Taxing Legal Services: The Next Frontier in State Budget Woes?
by Scott Challinor
Traditionally exempt from Colorado’s state taxation scheme, legal services appear to be the next frontier in Colorado’s budget battles. Bills co-sponsored by Democrats and Republicans are expected to be introduced in both the Senate and the House in the next several weeks and, according to sources close to Gov. John Hickenlooper, if a final bill emerges from the process, the governor likely will sign it.
The measure’s bipartisan support likely stems from the fact that the tax advances issues important to both Democrats and Republicans. For Democrats, the tax helps to raise much needed revenue that might otherwise be diverted from K–12 education.
“We’ve seen some projections in the tens of millions of dollars,” noted one source close to Senate Democrats. “In an era of overcrowded classrooms, laid-off teachers, and draconian school budgets, we don’t think this source of revenue can be overlooked any longer.”
Republican supporters of the tax note several reasons for supporting it, including encouraging prospective plaintiffs to settle disputes outside the court system; discouraging tort claims, which would have the added benefit of lowering or stabilizing insurance premiums; and, eventually, through less use, shrinking the size of the state’s judiciary, which one Republican source described as “bloated.”
“As proponents of small government, if we as Republicans can encourage people to resolve their disputes outside the court system, we believe it is important to do so,” one Republican, who asked to be kept anonymous so that he could speak candidly about the bill. “We believe this measure is an important first step toward tort reform and will, eventually, help to shrink the state’s judiciary, leading to a net tax savings for our constituents.”
An aide to Hickenlooper provided the following response to an email inquiry from The Docket regarding the proposed tax: “Governor Hickenlooper is aware that such a measure is being discussed in the General Assembly and is, in theory, supportive of such a measure. However, the Governor will be unable to comment further until more details are fleshed out through the legislative process.”
Sources close to assembly Democrats and Republicans note that the two sides have, at this point, agreed in principle to “a few broad strokes,” such as taxing a “unit” of legal service in the same manner as a retail sales transaction. Under this scenario, each unit of legal services rendered in Colorado would be subject to a 2.9 percent tax. Accordingly, a hypothetical hour of legal services rendered at $100 per hour would be subject to $2.90 in state taxes. Similarly, contingency fee arrangements also will be taxed at 2.9 percent; nevertheless, disagreement remains as to what amounts should be included in the taxable amount, with some arguing that compensatory payments for medical services, and the like, should not be subject to the tax.
A Republican Senate member noted that the only other services her colleagues had expressed any interest in taxing was medical services related to family planning. However, noting that such a provision would be a non-starter with Democrats, she stated that, with respect to taxing services, “This is as far as it goes.”
Despite garnering broad bipartisan support, both sides have expressed hesitancy regarding the precedent that will be set and the scope of the tax.
“The legal market is very competitive and it also is one that is disproportionately used by the wealthy, so we feel comfortable going forward with this,” one House Democrat noted in an email to The Docket. “Levying a tax on additional services, however, would have to be approached very cautiously and strictly on a case-by-case basis. We want to ensure the tax burden on middle- and lower-income Coloradans is not heightened while people are still suffering through the recession.” D
Scott Challinor is an attorney who specializes in tax law.