or driver (yep, that’s there, too!) are all on this new list of double taxation.

This change is a result of the annihilation of the miscellaneous itemized deduction (and deduction for itemized expenses) that was at the bottom of Schedule A, the itemized deduction form of the 1040.  (You can see where that appeared in the 2017 tax form, above.)

Oh, and a 2005 court decision, Commissioner v. Banks. (The commissioner in question is the IRS Commissioner, hence the tax effect- and don’t consider it’s not the law of the land, as would be true if it were a Tax Court result. This one is a US Supreme Court decision.) SCOTUS decided that plaintiffs are required to recognize (here’s that term again) 100% of the recovery as part of their gross income. (Congress sought fit to modify this requirement by passing an above the line deduction for employment and (some) whistleblower claims.)

It gets better (or worse, depending on your point of view). So many folks thought that if there are two checks issued- one to the lawyers and one to the plaintiff(s), that would solve the problem. Nope! That Banks decision, 543 U.S. 426 (2005) stipulates that the defendant is to issue a 1099 for the full settlement to the plaintiff.

So, before you agree to a contingent fee case, you better figure out how you are going to afford to pay the tax on any potential award.

Or, hope my wrinkle works out.

(Of course, I’m only sharing that with our clients )

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