By: Sophia Huang
With tax season now underway, the impacts on consumer-taxpayers of the so-called One Big Beautiful Bill Act, which became law last year, are becoming apparent. The law’s permanent elimination of miscellaneous itemized deductions has taken away one of harmed consumers’ only tools for avoiding unjust double taxation when they obtain legal accountability against bad actors in the marketplace. For these consumer-taxpayers, some of whom are already having trouble making ends meet and may rely on income-dependent tax benefits, this change has the potential to be financially devastating.
Currently, when consumers successfully bring a case under a state or federal consumer protection law, they are typically awarded damages to compensate them for the harm they experienced, and their attorneys may receive a separate award under the law for their work. This allows consumers who cannot otherwise afford legal help to hire an attorney to represent them in legal proceedings. However, due to a tax code glitch, the funds awarded to the attorneys are considered taxable income to both the attorneys and the consumers. The attorneys who actually earn and receive the funds pay income taxes on it, but consumers are expected to pay income taxes as well even though the money never reaches them and they are not entitled to it.
As a result, impacted consumers are losing some or all of their recoveries to additional taxes. In some situations, consumers can even end up paying more in additional taxes than they actually recover from their cases, leaving them worse off.
To illustrate, after struggling with fruitless disputes, a Nevada consumer brought suit against a credit card company that had begun mistakenly reporting a corporate account to his consumer credit profile and ruined his credit. After months of litigation, the company agreed to pay the consumer a small amount in damages and to pay the consumer’s attorney to cover his legal expenses, as allowed under the federal Fair Credit Reporting Act (FCRA). While that should have been the end of the consumer’s ordeal, the company later sent him an IRS 1099 form showing that he had received both the damages and the payment that went to his attorney. As a result, he was then expected to pay more in taxes than he received in damages.
For consumers like these, unfair tax treatment is essentially a punishment that prevents them from being made whole. At a time when American household expenses are skyrocketing, a tax code that illogically penalizes consumers is untenable. Previously, consumers could take a miscellaneous itemized deduction to partially offset this additional unjustified tax burden. However, in 2017, the Tax Cuts and Jobs Act (TCJA) suspended availability of miscellaneous itemized deductions until 2025. This temporary suspension was scheduled to end in 2025, but the new law made the suspension permanent.
Beyond just paying excessive taxes, some consumers stand to lose even more from unfair tax treatment. Because the tax code considers recovered legal expenses to be income to a consumer, many consumers who win or settle their cases have their incomes artificially inflated. As a result, impacted low and moderate-income consumers may lose eligibility for income-dependent credits and benefits like the Earned Income Tax Credit, Child Tax Credit, subsidized housing, free or reduced school lunch, food and utility assistance, and more. Further, they may not receive their expected tax refund because their income appears higher than it actually is.
To ensure consumer-taxpayers are not unjustly punished for enforcing their legal rights, Congress must act to create a new deduction for consumers that allows them to fully deduct recovered legal expenses from their income. Previously in 2004, Congress created such a deduction for taxpayers who brought successful civil rights and employment claims. The End Double Taxation of Successful Consumer Claims Act, S. 467 would do the same for consumers.
