Tax code changes effective in 2018 inflicted a crippling blow to consumers who must sue to enforce their rights. And few have yet noticed.
The tax deduction for miscellaneous itemized deductions under IRC Section 212 is gone. So now, consumers who prevail under statutes that award attorneys fees to the successful plaintiff are denied a deduction for the legal expense of winning that victory.
The income is taxed but the cost of producing that income is no longer deductible.
So, a large hunk of a consumer’s recovery goes, not to the injured consumer, but to the IRS. Or even, all of a consumer’s judgment is consumed by taxes.
What happened to consumer litigants
IRC Section 212 has long allowed individuals to deduct the ordinary and necessary expenses incurred to produce income. At least partially.
That is, until the Tax Cuts and Jobs Act, passed December, 2017, including this zinger:
Notwithstanding subsection (a), no miscellaneous itemized deduction shall be allowed for any taxable year beginning after December 31, 2017, and before January 1, 2026. Section 67(g)
So the deduction for the expense of producing income as a miscellaneous itemized deduction for individual tax payers vanished. Poof.
The rational for its removal sounds great:
“Not that many taxpayers itemize their deductions so the deduction(s) won’t be missed.”
And thus, a bedrock principle of taxation, that the expenses of producing that income is deductible before tax is imposed, was cast aside. With dire consequences for consumer rights, whether intended or not.
Tax changes abound
Miscellaneous itemized deductions weren’t the only victims of the 2017 tax act. HUGE things happened in the world of taxation on Jan 1, 2018 when the tax bill became effective.
For good or ill, perhaps wholly or partially dependent on your politics, the practical world of untold millions of individual taxpayers changed radically.
- What would be alimony and heretofore deductible isn’t. (At least for most January 1, 2018 divorces.)
- One very important protection afforded for debt relief from the disposition of a personal residence lapsed and has not been resuscitated.
There are many others.
But the devastation inflicted by Section 67(g) was initially far from obvious. It typically doesn’t become clear until it’s time to file a federal tax return.
What had been a longtime method for getting at least some deduction for real expenses is gone.
But thereby hangs a tale. Most taxpayers don’t itemize UNTIL THEY NEED TO DO SO. Now they can’t. Not even a little. And it gets much worse.
The power to tax….
The deduction allowed by under IRC 212 prior to 2018 was already a ludicrously constructed monkey-motion system. Lawsuit recoveries are typically reportable to the recipient in the GROSS recovery amount without diminution for attorneys’ fees payable to the attorney(s) whose services were indispensable in creating the income,
In order to get any deduction for attorneys fees paid, IRC Section 67 mandated:
The miscellaneous itemized deductions for any taxable year shall be allowed only to the extent that the aggregate of such deductions exceeds 2 percent of adjusted gross income.
This calculation often results in a sizeable bite coming out of the deduction the hapless taxpayer ultimately gets to take.
Now after Jan. 1, 2018, there is no deduction at all.
Picture the average non-itemizing single parent taxpayer suing for wrongful termination under this new tax regime.
- The legal pushback from the errant employer is fierce and attorneys’ fees on both sides are high.
- The settlement calls for $500,000 to be paid to the plaintiff .and,
- 40% of the recovery goes to the plaintiff’s attorney as fees.
In the typical course of things post Jan 1, 2018, the plaintiff will be taxed on the FULL $500,000 recovery. Plaintiff gets NO deduction for the $200,000 in attorneys’ fees paid. None…
The plaintiff walks away (limps away actually) having paid taxes on AT LEAST $500,000 of income out of the $300,000 of money they actually net. (Yes, the attorney then pays tax on the $200,000 already included in the plaintiff’s income.)
Kinda discourages injured individuals from using consumer protection laws to protect themselves, doesn’t it?
Statutory penalties without deduction
If you perhaps think this isn’t so bad, picture the many hundreds of thousands of suits brought where the plaintiff is entitled to a fixed fee, fine or other relatively low statutory amount.
The purpose of these consumer lawsuits is to promote regulation of activities like as an example, lending-related abuses. In these cases the state consumer laws providing for the suits often allow the attorneys for the plaintiff to collect their fees from the lender or other business.
These suits now regularly result in the plaintiff being in deep debt to the IRS with insufficient funds to pay even the tax. AKA: Tax Hell.
Without direct decisive legislative change this horrendous damage will play out across the country for years.
It will continue until the right people suffer from its effects. Only then will there be any change(s).