()

Once again, Pennsylvania lawyers are finding themselves caught in the crosshairs of legislation that would have a dramatic impact on the way they do business, and, according to many of those lawyers, would hurt their ability to compete with other jurisdictions.

As attorneys continue to monitor and oppose federal legislation proposed last year that would move law firms from a cash to an accrual method of accounting and result in those firms paying hundreds of millions of dollars in additional taxes at the outset, Pennsylvania lawyers are coming out against a state Senate bill that would impose a sales tax on legal services.

SB 76, known as the Property Tax Independence Act, is aimed at eliminating the school property tax across the commonwealth. The tax would be replaced through a combination of funding from personal income taxes and sales taxes.

The act would also broaden the sales tax base to include more services and products, including certain legal services.

The state sales tax would be increased from 6 percent to 7 percent under the legislation and the remaining funding necessary to make up for the elimination of the school property tax would come through an increase in the personal income tax from 3.07 percent to 4.34 percent, according to a memorandum issued by bill sponsor Sen. David Argall, R-Schuylkill.

The Pennsylvania and Philadelphia bar associations have come out against the legislation. In a letter issued to members last week, Philadelphia Bar Association Chancellor William P. Fedullo noted the tax would be felt even more heavily in Philadelphia where legal services would be taxed at a rate of 9 percent. Fedullo said the biggest impact, however, will be on clients, who will be forced to pay the tax.

“The need for legal representation is not a voluntary choice and explicitly not a non-essential service,” Fedullo said.

Fedullo also noted that a tax on legal services in Pennsylvania would place the state’s lawyers at a competitive disadvantage to lawyers in nearby cities given none of the surrounding jurisdictions tax legal services.

“Clients who can direct work to other locations would quickly save on costs by selecting firms outside Pennsylvania or Philadelphia,” Fedullo said in the letter. “Those firms with offices in multiple locations may see requests to direct work to attorneys who do not practice in Pennsylvania. We currently enjoy a competitive advantage over New York and Washington, D.C., on rates. We do not need to eliminate this gap by filling it with a sales tax.”

Similar to concerns raised earlier this year by those who opposed the federal legislation, Fedullo said the sales tax could result in lost business and lost jobs just as the legal community is beginning to recover from the recession.

Lee A. Zoeller, chairman of Reed Smith’s state tax group, said this type of legislation gets proposed every few years. But he said “this one does appear to have perhaps some legs on it.”

Zoeller could only point to two other states—Hawaii and New Mexico—that tax legal services, but that is under those states’ gross receipts tax model that taxes all services without exemptions.

“Pennsylvania would be an outlier in the states in terms of the only state that imposes a true sales tax on legal services,” he said.

And the legal industry is one unfamiliar with the business of paying sales tax. While Walmart could easily start collecting sales tax on toothpaste tomorrow, law firms have never registered to collect sales tax on anything and would need to enter an entire new system, Zoeller said.

“This is a whole new industry that is not geared up to collect tax,” he said, noting there would be cost and compliance burdens facing law firms that they never had to address before.

The other question, Zoeller said, is whether the legislation will follow the typical tax structure of taxing services where they are rendered, or if they would be taxed based on where the benefit of a service was received. In the former scenario, a lawyer based in Pennsylvania would have to tax for his services regardless of where the client was based. In the latter scenario, Zoeller said, a New Jersey lawyer doing work for a Pennsylvania-based company would have to charge taxes on that work.

Stewart M. Weintraub, chairman of Chamberlain Hrdlicka’s state and local tax practice, pondered whether Pennsylvania’s national and international firms would be forced to have lawyers from out-of-state offices working on matters to avoid the tax.

“If a law firm in Philadelphia is representing a client that is headquartered in Chicago for a transaction in England, they can go to any law firm in the country, why should they go to a Philadelphia law firm?” Weintraub asked.

Those are just some of the many questions Weintraub said are created by the legislation. The law does allow for the exemption from the tax of certain legal services—criminal cases, family law cases and business-to-business matters.

Weintraub said he wasn’t clear what would constitute a business-to-business matter. Perhaps patent litigation between companies wouldn’t be taxed but a company’s patent filing before the U.S. Patent and Trademark Office would be, Weintraub said.

One area that would be taxed under Weintraub’s understanding of the legislation is personal injury cases.

“So you are taking money out of the proceeds to the plaintiff,” Weintraub said.

He had other concerns from a policy perspective as well. The replacement from the school property tax is coming from three places—an increase in the personal income base, an increase in sales tax rates and a broadening of the sales tax base.

Sales and income tax are largely driven by the economy, so when the economy falters, those tax collections fall, Weintraub said, noting property taxes are usually rather steady.

“There is the potential for dramatic fluctuations in funding sources from year to year,” Weintraub said. “What does it do to school district budgets?”

SB 76 was last referred to the Senate Finance Committee on March 14. It currently has 26 sponsors, nearly evenly split between Republicans and Democrats.

Gina Passarella can be contacted at 215-557-2494 or at gpassarella@alm.com. Follow her on Twitter @GPassarellaTLI.