Beyond the Little Dutch Boy : An Argument for Structural Change in Tax Deduction Classification

One of the most active disputes in tax law today is the question of the proper tax consequences for a successful plaintiff, a portion of whose taxable damage award is paid to his or her attorney pursuant to a contingent fee arrangement. At issue is whether the plaintiff is taxable on the portion of the award that is payable to the attorney. One aspect of this problem was resolved prospectively by the adoption of the American Jobs Creation Act of 2004, but the problem continues to exist in other areas. The United States Supreme Court resolved a split in the United States Circuit Courts of Appeals with respect to the taxation of contingent attorney's fees in Commissioner v. Banks, but that decision provides no comfort for the plight of taxpayers because the government prevailed. Moreover, the attorney's fee dispute is only one small example of a much larger problem. Instead of dealing with the root cause of the problem, the focus (both in the courts and in Congress) has been on whether to provide a "fix" for the specific plight of the taxpayers who have raised issues in court. The courts and Congress, like the Little Dutch Boy, may be willing to plug one hole, but the broader problem is a structural fault in the "dam" of the tax law system - namely, the improper classification of a significant number of expenditures as itemized deductions. This Article argues that the current list of nonitemized deductions wrongly excludes a number of items, especially some that are directly connected to the production of income. This erroneous exclusion imposes an unwarranted and severe tax burden in far more circumstances than the attorney's fee problem on which Congress exclusively focused in the American Job Creation Act of 2004. The harsh consequences resulting from the misclassification of a number of items are exacerbated by the stringent limitations currently imposed on many itemized deductions; but even a repeal of those limitations, which is unlikely to occur, will not cure all of the harm that a wrongful classification causes. This author hopes that highlighting several examples of misclassification will induce Congress to implement a commission to study the entire classification system, rather than to rest on its laurels for solving one small part of the problem in the American Job Creation Act of 2004