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Amidst all the corporate tax benefits enacted by the U.S. Senate on Oct. 10, one little-noticed provision may turn out to be a boon for civil rights plaintiffs, public interest groups, whistleblowers and even trial lawyers. The American Jobs Creation Act of 2004, which now heads to President George W. Bush for signature, contains a section ending the “double taxation” of lawyer contingent fees in several types of litigation. The Internal Revenue Service (IRS) has favored double taxation for years, and its policy is the subject of two cases set for argument at the Supreme Court on Nov. 1. Until now, the IRS required a victorious plaintiff, civil rights or otherwise, who won, for example, a damages award of $100,000 to pay taxes on the entire amount, even though a contingent fee of $30,000 went to the plaintiff’s attorney, and even though the attorney would pay taxes on that $30,000. The government’s theory was that the entire award went to the client and should be taxed to the client, no matter where a chunk of the award ended up. Languishing for five years This double taxation has been challenged in court, with mixed success, as a powerful disincentive for public interest and civil rights litigation. A bill to fix the problem, the Civil Rights Tax Relief Act, has languished in Congress for nearly five years without success until this week. “I am proud to say today we are putting a permanent provision in law that will protect people who risk their health and safety to help the government identify and prosecute fraud, and others who fight to protect their civil rights,” said Representative Deborah Pryce, R-Ohio, an original co-sponsor of the bill four years ago. Senator Susan Collins, R-Maine, also pushed for the legislation. The National Employment Lawyers Association, one of a coalition of groups that fought for the bill, was also celebrating last week. “We are thrilled that Congress saw the wisdom of relieving individuals from having to pay taxes on fees that are paid to their attorneys, where the attorneys are already taxed on those same fees,” said Bruce Fredrickson, vice president of public policy. Fredrickson said the bill was supported by groups ranging from AARP to the National Whistleblower Center and including the U.S. Chamber of Commerce. Even though they are on the other side of affected litigation, businesses did not like the double-taxation policy because it would jack up the cost of settling suits to compensate for the extra tax payments. “This tax issue complicated nearly every employment discrimination settlement we dealt with,” said Fredrickson. The fact that groups across the political spectrum sought the change, Fredrickson said, was a big factor in the legislation’s success. “When we would go into meetings together, people would look at us like we were a two-headed calf,” he said. The old tax policy began to show signs of weakness when appeals courts began siding with taxpayers who challenged it. The IRS, in turn, sought to defend the policy in a pair of cases now before the Supreme Court: Commissioner of Internal Revenue v. Banks, and Commissioner of Internal Revenue v. Banaitis. Both won awards in employment disputes and challenged tax bills based on the full amount. The fact that Congress has now overturned the disputed policy has thrown those cases into uncertainty, though they do not become entirely moot. Jerome Libin, a partner in Sutherland Asbill & Brennan’s Washington office who wrote a brief in the Supreme Court cases on behalf of several civil rights groups, said his understanding of the new provision is that it is prospective and that it may cover only contingent fees in litigation under specific laws listed in the legislation. “There is still a broader issue of other kinds of litigation,” says Libin. Since Banks and Banaitis involve two taxpayers among the hundreds who have been levied the disputed tax in the past, their cases might still be alive. “There are lots of people in that position who might not be affected by a prospective law,” said University of Washington School of Law Professor Eric Schnapper, lawyer for Sigitas Banaitis, who challenged his tax bill on an $8.7 million settlement he won in an employment dispute, even though $3.8 million went to his attorneys. Schnapper said it was too soon to assess the full impact of the congressional enactment on the pending Supreme Court cases.

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