BILL ANALYSIS                                                                                                                                                                                                    




                     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.