Legislature(2003 - 2004)

03/23/2004 09:04 AM Senate FIN

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
     SENATE BILL NO. 300                                                                                                        
     "An Act relating to an attorney's lien, to court actions, and                                                              
     to other proceedings where attorneys are employed."                                                                        
This  was the first  hearing  for this  bill in  the Senate  Finance                                                            
Co-Chair  Wilken  stated this  bill  sponsored by  Senator  Stedman,                                                            
"addresses  a ruling  by the  Ninth Circuit  Court  of Appeals.  The                                                            
Court held that Alaskans  who win an award in court must pay federal                                                            
income tax on the award,  including attorney fees, and then when the                                                            
plaintiff pays the attorney, the income is taxes a second time."                                                                
SENATOR BERT STEDMAN read the sponsor statement into the record as                                                              
     SB 300 eliminates  an unfair and potentially disastrous federal                                                            
     income tax  issue affecting Alaskan taxpayers  and prevents the                                                            
     IRS [U.S.  Internal Revenue Service]  from taxing two  Alaskans                                                            
     on the  same income. SB 300 corrects  this unjust treatment  of                                                            
     Alaskans under current 9th Circuit rulings.                                                                                
     Because  of a peculiarity in  Alaskan law, Alaskans  who win in                                                            
     court  may  pay federal  income  tax  on phantom  income.  When                                                            
     Alaskans  file their federal  tax return, they must  report any                                                            
     litigation  recovery   allocated  to  attorney  fees  as  gross                                                            
     income,  even  though they  receive  no economic  benefit  from                                                            
     those  fees. The federal government  taxes that portion  of the                                                            
     prevailing  side's award  twice; once  as income to the  client                                                            
     and  again as  income  to the  client's  attorney. Incredibly,                                                             
     there  is no  federal tax  deduction to  offset this  inequity.                                                            
     It's  even possible for  someone to win  in court but  come out                                                            
     with a net loss after paying legal bills and taxes.                                                                        
     Under current Alaska  lien law <AS 34.35.430>, attorneys have a                                                            
     "subordinate  lien"  or ownership  interest  in  the "cause  of                                                            
     action".   Other  states,  Including   Oregon,  use   different                                                            
     language  to specify that as  long as an attorney has  filed an                                                            
     appropriate  lien and is owed money by the winning  client, all                                                            
     fee awards  or payments made  to the client belong exclusively                                                             
     to the attorney.  In so vesting the attorney  with the property                                                            
     interests  of  the award,  those states  avoid  the unfair  tax                                                            
     burden currently  imposed on Alaskans. Instead,  any portion of                                                            
     an award  retained to pay attorney costs, is  not income to the                                                            
     SB  300 changes  Alaskan  law to prevent  the  IRS from  taxing                                                            
     Alaskans  on income  they don't receive.  This bill  recognizes                                                            
     that court  awarded fees which  pass through to one's  attorney                                                            
     is  income  to the  attorney.  And  as such,  the  attorney  is                                                            
     responsible  for paying federal  income tax on that  portion of                                                            
     their income.                                                                                                              
Senator  Stedman noted  that when  drafting statutes  for the  legal                                                            
system, Alaska  mirrored the state  of Oregon statutes in  many ways                                                            
and that  Oregon has  this same inequity.  He gave  an example  of a                                                            
case involving  the wrongful  termination of  an employee,  in which                                                            
that employee prevailed  and received a "small" award in addition to                                                            
attorney fees.  Under current statute,  Senator Stedman pointed  out                                                            
this employee  would receive a net  loss because the employee  would                                                            
be required  to claim the  attorney fees as  income and pay  federal                                                            
taxes on that amount.                                                                                                           
SFC 04 # 54, Side B 09:52 AM                                                                                                    
Senator Stedman continued  that many plaintiffs do not have adequate                                                            
resources to absorb the  tax burden of this additional income, which                                                            
they did not receive.                                                                                                           
Co-Chair  Green  referenced  a  letter  dated February  6,  2004  to                                                            
Senator Stedman from Kevin  Walsh, of Walsh, Kelliher and Sharp. She                                                            
asked if  this legislation  would only apply  to cases heard  in the                                                            
Alaska Court System  or to cases before the Human  Rights Commission                                                            
as well.                                                                                                                        
Senator  Stedman understood  this  legislation applies  only to  the                                                            
award of attorney fees from court cases.                                                                                        
KEVIN  WALSH,  Certified  Public  Accountant,  Walsh,  Kelliher  and                                                            
Sharp, testified  via teleconference  from  Fairbanks in support  of                                                            
this bill and about his  25 years experience and service as chair of                                                            
the IRS/CPA Liaison Committee  and chair of the Tax Committee of the                                                            
Alaska Society  of CPAs. He emphasized  this bill was not  sponsored                                                            
at the  request of the  Alaska Bar Association  (ABA). He stated  he                                                            
supports this  bill because he was  "tired of" the IRS becoming  the                                                            
prime beneficiary of court settlements.                                                                                         
Co-Chair Green restated her question.                                                                                           
Mr. Walsh affirmed  this legislation  only relates to awards  issued                                                            
as a result of a court case.                                                                                                    
Senator Olson  asked how this legislation  would affect federal  IRS                                                            
Mr.  Walsh  replied  that  the  IRS  considers  property  rights  as                                                            
described in state  laws. He stated that the Ninth  Circuit Court of                                                            
Appeals  held that  the property  rights were  such that  plaintiffs                                                            
must pay tax  on their attorney fees  under California law,  Arizona                                                            
law and Alaska law. However,  he noted that the Court found that the                                                            
state of Oregon laws were  somewhat different and therefore provided                                                            
that  the plaintiff's  attorney  is the  only party  liable for  the                                                            
property rights taxes.                                                                                                          
Senator Bunde  clarified that  the impetus  of this bill is  not the                                                            
Alaska Bar Association and asked the ABA position.                                                                              
Mr.  Walsh affirmed  the  ABA  did not  initiate  this legislation,                                                             
commenting that all credit  or blame falls to him. He qualified that                                                            
he  asked   the  Association   for  assistance   in  drafting   this                                                            
legislation; however, noted  that the ABA does not take positions on                                                            
legislation.  He relayed that the  president of the Association  has                                                            
indicated  interest   in the  matter.   He  also  informed  that  he                                                            
requested  the opinion  of the  Alaska Legal  Services Corporation,                                                             
which  represents  disadvantaged  parties, but  had  not received  a                                                            
reply.  He wanted  to  ensure  this legislation  would  not  benefit                                                            
attorneys  at the  expense of taxpayers.  He  referenced an  article                                                            
published in  the Wall Street Journal  [copy on file] regarding  the                                                            
National  Taxpayer Advocate,  Nina Olson's  attempt  to have the  US                                                            
Congress address the matter  through federal law, although he stated                                                            
these efforts have been  unsuccessful. However, he remarked that the                                                            
Alaska Legislature  has the  ability to change  statute in  a manner                                                            
that the federal Ninth Circuit Court of Appeals could affirm.                                                                   
Senator Bunde  never mind other discussion  re tort reform  they say                                                            
in it for benefit of the people.                                                                                                
Co-Chair Wilken referenced  letters in support of this bill from the                                                            
Windfree  Law  Office  and  Cook  Schuhmann   and Groseclose,   Inc.                                                            
Attorneys at Law [copies on file].                                                                                              
Senator Olson  asked the  reason for the  language contained  in the                                                            
bill as  opposed to language  changing  existing statutes  governing                                                            
property rights.                                                                                                                
Mr. Walsh  replied that he  had requested  the ABA provide  him with                                                            
language identical to that  adopted by the state of Oregon and ruled                                                            
adequate by the Ninth Circuit Court of Appeals.                                                                                 
Senator Olson cautioned  this "remedy" might inadvertently provide a                                                            
loophole relating to property rights.                                                                                           
Co-Chair  Wilken  asked  if  the  Senate  Judiciary   Committee  had                                                            
discussed this possibility.                                                                                                     
Senator Stedman replied it did not.                                                                                             
Co-Chair  Wilken asked  if Senator  Olson wanted  this bill held  in                                                            
Committee to address this concern.                                                                                              
Senator Olson deferred to the sponsor and the co-chair.                                                                         
Co-Chair Wilken  suggested highlighting the issue  with intent it be                                                            
addressed   when  the   bill   is  considered   in   the  House   of                                                            
Co-Chair  Green   wanted  assurance   that  in  remedying   the  tax                                                            
consequence,  this legislation would  place the attorneys  "in front                                                            
of" of plaintiffs regarding receipt of settlement payments.                                                                     
Senator Stedman assured  it would not allow such "front-running". He                                                            
stressed  that the  laws  governing  attorney's trust  accounts  are                                                            
"extremely tight" and this  legislation would not grant the attorney                                                            
additional claim to a settlement.                                                                                               
Co-Chair Green  asked if this requires that a client  who receives a                                                            
settlement make payment to an attorney.                                                                                         
Senator Stedman  described  the "flow of funds"  to a trust  account                                                            
governed by the attorney then distributed to the client.                                                                        
Co-Chair Green surmised  if 100 percent of an award amount were paid                                                            
to the client  who then fails to pay  the attorney fees,  the client                                                            
would not  be required to  pay taxes on that  amount. She asked  how                                                            
this could be justified.                                                                                                        
Mr. Walsh  responded that  the individual  receiving funds  would be                                                            
taxed  for  the  entire  amount  that  person  is  entitled  to.  He                                                            
explained that  an attorney could file a lien against  the client if                                                            
not paid for services.  He also noted that if an attorney chooses to                                                            
not collect  a fee, the client would  be liable for taxation  on the                                                            
entire amount of a settlement.                                                                                                  
Co-Chair Wilken  noted this bill does not specify  an effective date                                                            
and asked whether  the sponsor would support an immediate  effective                                                            
Senator Stedman supported this.                                                                                                 
AMENDMENT #1: This conceptual  amendment adds a new Section 3 to the                                                            
bill providing for an immediate  effective date of the provisions of                                                            
Sections 1 and 2.                                                                                                               
Co-Chair Green moved for adoption.                                                                                              
Without objection the amendment was ADOPTED.                                                                                    
Co-Chair Green  offered a motion to  report the bill from  Committee                                                            
as amended with  individual recommendations and accompanying  fiscal                                                            
There was  no objection  and CS  SB 300 (FIN)  MOVED from  Committee                                                            
with zero fiscal notes  #1 from the Department of Natural Resources,                                                            
#2 from the Alaska Court  System, and #3 from the Department of Law.                                                            

Document Name Date/Time Subjects