February 2001 

Why Not Tax Legal Services?

by Kent A. Gernander

For the fourth time since 1967, when Minnesota enacted its sales tax, the Legislature will be asked this year to consider extending the tax to legal services and other services. Previous proposals were advanced reluctantly to expand sales tax collections at times of budget shortages; in contrast, the current proposal is being advanced in the name of tax reform at a time of budget surpluses. Matt Smith, Minnesota's Commissioner of Revenue, argues that "broadening the sales tax base" to include services would permit the state to reduce sales tax rates and reduce other Minnesota taxes, such as real property taxes and income taxes. This, he argues, would enhance fairness, simplicity, and stability in tax collections. Governor Ventura asks a more compelling -- albeit simplistic -- question: "Don't you think lawyers and accountants should pay taxes like the rest of us?"

This ignores the obvious: a sales tax on professional services would be itemized separately, added to the cost of the services and paid by clients. Why should we oppose the tax? Here are ten reasons.

1. A sales tax on legal services would tax people at times of misery, misfortune, and vulnerability. The governor argues that sales taxes are "fair" because they tax choices to consume goods and services; however, this is not the case with most legal fees incurred by individuals. Clients dealing with criminal charges, injury, death, divorce, domestic abuse, housing, credit, and bankruptcy seek legal services not from choice but from necessity.

2. Many transactions already taxed would be subject to additional taxes on legal fees. Examples include estate administration and property transfers.

3. The tax would be borne disproportionately by individuals and small businesses; large organizations could avoid the tax by employing professionals whose salaries would not be subject to the tax.

4. The tax would encourage Minnesotans to seek professional services from out-of-state providers. A Minnesota business could obtain advice in intellectual property, federal taxes, or international business from a lawyer in Chicago as readily as from one in Minnesota. Similarly, individuals could obtain estate planning or business advice from non-Minnesota lawyers via electronic communications.

5. The tax would encourage Minnesota professional firms to relocate to other states, or to perform services at satellite offices in other states. Many Minnesota firms now have offices and lawyers in other states. Their fees for services performed at those offices would escape Minnesota's tax.

6. The tax would result in multiple taxation of the goods and services used in producing taxable services. Currently, producers of taxable goods are allowed exemptions from sales tax on such inputs. Proponents of taxing services acknowledge that it would be more difficult to define and exempt inputs to services.

7. Requiring lawyers to collect sales tax from their clients would intrude on the attorney-client relationship. It could create conflict between lawyer and client, and could compromise the confidentiality of client communications. Taxing legal services needed for access to justice could raise constitutional issues.

8. Determining which services performed in Minnesota and elsewhere are subject to tax would be an administrative nightmare. Goods have places of delivery and use that can determine taxability; it is difficult to say with certainty where services are delivered or used. For example, suppose Minnesota and Wisconsin lawyers provide services to Minnesota and Wisconsin companies in connection with a business transaction, and activities take place in both states. What fees of the Minnesota and Wisconsin lawyers would be subject to a Minnesota tax? What records of each would be subject to audit? How would Minnesota collect the tax on the Wisconsin lawyer's fees? Minnesota's local sales taxes add to the complexity; it may be necessary to determine not only in what state but in what city services are performed.

9. A sales tax is considered regressive -- that is, the poor pay a larger percentage of their income in total sales taxes than the wealthy. Minnesota's total tax burden is generally regarded as one of the country's most progressive. The Department of Revenue reports that taxes as a percentage of income are relatively constant at various income levels. At a time of budget surpluses and strong economic forecasts, why expand a regressive sales tax in order to reduce progressive income tax rates?

10. Part of the cost of state income and real property taxes is "shifted" to the federal government -- that is, such taxes are deductible from federal taxable income, resulting in a lower effective tax rate. Sales taxes are not deductible by individuals. Increasing sales taxes and reducing income and property taxes would increase the overall tax burden on Minnesota taxpayers.

Taxes on legal services have been considered and rejected three times in Minnesota over a period of three decades. Only South Dakota, New Mexico, and Hawaii currently tax legal services. Florida and Massachusetts enacted sales taxes on services, but promptly repealed the measures when they proved to be unpopular and difficult to administer. Several other states, including Maine, Maryland, Michigan, Ohio, and Vermont have considered and defeated proposals to tax services in recent years. The District of Columbia also rejected a tax on legal services. This nearly universal rejection of taxing legal services suggests that the arguments against it are compelling.

The MSBA has expressed its opposition to each previous proposal to tax legal services. At its December 2000 meeting, the Board of Governors adopted a resolution opposing the current proposal. Defeat of this proposal will require our concerted efforts. Please share your thoughts on this important issue with your clients and friends, and by all means with your legislators and our governor.

Kent A. Gernander is president of the MSBA. A general practice and trial lawyer in the Winona firm of Streater & Murphy, P.A., he is a graduate of Harvard College and of the University of Minnesota Law School.