Amicus Curiae

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					                                   Let’s All Move to Alabama!
                                       By Fred A. Simpson

         A matter of great importance to trial lawyers on both sides of the docket is now under
review by the Fifth Circuit. In fact, the case has prompted the Texas Trial Lawyers’ Association
to file an amicus curiae brief to help get the fat out of the fire. The issue concerns taxability of
personal injury tort damages and whether a plaintiff receiving those damages must pay federal
income tax on the gross amount of the award or settlement, or only on the net amount after
deducting expenses and attorneys’ fees. An anomaly arises because Alabama has a statute that
allows the tort victim to declare only the net amount as taxable income, but Texas has no such
statute.

        The Alabama statute grants the contingent fee lawyer ownership rights to the claims
being litigated that are equal to those of the client. The Tax Court regards that Alabama statute
as a clear preference over prevailing Texas common law that appears to give a Texas lawyer less
than an equal interest in his client’s claim. The Tax Court relies on a 1962 Texas Supreme Court
decision to support its recent holding. That 1962 supreme court case is in an entirely different
context and does not take reveal that Texas courts have long held that even a simple lawyer’s
lien in a contingent fee contract creates an equitable assignment of claims in the client’s cause of
action. The Tax Court decision may also not pass the smell test of the Uniformity Clause in the
U.S. Constitution which prohibits indirect methods of taxation that are not geographically
uniform.

        So, let’s all move to Alabama where tort plaintiffs enjoy income tax benefits denied by
the Feds to us poor plaintiff folk here in Texas. Alabama taxpayers recovering taxable tort
damages keep, after taxes, a least 16 cents more per taxed dollar than Texas residents. That’s not
a big difference you may think, but on a $Million dollar settlement or judgment we’re talking
about $160,000 in after tax money. “How is this possible?” First of all, the tort recoveries
described are the non-physical type (with interest always being taxable) along with punitive
damages that are now subject to tax because of a change in the law a few years ago. Texas
plaintiffs receiving money for nonphysical injury torts because their attorneys agreed to serve
them on a contingent fee basis have the described unfair and perhaps unconstitutional tax
disadvantage, if a recent Tax Court case is allowed to stand.

       The anomaly compelling us to stampede into Alabama arises from the Tax Court’s recent
determination of who owns that particular part of the litigated dollar recoveries that end up in the
pockets of the lawyers engaged to prosecute tort claims in exchange for a contingent fee. The
real question is whether the winning Texas lawyers have any ownership rights to their earned
contingent fees at any point in time before those fees actually materialize into cash and are no
longer contingent. The ultimate issue is therefore whether the client who enters a contingent fee
agreement with his attorney constructively receives 100% of settlement or judgment proceeds
(from which funds he thereafter pays his hired gunslinger), or whether the client only receives as
taxable income the net amount the attorney forwards after first subtracting all costs and the
contingent fee. Alabama taxpayers get to deduct the contingent fees and costs, Texas taxpayers
do not
        If it is lawfully correct that clients really do constructively receive 100% of all
judgments or settlements and that those clients then constructively pay litigation expenses and
attorneys’ fees, the clients are saddled with federal income tax liability on the full amount. But if
the attorneys actually own part of their clients’ recoveries before payment by the defendants or
their insurers, the clients are deemed to receive only the net amount for tax purposes, typically
less than 65% of the gross amount after contingent fees and all expenses of litigation are
deducted.

        The individual Texas taxpayer may of course deduct on his tax return the fees and costs
related to taxable income from litigation as “other expense,” an itemized deduction “below the
line” from adjusted gross income. The rub comes where this category of deductions is (a)
subject to a 2% of adjusted gross income “floor” before becoming visible, and (b) completely
ignored in the mandatory alternative tax calculation, which usually means the deduction for
legal expense yields no tax benefit for the individual tort plaintiff. This is in contrast to the
business taxpayer who deducts reasonable and necessary legal expenses “above the line” to
arrive at net taxable income.

        We should all keep our eyes on the Fifth Circuit as it deals with this matter. Other things
plaintiffs’ lawyers should consider are: (1) tightening up their contingent fee contract forms with
respect to securing a present interest in clients’ claims; (2) consciously structuring settlement
agreements in a manner that assign damages to nontaxable categories; and, (3) asking the Texas
Legislature to enact a statute similar to, if not better than, the Alabama statute but consistent with
the policies of Texas. Regarding such statutes, the Tax Court notes in another 1998 decision that
statutes of several states regarding lawyers’ liens don’t yield the same tax benefits as the
Alabama statue.

       For those who like citations, the devastating Tax Court case is Srivastava v.
Commissioner, T.C.Memo. 1998-362 1998 WL 712467, in the Fifth Circuit as Docket No. 99-
60437; the Texas Supreme Court case the Tax Court relied on is Dow Chem. Co. v. Benton, 357
S.W. 2d 565 (Tex. 1962); the statute we should embrace is 46 Code of Alabama (1940) § 64,
“Lien of attorneys at law”; the Texas case that discusses lawyers’ equitable assignments is
Northern Texas Traction Co. v. Clark & Sweeton, 227 S. W. 564 (Tex. Civ. App. — Texarkana
1925, no writ); see also Mandell & Wright v. Thomas, 441 S. W. 2d 841, 846 (Tex. 1969) ; the
Tax Court case that disapproves of some state statutes other than Alabama is Coady v.
Commissioner, T.C. Memo. 1998-291 1998 WL 453669; and, for a discussion of the Uniformity
Clause (U.S. Const. art. I §8, cl.1), See Apache Bend Apartments, Ltd. v. U.S., 702 F. Supp.
1285, 1295-96 (N.D. Tex. 1988). The taxpayers’ lawyer is Michael D. Cropper of Midland, and
those on the amicus brief for the Texas Trial Lawyers’ Association are: Henry Binder of Porter
& Hedges, and Hartley J. Hampton of Gallagher, Young, Lewis, Hampton, Downey & Kim.




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posted:4/17/2013
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