BILL ANALYSIS Ó
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: SB 342 HEARING: 04/27/11
AUTHOR: Wolk FISCAL: Yes
VERSION: 04/25/11 TAX LEVY: No
CONSULTANT: Miller and Grinnell
CONTINGENCY & ATTORNEY'S FEES
Prohibits contingency fees in tax matters and limits the
computation of attorney's fees to the Revenue & Taxation
Code.
Background and Existing Law
I. Contingency fees. Federal law allows the Secretary of
the Treasury to regulate practitioners with cases before
the Internal Revenue Service (IRS). IRS Circular 230
generally spells out requirements for these practitioners,
and also regulates the conduct of anyone providing tax
advice or preparing tax returns for compensation, including
attorneys, certified public accountants, and enrolled
agents. In 2009, IRS revised Circular 230 to bar
individuals practicing before the IRS from charging clients
contingency fees, with specified exceptions, because of the
potential to exploit the audit selection process and
compromise a practitioner's duty of independent judgment.
Federal law also applies an erroneous claim for refund
penalty equal to 20% of the amount of the claim that lacks
a reasonable basis for the refund. California does not
conform to this penalty (See Comment #4). Additionally,
the American Institute of Certified Public Accountants Code
of Professional Conduct precludes accountants from charging
contingency fees for preparing an original or amended tax
return, with specified exceptions.
State law restricts commissions charged by certified public
accountants in specified circumstances (SB 1289, Calderon,
1998). However, sophisticated cottage industries of
non-accountant tax consultants have grown considerably in
recent years, offering to amend a taxpayer's previous state
income tax returns seeking refunds of previous taxes paid
by claiming tax credits not included on the taxpayer's
original return. Additionally, consultants assist
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taxpayers protesting an assessor's valuation of his or her
property by pursuing appeals seeking to reduce the value
with county assessment appeals boards. In both cases, the
taxpayer compensates the consultant as a percentage of the
refund, providing a significant incentive to file
aggressive claims with questionable justification. As
many of these consultants are neither accountants subject
to state law or codes of ethics, nor practitioners covered
by Circular 230, they may charge taxpayers contingency fees
without any limitation.
II. Attorney's fees. Current state law provides two
methods for determining attorney's fees in tax related
cases: the Revenue & Taxation Code which caps attorney's
fees at an hourly rate, and the Code of Civil Procedure
which uses a multiplier to determine attorney's fees. The
California Constitution requires a state agency to enforce
a statute until an appellate court determines it
unconstitutional. To be substantially justified, the
state's position must have a reasonable basis in law and
fact. It does not need to be a winning argument.
The Revenue & Taxation Code provides that certain parties
that prevail against Franchise Tax Board (FTB) in a civil
proceeding may be awarded reasonable litigation costs,
defined to include court costs, expert witness fees, the
cost of studies, and attorney fees. To receive attorney
fees, a prevailing party must meet three requirements:
(1) Exhausted all available administrative remedies
prior to initiating the lawsuit,
(2) Reasonable litigation costs allocable solely to the
State of California,
(3) Reasonable litigation costs during the civil
proceeding, except for the period in which the
prevailing party has unreasonably protracted that
proceeding.
The hourly rate for attorney fees is capped and adjusted
each calendar year using a statutory cost-of-living rate.
The rate for calendar year 2006 is $140 per hour. The rate
for calendar year 2007 is $150 per hour. A court may award
attorney fees above the capped rate when a special factor
presents itself. The statutory examples of special factors
are:
(1) The availability of qualified attorneys for the
type of case,
(2) The difficulty of the case,
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(3) The local availability of tax attorneys.
To be considered a prevailing party, the party must
substantially prevail on the disputed amount, or
substantially prevail on the significant issues in the
case. However, if the State of California establishes that
its position was substantially justified, then the
prevailing party may not recover any litigation costs.
Under the Code of Civil Procedure, a prevailing party whose
litigation results in the enforcement of an important
public interest may be awarded attorney fees. To receive
attorney fees a party must meet three requirements:
(1) Provide a significant benefit to the general
public,
(2) Have a financial burden that makes the attorney fee
award appropriate,
(3) To achieve justice the circumstances require that
attorney fees be provided in addition to the recovery.
A financial burden makes an award appropriate is one where
the cost of victory exceeds the party's personal interest
so that the cost of the lawsuit is disproportionate to the
disputed issue. A court may award less than the full
amount of attorney fees when a successful party's financial
gain warrants. Public entities may not receive attorney
fees in litigation against individuals. Attorney fees are
calculated by determining the lodestar and applying a
multiplier. The lodestar is the product of hours the
attorney worked times a reasonable hourly rate.
The trial court may increase or decrease the lodestar by a
multiplier. For example, if an attorney worked ten hours
at a reasonable hourly rate of $350, then the lodestar is
$3,500. If a multiplier of 2 is applied, the final
attorney fees awarded are $7,000.
Unlike the Revenue & Taxation Code section, the Code of
Civil Procedure and the Private Attorney General Doctrine
do not require the exhaustion of administrative remedies
and allows an award of attorney fees even if the defendant
(here FTB) was substantially justified in defending the
lawsuit.
Current federal law provides similar provisions to the
state Revenue & Taxation Code for capping attorney's fees
with no additional option for increased fees.
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Specifically, parties that prevail against the Internal
Revenue Service (IRS) may be awarded reasonable litigation
costs. To receive attorney fees, a prevailing party must
meet three requirements: (1) have exhausted all available
administrative remedies prior to initiating the lawsuit,
(2) have reasonable litigation costs allocable solely to
the United States, and (3) have reasonable litigation costs
during the court proceeding, except for the period in which
the prevailing party has unreasonably protracted that
proceeding. Reasonable litigation costs include court
costs, expert witness fees, the cost of studies, and
attorney fees. The hourly rate for attorney fees is
capped. The cap is adjusted each calendar year using a
statutory cost-of-living rate. The rate for calendar year
2006 is $160 per hour. A court may award attorney fees
above the capped rate when a special factor presents
itself. The statutory examples of special factors include
the following: the availability of qualified attorneys for
the type of case, the difficulty of the case, and the local
availability of tax attorneys. To be considered a
prevailing party, the party must substantially prevail on
the disputed amount, or substantially prevail on the
significant issues in the case. The Internal Revenue Code
(IRC) contains a net worth requirement that is not found in
the Revenue & Taxation Code. Under the IRC, to qualify for
the award, an individual's net worth may not exceed
$2,000,000, and a business may not have a net worth over
$7,000,000 and over 500 employees. However, if the IRS
establishes that its position was substantially justified,
then the prevailing party may not recover any attorney fees
or litigation costs. To be substantially justified, the
IRS's position must have a reasonable basis in law and
fact. It does not need to be a winning argument.
The Private Attorney General Doctrine. In 1974, the United
States Court of Appeals for the District of Columbia
awarded the Wilderness Society, Environmental Defense Fund,
and Friends of the Earth attorney fees for serving as a
private attorney general. The attorney fees were sought
for the plaintiff's litigation to prevent construction of
an Alaskan pipeline. The Court of Appeals found that the
plaintiffs acted as a private attorney general by enforcing
public policy and should not have to finance litigation
that was for a public benefit. The fee shifting was not
intended to be punitive. In 1975, the United States
Supreme Court reversed the decision in Alyeska Pipeline
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Serv. Co. v. Wilderness Soc'y because the Court of Appeals
awarded the attorney fees without a statutory basis and
because this award was contrary to "the general 'American
rule' that the prevailing party may not recover attorneys'
fees as costs or otherwise." The Supreme Court in this case
also stated that it was within the authority of Congress to
create a private attorney general doctrine.
Proposed Law
I. Contingency fees. Senate Bill 342 prohibits a person
from charging a contingency fee for services rendered in
connection with any matter before the State Board of
Equalization, Franchise Tax Board, or assessment appeals
board, or for any other tax imposed under state law. The
prohibition applies to all fee arrangements entered into on
or after the effective date of the bill.
The bill defines "contingent fee" identically to Circular
230, but without the exceptions, as any fee that is:
Based in whole or in part on whether or not a
position on a tax return or other filing avoids
challenge or is sustained either by the State Board of
Equalization, the Franchise Tax Board, or in
litigation.
A fee that is based on the percentage of the refund
reported on a return, a fee that is based on a
percentage of the taxes saved, or a fee that depends
on the specific tax result attained.
Any fee arrangement in which the party to whom
services are rendered, or a designee of the party to
whom services are rendered, is reimbursed or credited
for all or a portion of the fee paid or agreed to be
paid if a position taken on a tax return or other
filing is challenged or is not sustained, whether
pursuant to an indemnity agreement, a guarantee, a
right of rescission, or any other arrangement with
similar effect.
The governmental entity responsible for administering the
tax shall impose a penalty equal to the amount of the
contingency fee for persons who fail to comply.
II. Attorney's fees. Senate Bill 342 specifies that the
Revenue & Taxation Code section is the exclusive attorney
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fee remedy for a party that prevails in a law suit against
the FTB.
State Revenue Impact
An FTB estimate for prohibiting contingency fee
arrangements is pending.
According to the FTB, this bill could result in savings to
the State but the amount of savings is unknown because it
depends on the frequency of relevant litigation and on the
size of future awards, both of which are unknown.
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Comments
1. Purpose of the bill . According to the Author, "In
today's fiscal crisis, state and local governments across
the country have been forced to ask citizens for higher
taxes and enacted significant cuts in public services. We
recently enacted billions of dollars in cuts, with several
billion more on the horizon, often requiring sacrifices
from the most vulnerable among us. SB 342 provides a way
to make the tax system more honest by taking away the
incentive for unregulated consultants to seek aggressive
tax returns on a contingency fee basis. Contingency fees
tie a consultant's compensation to the amount of a
taxpayer's tax refund, providing a strong incentive to play
fast and loose with rules, requiring pay outs of big tax
refunds from taxes previously collected and spent, and
often leading unsophisticated firms into audits. This bill
doesn't affect a taxpayer's right to file a claim for
refund for any tax, only regulates the way they pay
unrelated third parties seeking refunds on their behalf."
As it relates to attorney's fees, the author states "This
bill clarifies a drafting error from 1983 when the state
intended to conform to federal law requiring all attorney's
fees related to tax cases to be awarded under the Revenue &
Taxation Code with an hourly cap versus under the Code of
Civil Procedure."
2. Back off . Many taxpayers prepare their tax returns
unaware of many benefits to which they're lawfully
entitled, such as Research and Development and
Geographically Targeted Economic Development Area credits.
Documenting eligibility, filing amended returns, or
challenging an assessor's valuation can be time consuming
and costly, often too much so for smaller businesses and
individuals, who can only afford to pursue these benefits
using a consultant willing to work on contingency. SB 342
would cut off a means for taxpayers to reduce their taxes
to only that level that they truly owe under the law by
ending contingency fee arrangements.
3. Balance of power. Opponents of this bill may argue that
attorney's fees decisions are best left to the court and
should not be dictated by the Legislature as this bill
attempts to do. Unlike most cases, however, the State and
the FTB have a constitutional requirement to enforce a
statute until an appellate court determines it
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unconstitutional.
4. Of skinning cats . SB 342's prohibition on contingency
fees is one way to limit consultants from filing
questionable and costly claims for refund for income and
corporation taxes. The Legislature has also sought to
conform California law to federal law's erroneous claim for
refund penalty equal to 20% of a disallowed refund claim
that lacks reasonable basis. The penalty is intended to
ensure that taxpayers simply do not file conservative
original returns to avoid understatement penalties, only to
file more aggressive amended returns seeking refunds. FTB
currently has no legal ability to apply a penalty on refund
claims except in very limited circumstances, and can only
deny a refund claim when detected during an audit, leaving
taxpayers little incentive not to play the "audit lottery"
and file the most aggressive refund claims possible. Since
2007, taxpayers have been subject to the penalty for
federal income taxes, but not for California returns.
Governor Arnold Schwarzenegger vetoed two measures that
would have conformed California law to the federal penalty,
AB 1580 (Calderon, 2009) and SBx1 28 (Wolk, 2010).
5. Show me some proof. The most recent encounters FTB has
had with awards of attorneys' fees under the private
Attorney General doctrine have been in connection with the
litigation contesting the constitutionality of the LLC fee
statute.
To date, FTB has been named the defendant in four separate
lawsuits on this topic with the same attorneys in all four
cases. The first such case was Northwest Energetics, LLC
v. Franchise Tax Board. The Northwest case involved an LLC
that conducted no business in California and generated a
Superior Court judgment ruling that the LLC fee was in fact
a tax; that the tax, as applied to Northwest, was
unconstitutional; that FTB refund all LLC "fees" paid by
Northwest; and that Northwest's attorneys be paid $3.5
million for professional services rendered in that case.
The award of attorneys' fees was based upon the private
attorney general doctrine, with the court accepting the
argument that Northwest's attorneys had performed a service
that was beneficial to many LLCs other than their
particular client, Northwest. The award was also less than
the $5 million requested by Northwest's attorneys.
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FTB appealed the Northwest judgment. Among other things,
FTB argued that the statute was constitutional, that fees
could not be awarded under either the private attorney
general or common fund doctrines as the Revenue & Taxation
code was the exclusive avenue upon which attorneys' fees
could be recovered in tax litigation, and that if private
attorney general recovery was permissible, the amount was
excessive. In a published opinion, the Court of Appeal
found that the statute was unconstitutional as applied to
Northwest and that attorneys' fees could be awarded under
the private attorney general doctrine. The Court of Appeal
also found that the Superior Court had not properly
considered many of the factors to be evaluated before
awarding any such fees and remanded the matter to Superior
Court for further consideration. On remand, the Superior
Court revised its attorneys' fee award to slightly less
than $1.8 million. FTB then negotiated and paid a
compromise of that sum and the case is done.
The second LLC fee case is Ventas Finance I, LLC v.
Franchise Tax Board. For the tax years in question, Ventas
was an LLC that conducted business both within and outside
California. The Ventas case generated a Superior Court
judgment ruling that the LLC fee was in fact a tax; that
the tax as applied to Ventas was unconstitutional; that FTB
refund all LLC "fees" paid by Ventas; and that Ventas'
attorneys be paid more than $200,000 for professional
services rendered in that case. The award of attorneys'
fees was based upon the private attorney general doctrine,
with the court accepting the argument that Northwest's
attorneys had performed a service that was beneficial to
many LLCs other than their particular client. However, the
court declined to apply a significant multiplier to the
dollar value of the time expended in prosecuting the case
because the effort was duplicative of Northwest and the
source of payment of the fees was likely to be the public.
The award was also significantly less than the $30 million
requested by Ventas' attorneys.
The appellant challenged the Legislative remedy for the
unconstitutional LLC fee in AB 195 (Calderon, 2007). The
amount claimed has been reduced to just under $700,000, and
a hearing is set for May 18 to decide the issue.
The third and fourth LLC fee cases are Bakersfield Mall,
LLC v. Franchise Tax Board and CA Centerside LLC v.
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Franchise Tax Board. The Bakersfield Mall case began as a
suit filed by an LLC doing business only in California, and
sought class-action status for all similarly situated LLCs.
Discovery in that case reveals, however, that Bakersfield
Mall may well have conducted business both within and
outside California, and, as such, should be controlled by
Ventas. In addition, FTB appears to have successfully
negated the attempt by Bakersfield's attorneys (same
attorneys in all four cases) to obtain class-action
certification as for all California-only LLCs. In the
early stages of this case, FTB attacked the class-action
certification attempt, seeking a Writ of Mandate from the
Court of Appeal directing the Superior Court to throw out
the class-action portion of the lawsuit, limiting
Bakersfield to the role of representing no one but itself.
While the Court of Appeal did not issue the writ requested,
it did issue an order containing language stating it would
entertain the writ petition should the Superior Court
actually grant class-action status.
CA Centerside is the most recent lawsuit filed in the LLC
fee arena. The Complaint in this suit is substantially
similar to the Complaint originally filed in the
Bakersfield case and again seeks class-action
certification. As in Bakersfield, FTB immediately attacked
the class-action certification aspect of this case, again
requesting the Court of Appeal to issue a Writ of Mandate
directing the Superior Court to throw out the class-action
portion of the lawsuit. Unfortunately, the Court of Appeal
did not issue the writ, and did not indicate what it would
do should the Superior Court actually certify the case as a
class-action. While neither of these cases has been
designated a class-action, the pursuit of class-action
status is significant in that it clearly underscores the
desire of the taxpayers' lawyers to put themselves in a
position to request attorneys' fees on behalf of thousands
of LLCs in these ongoing disputes.
As noted above, the Court of Appeal in Northwest sanctioned
the use of the private attorney general doctrine as a basis
for requesting substantial attorneys' fees in cases finding
a tax statute to be improper. Since that time, FTB has
been sued in multiple cases seeking to have a statute
deemed unconstitutional or otherwise infirm. These cases
all request the recovery of attorneys' fees, and the bulk
of them are cases in that the taxpayer did not take its
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dispute to the Board of Equalization, a fact that would
preclude recovery of fees under RTC 19717. These cases
include:
California Taxpayers' Association v. Franchise Tax Board ;
Sacramento County Superior Court No. 34-20009-80000138;
Court of Appeal, 3rd Appellate District No. C062791
Case attacked the validity of California's large corporate
underpayment of tax penalty (no BOE). Case is final in
favor of FTB and no attorney's fees awarded.
Frank Cutler v. Franchise Tax Board; Los Angeles County
Superior Court No. BC421864
Case attacks the constitutionality of California's small
business stock statutes (BOE).
The Gillette Company & Subsidiaries v Franchise Tax Board;
San Francisco County Superior Court No. CGC10495911;
consolidated with Jones Apparel Group, Inc. & Subsidiaries
v. Franchise Tax Board, San Francisco County Superior court
No. CGC10499083; Kimberly-Clark World Wide, Inc. &
Subsidiaries v. Franchise Tax Board, San Francisco County
Superior Court No. CGC10495916; Proctor & Gamble
Manufacturing Co. & Affiliates v. Franchise Tax Board, San
Francisco County Superior Court No. CGC10495912; RB
Holdings (USA) Inc. & Subsidiaries v. Franchise Tax Board ,
San Francisco County Superior Court No. CGC10496438; and
Sigma-Aldrich Corporation & Subsidiaries v Franchise Tax
Board , San Francisco County Superior Court No. CGC10496437
Cases all contend that California's amendment of RTC 25128
during 1993, which introduced the double-weighting of the
sales factor into the formula through which California
taxes corporations engaged in multi-state business, is both
unconstitutional and/or invalid because the Legislature
only amended RTC 25128 as opposed to the entire Multistate
Compact, of which 25128 is a part. (no BOE in any of them)
Trial court ruling was in favor of FTB so no attorney's
fees awarded at this time, but the case is pending with the
Court of Appeal.
Personal Selling Power, Inc. v Franchise Tax Board; Alameda
County Superior Court No. RG09462520
Case purports to seek a determination of whether sales of
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to-be-printed advertising constitutes a sale of tangible
property for purposes of Public Law 86-272. (Principal
amount in controversy is less than $1,000) (no BOE) This
case has been settled, and no attorney's fees were paid.
Quellos Financial Advisors, LLC v Franchise Tax Board; San
Francisco County Superior Court No. CGC09487540; and
Quellos Group, LLC v Franchise Tax Board; San Francisco
County Superior Court No. CGC10501299
Both cases involve the constitutionality of California's
abusive tax shelter promoter penalty (no BOE). Trial has
started and is continuing.
Taiheiyo Cement U.S.A., Inc. v Franchise Tax Board; Los
Angeles County Superior Court No. BC422623
Case involves the interpretation of the language "placed in
service" as used in California's enterprise zone sales and
use tax credit statutes. ( BOE) FTB prevailed at trial
court, but taxpayer has appealed.
6. Suggested amendments . Committee staff recommends the
following amendments be adopted if the Committee approves
the measure. Because the Senate Committee on Judiciary may
request to hear the bill, amendments will need to be
adopted there:
Provide for a penalty that would be the greater of
$5,000 or 100 percent of the contingent fee charged.
Specify that contingent fee arrangements are
against public policy and void and unenforceable.
Allow BOE, FTB, and assessment appeals boards to
obtain written certification, under penalty of
perjury, that a fee for services is exclusive of any
contingent fee.
Authorize BOE and FTB to adopt regulations, exempt
from the Administrative Procedure Act requirements, to
prevent the use of contingent fee arrangements.
7. Double Referral. Should this bill get out of this
committee, the motion should be do pass to the Rules
Committee so that it can be referred to the Judiciary
Committee.
Support and Opposition (4/21/11)
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Support : Franchise Tax Board (attorney fee portion).
Opposition : Unknown.