Research Project

ACC 431 - Group Tax Research Problem #3

Your client, Victor Strand (“Strand”), is seeking guidance on the timing of reporting fees earned from litigating class action lawsuits.

FACTS:

Strand practices law as a solo practitioner doing business as the Law Office of Victor Strand (“LOVS''). Strand is a calendar year taxpayer with a tax year ending December 31. Strand's specialty is representing clients who mutated into zombies as a result of receiving an immunization shot from a bad batch of vaccine serum, as well as victims of his clients who subsequently became zombies through being bitten. Strand is paid on a contingency fee basis. Thus, he only gets paid if his clients win their case against the defendants, pharmaceutical companies.

As there is a horde of Zombie Vaccine cases, Strand works with several other law firms/lawyers to jointly handle these cases. These attorneys (collectively referred to as “Counsel”) entered into written “co-counsel agreements” detailing their agreement on how to handle the lawsuits, the allocation of work, cost splitting, etc. Under the co­counsel agreements, if a case is won: 1) the contingency fee is deposited into LOVS' Client Trust Account,; 2) each Counsel submits a detailed list of their hours worked and costs; and 3) Strand allocates the contingency fee and distributes funds to each Counsel their share of the contingency fee award. Strand issues Forms 1099 to the other attorneys reporting their share of the contingency fee.

Strand says the Counsel also had an oral agreement regarding distribution of the contingency fees—no fees could be distributed to any of the lawyers without Strand's and F&P's mutual consent. While this prohibition on distribution is not explicitly stated in the co-counsel agreements, Counsel had complied with this restriction and maintained this practice since 2010 when they began working together on the Zombie Vaccine class actions suits.

In 2015, Counsel resolved the class action cases under the Federal Transmutation Wounded & Damaged (FTWD) Act against the following pharmaceutical companies: GlaxoSalazarClark, Manawalmmune and ExnerPharma.

GlaxoSalazarClark and Manawalmmune Cases

Strand, Fear & Payne (“F&P”) and Douglas Thompson & Associates (“Thompson”), jointly handled these class action suits. In January 2015, GlaxoSalazarClark and Manawalmmune proposed a settlement amount, of which Counsel would receive 50% as their contingency fee. Counsel and their clients agreed to the settlement after consulting with their clients. In March 2015, GlaxoSalazarClark and Manawalmmune paid the settlement amount, 50% of which was deposited into LOVS’ Client Trust Account (under the terms of the co-counsel agreements between Strand, F&P and Thompson) to pay Counsel for their fees and costs.

The contingency fee relating to these two cases were allocated among Strand, F&P and Thompson. However, a dispute arose between F&P and Strand regarding the correct allocation of fees. Strand contends F&P improperly/excessively billed, so its share of the fees grew to the detriment of Strand. Under the co-counsel agreements, fee awards are split based on the number of hours worked. Thus, F&P had an incentive to improperly inflate its hours because it would increase its percentage of the fees awarded. For its part, F&P disputes Strand's hours and asserts its entitled to more than the amount allocated to it. Thus, upon resolution of the fee dispute, Strand's allocation of fees could increase or decrease.

Although the GlaxoSalazarClark and Manawalmmune fees were deposited in LOVS' Client Trust Account in January 2015, because of the dispute between Strand and F&P and the requirement for mutual consent from Strand and F&P before any distribution could be made, the distribution of fees from the GlaxoSalazarClark and Manawalmmune cases was substantially delayed. Finally, in December 2015, under an interim agreement between Strand and F&P on the allocation of fees pending resolution of the fee dispute, Strand made distributions of the GlaxoSalazarClark and Manawalmmune fees to all of the counsel involved in those cases. These distributions were made without prejudice (i.e., none of the rights or claims of F&P or Strand are considered lost or waived if they accepted a distribution). Distributions to Strand in 2015 from the GlaxoSalazarClark and Manawalmmune cases totaled approximately $5M. However, Strand contends he is entitled to more than $5M.

The dispute between Strand and F&P regarding the allocation of fees in the GlaxoSalazarClark and Manawalmmune cases is currently in arbitration being heard before a retired judge. Strand is represented by an attorney.

ExnerPharma

Strand handled these cases along with the following co-counsel: F&P, Thompson, Madison & Travis P.A. (“M&T”) and C. Darryl Carol Inc. (“CDC Inc.”). Under the terms of the Co-Counsel Agreement for the ExnerPharma cases:

· All cost incurred “shall be immediately reimbursed to Counsel before any attorneys' fees are paid from the cost or fee award.”

· The division of fee awards between Strand, F&P, CDC Inc. and M&T is based on hours worked. Thompson is entitled to a flat 10% of fees, after costs.

· Any cost and fee awards must be deposited into LOVS' Client Trust Account.

Before the receipt of the ExnerPharma fees and costs, a dispute regarding the allocation of fees also arose between Strand and F&P. Strand claims F&P inflated its hours and F&P claims Strand inflated his hours. In addition to the mutual claims of inflated hours, Strand asserts F&P agreed to “pool” the results from the ExnerPharma cases with the results from a series of cases other than GlaxoSalazarClark and Manawalmmune (including cases where the plaintiffs were not successful). F&P disputes any claim of a pooling arrangement. Further, despite numerous requests by Strand's counsel, F&P refuses to provide information necessary for Strand to make an adjustment for pooling (e.g., F&P's hours in the other cases). It’s anticipated the ExnerPharma fee dispute will also end up in arbitration.

Also before the receipt of the ExnerPharma fees and costs, a fee dispute also arose between Strand and Thompson regarding Thompson's potential allocation of the ExnerPharma fee. On a different case, Thompson did things that created a conflict and forced a dismissal the case after Strand had incurred expenditures of approximately $31,000 in time/costs. Under the ExnerPharma Co-Counsel Agreement, Thompson was entitled to $377,298 (i.e., a flat 10% of the fees after costs). Strand proposed to offset the $31,298 he contends Thompson owed him from this other case from Thompson's share of the ExnerPharma fees. Thompson did not agree to the offset.

On December 31, 2015, ExnerPharma's payment of plaintiffs' attorneys' fees and costs of $3.9M were deposited in LOVS' Client Trust Account. ExnerPharma issued a Form 1099 to Strand for the full $3.9M for the 2015 tax year.

Consistent with the parties' agreement and practice, no distribution of these fees could be made without consent from Strand and F&P. F&P provided its consent to the distribution of ExnerPharma fees on January 6, 2016, and Strand made the following distributions without prejudice from the Client Trust Account:

F&P	$1,970,000
M&T	$218,000
Thompson	$346,000
Strand	$1,365,000

Strand claims he’s entitled to more than $1.365M from the ExnerPharma fees. F&P disputes Strand is even entitled to $1.365M. Thompson refused to accept the check for $346,000 ($377,298 - $31,298) reflecting the offset. On January 11, 2016, Strand opened a saving account for the benefit of Thompson at Raynard Community College Credit Union and deposited the $345,600 into the account. Thus, upon resolution of the fee disputes, Strand's allocation of fees could increase or decrease.

Strand would like to report the ExnerPharma fees in 2016 for tax purposes (i.e., he would pay less taxes if the money was received in 2016). He does not mind taking an aggressive approach on his return regarding reporting the timing of these fees. However, he does not want to pay any extra interest, and no penalties should the IRS disagree with how Strand reports the ExnerPharma fees.

Thus, Strand has the following questions regarding the ExnerPharma fees:

1. For tax reporting purposes, can Strand take the position the ExnerPharma fees were received by Strand in 2016 when the restriction on distribution of the fees was lifted by consent of the Counsel or must Strand report these fees in 2015 when the funds were wired to the Client Trust account?

2. For purposes of Strand issuing Forms 1099, what tax year did the co-counsel receive the ExnerPharma fees—2015 or 2016?

3. If Strand takes the position he received the ExnerPharma fees in 2016, and the IRS challenges this position, what actions can Strand take to reduce his exposure to interest or penalties?

INSTRUCTIONS

Prepare a Memorandum addressing Strand's questions and advising him on benefits//risks of each position. Your goal is to provide Strand with the best advice regarding the timing of reporting the ExnerPharma fees for Strand and the co-counsel based on the facts and the applicable current authorities (i.e., Code, regulations, case law, etc.) and what Strand needs to do to protect himself from penalties.

While you are Strand's advocate, don’t ignore how the IRS would perceive the timing of the reporting of the ExnerPharma fees and any penalty exposure Strand may have should the IRS disagree with his tax treatment. It may be the IRS has a stronger position. Thus, your Memorandum should reflect this. However, this doesn't preclude you from coming up with creative arguments if you can support them and you remain in compliance with Circular 230.

The grade on your Memorandum will include points for:

· Format. Your Memorandum should be in the format discussed in class regarding Chapter 2 (i.e., Facts, Issues/Questions, Conclusions/Short Answers, Analysis) and include a cover sheet with the Group number and members of Group.

· Content. Your Memorandum should include:

· Essential facts to sufficiently understand the issues;

· Applicable rule(s) of law explained in a concise manner;

· Cases that support your position explained as to why they are relevant and how these cases apply to the facts in this case (i.e., compare and contrast).

· Any potential arguments the IRS could raise regarding the timing of the reporting of the ExnerPharma fees. A well-reasoned Memorandum will address both sides (taxpayer and IRS) of any issue.

· Authorities. You will need to properly cite the authority (e.g., Code, regulations, Revenue Ruling, cases, etc.) that support each proposition (i.e., the point or statement) you are making. See Chapters 1 & 2 for proper citation. Citations should be in footnotes. You will need to use references other than your textbook (e.g., Westlaw, Checkpoint, etc.).

· Presentation. The project should have a professional appearance (e.g., typed, spell-checked, grammar, punctuation and writing style) in Times New Roman, Font size 12, and double-spaced.

ASSISTANCE

· Review the information and links on tax research in the “Tax Research” and “Tax Research Project” folders on Blackboard.

· Review your notes during the lecture on navigating the databases available on our library's website.

· Review the Syllabus regarding the Tax Research Project.

· Research codes, regulations and cases that are relevant to the issue(s). The following authorities and cases may be of assistance; however, you should NOT limit your research to these items:

· Timing of Payment Issue (“Constructive Receipt”):

· IRC § 451

· Treas. Reg §1.451-2(a)

· Treas. Reg §1.6045-5

· Baxter v. Comm’r, 816 F.2d 493, 495 (9th Cir. 1987)

· Bennett v. United States, 293 F.2d 323, 326 (9th Cir. 1961)

· Hamilton National Bank v. Comm’r, 29 BTA 63 (1933)

· Iler v. Comm’r, TC Memo 1978-182

· In re Shikarozahn, 391 B.R. 840, 2008 Bankr. LEXIS 2134 (BAP8 Aug. 14, 2008)

· Kahn v. United States, 1981 U.S. Dist. LEXIS 10858 (DC W. NC 1981)

· McEuen v. Commissioner, 196 F.2d 127 (5th Cir. 1952)

· Miller v. Heller, 915 F. Supp. 651, 1996 U.S. Dist. LEXIS 1665 (SD NY Feb. 15, 1996)

· North American Oil Consol. v. Burnet (1932, S Ct) 286 US 417

· Oliver v. United States, 193 F. Supp. 930 (E.D. Ark. 1961)

· Olson v. Comm’r, 24 BTA 702 (1931), aff’d 67 F2d 726 (1933, CA7), cert den 292 US 637 (1934, S Ct)

· Rosenberg v. United States, 295 F. Supp. 820 (E.D. Mo. 1969)

· Sullivan v. Comm’r, TC Memo 1999-341

· Reporting Income for Co-Counsel Issue (“Assignment of Income Doctrine”)

· Chapter 4 will also be helpful in drafting this Memorandum.

· Avoiding Penalties

· IRC §6662(a), (c), (d)

· Form 8875, Disclosure Statement

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