Opinion
Civil No. 00-2310 (DWF/AJB)
May 29, 2001
William A. Erhart, Esq., Erhart Law Office, Anoka, Minnesota, Plaintiff pro se and on behalf of Plaintiff Elizabeth M. Erhart.
Carl J. Tierney, U.S. Department of Justice, Tax Division, Washington, D.C., appeared on behalf of the Defendant.
MEMORANDUM OPINION AND ORDER
Introduction
The above-entitled matter came on for hearing before the undersigned United States District Judge on April 20, 2001, pursuant to Defendant's Motion to Dismiss, or in the alternative, for Summary Judgment. In their Complaint, Plaintiffs seek a refund of federal income taxes claiming that certain business expense deductions for tax years 1995 and 1996 were incorrectly denied under 26 U.S.C. § 162. The parties dispute whether certain retainer contracts used by Plaintiff William A. Erhart in his law practice should be characterized as "net fee" or "gross fee," and thus when certain business expense reductions are properly claimed. Defendant seeks to dismiss Plaintiffs' claims in their entirety for lack of legal support. For the reasons set forth below, Defendant's motion is granted.
Background
Plaintiff William A. Erhart is an attorney whose practice involves personal injury law. During 1995 and 1996, Mr. Erhart used an "Attorney Contingency Fee Agreement" in his personal injury cases which stated in relevant part that:
Plaintiff Elizabeth M. Erhart is married to Plaintiff William A. Erhart, and the expenses at issue were claimed on Plaintiffs' jointly filed tax forms for 1995 and 1996.
It is agreed that in addition to the above attorney's fees, all court costs subpoena costs, photos, depositions and court reporter costs, reports, witness statements, expert witnesses, and expenses directly incurred in investigating or litigating this claim shall be paid by the undersigned client. I understand that I will continue to be responsible for payment of these costs regardless of whether there is a recovery.
Redacted from the paragraph of Mr. Erhart's general contingency agreement was the provision that: "I [William Erhart] understand that I [William Erhart] will continue to be responsible for payment of these costs regardless of whether there is a recovery."
In his practice, Mr. Erhart frequently paid for the above-mentioned costs in advance. If a case was resolved successfully, Mr. Erhart would then deduct the amount of costs advanced from the total recovery and would then calculate his attorney's fees based upon the total amount recovered. Some of the costs advanced by Mr. Erhart were not recouped because not all cases were resolved successfully. In tax years 1995 and 1996, Plaintiffs claimed the advances paid on client costs as business deductions. However, the IRS disallowed the deductions and assessed an additional tax of $14,316 for 1995 and $4,046 for 1996. Plaintiffs contend that the deductions were disallowed for those costs that were "un-recovered."
On November 22, 1999, Plaintiffs paid the additional tax assessed and simultaneously sought a refund from the IRS. The IRS denied a refund and abatement via letters sent July 26, 2000, and January 6, 2000. By their current action filed on October 5, 2000, Plaintiffs seek a refund of the additional tax assessed.
Defendant's current motion requests that all claims be dismissed with prejudice, arguing that the law is clear that Mr. Erhart's retainer agreements constitute "net fee" arrangements under which such advanced costs may not be claimed as business expenses.
Discussion 1. Standard of Review
Summary judgment is proper if there are no disputed issues of material fact and the moving party is entitled to judgment as a matter of law. Fed.R.Civ.P. 56(c). The court must view the evidence and the inferences which may be reasonably drawn from the evidence in the light most favorable to the nonmoving party. Enterprise Bank v. Magna Bank of Missouri, 92 F.3d 743, 747 (8th Cir. 1996). However, as the Supreme Court has stated, "summary judgment procedure is properly regarded not as a disfavored procedural shortcut, but rather as an integral part of the Federal Rules as a whole, which are designed to 'secure the just, speedy, and inexpensive determination of every action.'" Fed.R.Civ.P. 1. Celotex Corp. v. Catrett, 477 U.S. 317, 324 (1986).
The moving party bears the burden of showing that there is no genuine issue of material fact and that it is entitled to judgment as a matter of law. Enterprise Bank, 92 F.3d at 747. The nonmoving party must demonstrate the existence of specific facts in the record which create a genuine issue for trial. Krenik v. County of Le Sueur, 47 F.3d 953, 957 (8th Cir. 1995). A party opposing a properly supported motion for summary judgment may not rest upon mere allegations or denials, but must set forth specific facts showing that there is a genuine issue for trial. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 256 (1986); Krenik, 47 F.3d at 957.
2. Issues
Under 26 U.S.C. § 162, "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business . . ." shall be allowed as deductions from gross income. Expenses for which there is a right of reimbursement, however, do not qualify as business expenses covered under § 162. Instead, "such expenditures are in the nature of loans or advancements and are not deductible as business expenses." Canelo v. Commissioner, 53 T.C. 217, 224 (1969), aff'd 447 F.2d 484 (9th Cir. 1971) (citations omitted). See also Levy v. Commissioner, 212 F.2d 552, 554 (5th Cir. 1954); Glendinning, McLeish Co. v. Commissioner, 61 F.2d 950, 952 (2d Cir. 1932). Advanced litigation costs that will be collected upon recovery constitute such expenditures with a right to reimbursement and therefore are not allowable deductions under § 162. See Boccardo v. Commissioner, 12 Cl. Ct. 184, 186, 188 (1987) ("[A]dvances of litigation and other expenses by an attorney are not deductible if the attorney expects to be reimbursed, even if the reimbursement is contingent upon the success of the case.") ("Boccardo I"). See also Canelo, 53 T.C. at 224-25; Burnett v. Commissioner, 356 F.2d 755, 759-60 (5th Cir. 1966).
The fact that recoupment is dependent upon successful resolution of the case does not change the analysis. Courts have consistently reasoned, specifically within the context of advanced litigation costs, that because an attorney has the opportunity to evaluate the merits of a case and essentially to assess the risk of not being reimbursed before agreeing to represent a party, the likelihood of reimbursement is sufficiently substantial so that the advances operate as loans rather than expenses. See Boccardo, 12 Cl. Ct. at 186-89; Burnett, 356 F.2d at 224; Canelo 53 T.C. at 184. Plaintiff has presented no evidence to indicate that his practice is any different than those examined by other courts and thus the same reasoning applies here.
Plaintiff William A. Erhart's assertion that his retainer fee arrangement constitutes a gross fee contract is without merit. In Boccardo v. Commissioner of Internal Revenue, 56 F.3d 1016 (9th Cir. 1995) ("Boccardo II"), the same law firm involved in Boccardo I filed a successful suit for denied business expense reductions. The 9th Circuit distinguished Boccardo II from its predecessor by the form of the retainer agreement. In Boccardo I, the law firm utilized a "net fee" contract which provided that the law firm would pay all costs and the client would reimburse such costs only out of recovery. In contrast, by the time of Boccardo II, the firm had adjusted its retainer agreements so that they operated as a "gross fee" arrangement such that the law firm would pay all costs and be entitled to a certain flat percentage upon recovery. While a higher percentage for the attorney under such an arrangement would ultimately provide for the recoupment of costs plus fees, there still exists no explicit right to reimbursement as provided under a "net fee" arrangement.
The parties do not dispute the explicit language of Plaintiff's retainer fee agreements nor the method by which he calculates and recoups his costs and fees. By recouping his advanced costs from a client's recovery before calculating his fee, Plaintiff William Erhart is operating his business just as the law firm in Boccardo I. It is clear to the Court that Plaintiff operates under a net fee arrangement, and thus may not claim his advanced litigation costs as business expenses under § 162. While it is true that the unsuccessful resolution of a case may leave Plaintiff with unrecouped costs, it does not follow that Plaintiffs may insure against that potential by claiming business expenses when the right to reimbursement has also been negotiated.
For the reasons stated, IT IS HEREBY ORDERED THAT:
1. Defendant's Motion to Dismiss, or in the alternative, for Summary Judgment (Doc. No. 6) is GRANTED; and
2. Plaintiffs' Complaint (Doc. No. 1) is DISMISSED WITH PREJUDICE. LET JUDGMENT BE ENTERED ACCORDINGLY.