There has been considerable concern about the role of contingency fees as an incentive to tax attorneys to provide advice in support of aggressive or even risky positions on tax returns. The Treasury has looked at that in the context of the regulations governing practice before the Internal Revenue Service, commonly called "Circular 230" and has restricted the setting in which contingency fees are permissible in tax practice. Not surprisingly, tax practitioners have argued for loosening of those restrictions, claiming that contingency fees are not problematic in many situations.
California is apparently moving towards a position that is even stronger than the one currently followed in Circular 230. The California Senate Governance and Finance Committee approved S.B. 342 today on a 5-2 vote and the bill now goes to the Judiciary Committee. The bill would "ban contingency fees for anyone representing taxpayers in matters involving the Revenue and Taxation Code". It would also place a cap on attorneys' fees for lawyers in tax litigation and make clear that the provision in the Revenue and Taxation Code is the only remedy for fees in tax litigation, because of a recent attempt by attorneys to claim higher fees under the private attorney general doctrine.
The drafter of the legislation, Sen. Lois Wolk, stated that the ban would address the problem of tax advisers who file "highly aggressive tax refund claims hoping not to get caught in the audit lottery." BNA Daily Tax RealTime, Apr. 27, 2011 (7:54 pm). The statement in the bill's text worries in particular about "unregulated tax consultants" , as noted below.
However, sophisticated cottage industries of non-accountant tax consultants have grown considerably in recent years, offering to amend a taxpayer's previous state income tax returns seeking refunds of previous taxes paid by claiming tax credits not included on the taxpayer's original return. Additionally, consultants assist taxpayers protesting an assessor's valuation of his or her property by pursuing appeals seeking to reduce the value with county assessment appeals boards. In both cases, the taxpayer compensates the consultant as a percentage of the refund, providing a significant incentive to file aggressive claims with questionable justification. As many of these consultants are neither accountants subject to state law or codes of ethics, nor practitioners covered by Circular 230, they may charge taxpayers contingency fees without any limitation. Id. at 1-2.