On Friday, Rep. Steven Horsford (D-Nev.) introduced the End Double Taxation of Successful Consumer Claims Act, H.R. 4457, which would amend the tax code to create an above-the-line deduction for legal fees in consumer cases, ensuring that consumers will not be required to pay income tax for funds they never receive.
For example, in 2020, Mr. B, a Nevada consumer, received a tax surprise after settling a claim against a credit card company. According to an IRS-1099 form issued by the company, Mr. B was expected to pay income taxes on parts of the settlement he did not receive, namely the funds earmarked to pay his attorney.
A year earlier, Mr. B had initiated a case against the credit card company for credit reporting abuses. Specifically, he had noticed that a corporate credit card he had been an authorized user of for 32 years was mistakenly being reported on his personal credit file. Because of the corporate card’s high balance, Mr. B’s otherwise flawless credit profile had taken a significant hit.
Unable to get the company to fix its mistake on his own, Mr. B hired a local attorney who helped him file a claim under the federal Fair Credit Reporting Act, a law that protects consumers against errors and other abuses in credit reporting. After several months, a settlement was reached and the credit card company agreed to pay Mr. B damages for the harm it caused him and to pay legal fees to Mr. B’s attorney.
Mr. B did not receive the funds for the legal fees, only his attorney did. And yet, Mr. B and his attorney were both expected to pay income taxes on them. Worse still, Mr. B’s tax bill from the case was greater than what he actually recovered.
Confounding as it is, Mr. B’s tax predicament is not unusual. Due to the IRS’s current interpretation of the tax code, recovered legal fees are considered taxable income to both consumers and their attorneys even though only the attorneys receive the money. Consumers who win judgments and settlements have been struggling for years with this illogical tax code glitch.
Thanks to Nevada’s Rep. Horsford and Sen. Catherine Cortez Masto, who introduced an identical bill, S. 766, in the Senate earlier this year, consumers like Mr. B may see relief. If passed, consumers will be able to rightfully exclude any legal fees they recover from their taxable income.
With the deduction, consumers will no longer be required to pay income taxes on their recovered legal expenses. Consumers will also be able to avoid having their income artificially inflated by the fees, allowing them to remain eligible for any income-dependent tax credits and benefits they would normally qualify for.
“We want consumers who are defrauded to be able to hold bad actors accountable, but current tax laws end up protecting massive corporations instead of consumers,” said Sen. Cortez Masto in March when she introduced the Senate bill.
Indeed, Congress’s intent when allowing consumers to recover their legal fees was to encourage individuals to stand up for themselves and enforce consumer protection laws. Interpretating tax laws to essentially punish consumers who do just that can have a chilling effect on individuals with legitimate claims.
Congress recognized as much when it acted in 2004 to create an almost identical above-the-line deduction for victims of discrimination. Consumers, much like discrimination victims, also deserve to be treated fairly by the tax system.
This is a tax reform that all Americans should be able to get behind as well. According to a 2020 poll of 1000 likely voters, 81% of Republicans and 83% of Democrats said they would support changing the tax code so consumers aren’t taxed on their recovered legal fees. And why wouldn’t they? Badly drafted tax law should not result in some consumers having to pay more than their fair share.
Congress should follow Rep. Horsford and Sen. Cortez Masto’s lead and pass the End Double Taxation of Successful Consumer Claims Act to remove an unnecessary burden on consumers and repair an odd glitch in the system.