The Long and Winding Road: Workers Finally Will Experience Tax Relief (and Fairness)

Buried at page 343 in the midst of a corporate tax bill spanning more than six hundred pages may very well be the most significant piece of civil rights legislation passed in the last decade (and certainly in the past four years). While the existence of this particular tax break might not mean very much to reporters covering the most significant provisions of this bill, it means all the world to workers and their advocates who seek to be “made whole” after enduring discrimination, harassment, and other illegalities in the workplace. Efforts to include this piece of legislation into a bill primarily designed for pet projects simmering on Capitol Hill for years is a true example of “The Little Engine that Could.”

Since 1997, the National Employment Lawyers Association (NELA, our allied organization) has been combatting a tax problem that might seem relatively obscure at first blush, but can be financially devastating to those who fight against discrimination and win. Put simply, a person who is successful in an employment discrimination or civil rights case would, in many states, not only pay taxes on the portion of the award they received to compensate them for their injuries, but on the money they never saw: the fees and costs their attorneys receive for handling their case. Of course the attorneys pay taxes on that money too, so the same amount of money is taxed twice. This may not sound like a huge problem, but there are several reasons why it is.

First, it prevents those who fight discrimination from getting full compensation for what they’ve gone through, so they’re not in the same position as they would have been absent discrimination. Second, given the rigors of bringing a lawsuit, for example, being asked by your employer’s lawyer about every detail of your work experience and often the most intimate aspects of your personal life; waiting for years to receive some small measure of justice; and worrying whether your career will be over as a result of challenging your employer–any reasonable person would ask why go through all that and not even be made whole? Third, the “double tax” costs everyone more, which makes cases drag on longer and more difficult to resolve, while crowding our courts. Finally, due to the way our tax system works, there are people who go through the process and win, but still owe the IRS more money than what they received from their employer. That’s right: it’s possible to owe money as a result of winning your case.

This problem first came to more widespread public attention in 1997 as a result of a bill that became law in 1996: the Small Business Job Protection Act. A relatively obscure provision in this tax bill decreed that workers would now pay income taxes on the part of their award that compensates them for their non-economic damages (emotional pain and suffering). Workers filing tax returns in early 1997 found that not only were they paying those taxes for the first time, but also income taxes on the portion of the award for fees and costs that went to their attorneys. These individuals faced astronomical tax bills which were far higher than was ever contemplated.

The IRS took the position that the money going to the attorneys was in essence money received for extinguishing a debt. If someone gives you money that you then must use to pay someone else, that’s still considered income. That rationale, however, didn’t take into account that without the attorney’s assistance, there most likely wouldn’t be any income at all, as it generally takes the attorney’s skills to bring cases to a successful fruition in the first place.

Some courts adopted the “joint venture” rationale, which kept individuals from being taxed on the attorney’s portion of the award, but in a majority of the court cases where the issue was considered, the IRS’s position carried the day. And even where the law wasn’t clearly established and courts had not yet spoken, taxpayers faced the worry and uncertainty of potentially even more litigation down the line–against the IRS, a prospect perhaps even more frightening than taking on one’s employer.

While the battle for tax fairness continues to be fought in the courts, including the U.S. Supreme Court which will hear two cases in November, efforts were underway to persuade Congress to grant tax relief once and for all. The first was in 1997, when the late Rep. Gerald Solomon introduced the Employment Discrimination Award Tax Relief Act, introduced as a personal favor to his friend, the late Truman Crabbe, who was among a group of 32 age discrimination plaintiffs first hit with this problem. The Solomon bill garnered only three cosponsors quietly went away when Rep. Solomon left Congress in 1998.

In 1999, Rep. Deborah Pryce of Ohio, after being urged to address this issue by former NELA President Fred Gittes of Columbus, introduced the first version of what is now known as the Civil Rights Tax Relief Act. It was then called the Civil Rights Tax Fairness Act, and had 69 cosponsors by the end of 2000. In 2000, the bill was first introduced in the Senate, by Sen. Charles Grassley of Iowa, who learned about the experience of one of his constituents, the client of NELA member Victoria Herring of Des Moines. Since neither the House nor the Senate version of the bill was passed before the end of the 106th and 107th Congressional sessions, it was necessary to reintroduce the bills in 2001 and in 2003.

The original version of the Civil Rights Tax Relief Act included three separate components: 1) to end the double taxation of attorneys fees, 2) to allow income averaging so that people receiving lump sum awards for their back pay didn’t pay higher taxes, and 3) to eliminate the tax on non-economic damages in discrimination cases. While all three changes to the law were critical, along the way it became clear that the attorneys’ fee provision was the most likely one to be passed. Everyone understood the unfairness of double taxation and being taxed on money that you never received. The other two provisions, however, were a tougher sell on Capitol Hill. Although all vexing problems, the attorneys’ fees issue captured Congress’ interest.

The battle for the CRTRA was never easy, and rarely followed a traditional path. Those involved worked extremely hard to put together a bipartisan coalition of supporters, both inside and outside of Congress. The CRTRA’s Congressional cosponsors included the most liberal and conservative members of their respective houses, while it’s supporters were clearly “strange bedfellows.” Not many bills could claim the simultaneous support of the U.S. Chamber of Commerce, trial lawyers, and civil rights groups, who understood the importance of the bill for the varied constituencies represented in the broad coalition. Together, these groups presented a compelling argument for tax fairness when walking through the halls of Congress.

In Spring 2003, the Senate passed a provision to address the double taxation of attorneys’ fees as part of President Bush’s economic stimulus package. Unfortunately, the House version of the package did not include the attorneys’ fees fix and so the matter was left for another day. This year, there was again demonstrable progress in moving this part of the CRTRA through Congress. In May, the Senate passed a tax bill which included the attorneys fees provision of the CRTRA. Finally, after so many years of lobbying Congress, one provision of the CRTRA was “in” a viable bill. It was not part of the tax bill that passed the House of Representatives, and efforts to include it during the joint House-Senate conference were rejected. (See blog entry of 5/21/04.) So, it was necessary to keep lobbying for the inclusion of the attorneys fees provision in another tax bill. Since Congress adjourned in August without passing any more tax bills, it was uncertain whether there would be another possibility to include the CRTRA in another bill before Congress recessed again for the November elections.

There was immense pressure on Congress, however, to resolve a tariff issue that had subjected the U.S. to significant fines from the World Trade Organization. Since the matter had to be resolved by Congress to avoid further escalation of the fines imposed on the U.S., it was more likely than not that Congress would pass one last tax bill. As it turned out, over the Columbus Day weekend, a consensus emerged from the House and Senate on the American Jobs Creation Act of 2004. By Monday, October 11, both houses of Congress had passed the 600-plus page bill that included the most important provision of the Civil Rights Tax Relief Act: ending the double taxation of attorneys’ fees. (House vote/Senate consent agreement)

Once signed into law by President Bush, individuals who are successful in various employment cases can take what is known as an “above-the-line” deduction of their attorneys’ fees. Those who itemize may be familiar with the difference between “above-the-line” deductions, such as certain business expenses, which are 100% deductible from income, and “below-the-line” deductions. “Below-the-line” deductions are subject to certain limitations, the most significant of which is they are not applicable to the calculation of the alternative minimum tax. This equalizes the tax treatment of legal fee deductions for both workers and employers, as defendant employers were already allowed to fully deduct the cost of their legal defense.

One unfortunate note: it is not retroactive. In fact, it is doubly prospective, in that it applies to cases where a settlement agreement or verdict is reached after the effective date (which is when the President signs the bill into law), and the attorneys’ fees are also paid after the effective date. If possible, anyone currently in settlement negotiations should wait to finalize the agreement until the President signs the bill, as the effective date of the settlement could be very critical for tax purposes. All versions of the CRTRA contained some measure of retroactivity, to prevent the judicial system from grinding to a halt while parties awaited the outcome of the legislation, and to provide tax fairness to as many workers as possible. Thankfully, this bill has moved very quickly, with the President expected to sign the bill at any time. (As was pointed out in last night’s presidential debate, President Bush is the first president in a hundred years not to veto a bill during his presidency.)

Congress has always been resistant to retroactive tax laws, regardless of how compelling the reason for retroactivity might be, because it complicates tax calculations and invites a surge in substitute filings. There is still a possibility that the Supreme Court’s upcoming decision in the two pending tax cases, (see blog entry of 03/30/04) could resolve the cases in a way that allows for retroactivity for some of those who have already been harmed, so that is the best that can be hoped for at this point. Since the bill also doesn’t contain the non-economic damages and income averaging provisions that were part of the original CRTRA, that battle will have to wait for another day and another more receptive Congress.

This civil rights battle for tax fairness would not have been possible without an outpouring of effort by many people. The efforts of Bruce Fredrickson of Washington, DC, who devoted thousands of hours (and dollars) to this cause over the last five years, and the law firm of Bendich, Stobaugh & Strong, of Seattle, Washington, which provided key financial support for the CRTRA’s lobbying effort, are particularly noteworthy. This victory is also the result of hard work by every single advocate who educated their clients, provided financial support, wrote letters, and otherwise supported this historic “movement for tax fairness.”

The commitment and passion of those workers who are most affected by the Civil Rights Tax Relief Act was critical to this successful outcome. Politicians listen to their constituents! So, if you ever supported the Civil Rights Tax Relief Act by writing, calling or visiting your members of Congress or educating someone about the intricacies of the tax code, you played a role in this tremendous victory. And whether you call it “fairness” or “relief,” this bill has done more to promote civil rights and reduce discrimination than any legislation in the last several years, so it truly is a victory worth celebrating.

More information: article: Corporate Tax Law Wipes Out ‘Double Taxation’ on Contingency Fees

NELA Amicus Brief in Banks and Banaitis

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Madeline Messa

Madeline Messa is a 3L at Syracuse University College of Law. She graduated from Penn State with a degree in journalism. With her legal research and writing for Workplace Fairness, she strives to equip people with the information they need to be their own best advocate.