reason why they aren't entitled to the same pound of flesh from a lawyer as they are from a plumber? Mr. SMITH. The only reason I can see is that at the present time, the plumber is doing business and has the option of incorporating if he wants to or retaining a proprietarship business. The professional man does not have that option. Mr. MIKVA. If he does have that option, which they are proposing to give him here, it seems to me they ought to be subject to the same detriment. That is my point. I was not proposing a bill to bring lawyers and engineers in under the franchise tax. Mr. COREY. The District taxation doesn't afford most of the same benefits that the federal tax law does. I don't know if that is responsive to the question. Mr. HUNGATE. Suppose the Committee did not amend the legislation so that professional members, assuming their condition would be analogous to plumbers in other respects, that professional men who paid the franchise tax in the District of Columbia and lived in Maryland or Virginia would not be able to deduct that from their State income tax. Mr. COREY. Wouldn't be able to get a credit. Mr. HUNGATE. Would not be able to get credit for it. Would you still support this measure? Mr. COREY. As a matter of fact, the Board of Directors definitely put that caveat on the legislation, that without Section 2 they would not support the legislation. Mr. MIKVA. All right. We have one other point. If it were possible to amend it, and if it were amended, so that the personal liability that exists among the partners were retained even though they were in a professional corporation, would you still support the legislation? That is what you have to ascertain; is that right? Mr. MIDDLEKAUFF. We have to ascertain that particular matter; I can't respond to that. Mr. HUNGATE. This franchise tax, I take it, it is a deductible business expense, it is simply not a direct threat against the tax due; is that a fair statement? Mr. COREY. It would be a deduction in the State of Maryland. It would be a deduction for federal tax purposes. Mr. HUNGATE. Let's take the State tax, either Maryland or Virginia, or both. The fellow who is now not in a professional corporation, he is in a non-professional corporation, he pays the franchise tax; he cannot credit against his Maryland income tax; is that correct? Mr. COREY. That is correct. Mr. HUNGATE. Can he deduct it as an expense of doing business, as a business expense? Call H & R Block. Mr. MIKVA. Unless there is some real quirk in the Maryland and Virginia law that I don't know about, it would be treated like a telephone expense or any other. The partnership would deduct it as a cost of doing business and that would be one of the deductions before you reach the net income. Mr. COREY. I agree. I was checking my notes to see if there is something that is specific. There is a court case in Maryland that threw out the credit, the Gardella case. (Subsequently, the following letter was received for the record :) THE BAR ASSOCIATION OF THE DISTRICT OF COLUMBIA, Re H.R. 3121 (Professional Corporation Act). Hon. WILLIAM L. HUNGATE, Chairman, Subcommittee on Judiciary, House Committee on the District of Columbia, Longworth Building, Washington, D.C. DEAR MR. HUNGATE: With your permission, we would like to elaborate further on the reasons why the Bar Association conditions its support of H.R. 3121 on the inclusion of Section 2, which continues the exemption from the District of Columbia's Unincorporated Business Franchise Tax for those professionals who do not incorporate. It must be remembered that a tax on unincorporated business is rather unusual. When we last checked into the matter, apparently only three other jurisdictions had an Unincorporated Business Tax based on gross or net income. Such a tax is designed primarily to protect business subject to Corporate Income Tax from tax-free competition. An existing exemption exists where the trade or business by law, customs or ethics cannot be incorporated or where the trade or business is principally one of personal services and capital is not a material income-producing factor. If none of the individuals in a particular trade or business may incorporate by reason of law, customs or ethics, then, of course, there would be no need to protect any of them from an anti-competitive impact of a Corporate Income Tax. Also, in these professions, capital is not a material income-producing factor. The professionals who support H.R. 3121 and who want the right to incorporate will, upon incorporation, be voluntarily and knowingly subjecting themselves to the D.C. Corporate Franchise Tax. They will be in competition with their brethren who would be exempt as unincorporated businesses. The professional who does not want to incorporate, has not appeared before this subcommittee, and is probably the independent, sole practitioner, would be the individual adversely affected if H.R. 3121 were enacted without Section 2. He would be penalized because others in his profession have sought the right to incorporate. We believe that it is basically unfair for the District of Columbia Government to penalize such practitioners in a make-shift manner by opposing Section 2 of H.R. 3121. All the supporters of H.R. 3121 have conditioned their support on Section 2, and it is principally to protect those who do not want to incorporate, and did not ask for the right to incorporate. If the sole practitioner found himself subject to an Unincorporated Business Franchise Tax, it would be a simple matter for him to move his office into Maryland and Virginia, along with the many other corporations, service organizations, and trade associations that have moved into the suburbs. The professionals who want the right to incorporate are willing to pay for it, by assuming the obligation to pay the D.C. Corporate Francise Tax. In closing, we would like to emphasize that the D.C. Bar Association, in conditioning its endorsement of H.R. 3121 upon the retention of Section 2 thereof, is not trying to avoid District tax on nonresidents. (As you know, professionals who reside in the District are taxed on their professional earnings by the individual income tax.) The Association's principal objections, as indicated in the testimony on May 11, 1971, are that the D.C. Unincorporated Business Tax is not eligible for credit against the Maryland and Virginia income taxes and removal of the exemption for professionals who do not incorporate would be discriminating against one group of individuals who make their livelihoods by performing personal services. In fact, the Board of Directors of the Bar Association, at a meeting held on June 8, 1971, endorsed the principle of a reciprocal income tax contained in Article I of H.R. 8392 which would impose the District income tax upon income earned within the District by all nonresidents of the District. This tax would clearly be eligible under existing law for credit against the Maryland and Virginia income taxes. If the Congress approves the concept of a reciprocal income tax, the unincorporated business tax will be eliminated. We appreciate this opportunity to submit our views on behalf of the Bar ssociation. Respectfully yours, ROGER D. MIDDLEKAUFF. 62-364 0-71-6 Mr. HUNGATE. You gentlemen have been very patient and we have been very taxing. The next witness is Mr. Louis H. Diamond of the District of Columbia Bar. You have a written statement here and you are associated with our former colleague, Senator Tydings, in the practice of law; is that correct? STATEMENT OF LOUIS H. DIAMOND, A MEMBER OF THE BAR OF THE DISTRICT OF COLUMBIA Mr. DIAMOND. That is correct. He extended that I extend his regards. Mr. HUNGATE. We are very pleased to have you with us and if you wish, we will have your statement made a part of the record at this point, and then we will be glad to hear from you. Mr. DIAMOND. I appreciate that very much, Mr. Chairman. I am testifying here today on behalf of my law firm and on behalf of a number of clients who are professionals in the District of Columbia, and would like to avail themselves of the opportunity of incorporating. A professional practice is much the same as any other business in the sense that it is a business run by entrepreneurs attempting to make money and make a living. The fact that they are professionals does not really make their activity different from those of any other entrepreneur. The reason why professionals have not been entitled to incorporate, historically, is largely because in many instances self-imposed restrictions through association and, in turn, through influence in the States, something to the effect that it would not be in the best interest of the population for professionals to incorporate. Now, over the years these barriers have been removed, but they haven't been removed without the placing of protections that will protect the populous in their dealings with professionals, and we focused on that a few moments ago. I would like to perhaps expand on that. LIABILITY OF PROFESSIONALS The liability this statute would preserve intact is the professional liability of a professional in dealing with his clients or patients in his individual capacity. The only reason why a professional is liable for the negligent act or malpractice of a partner is because of the law of partnership; not because of the law of professional responsibility. The law of partnership says that every partner is liable for the acts of any other partner. A corporation statute would change the ground rules, would put the laws of corporation and substitute that the the law of partnerships and, therefore, an individual who would remain liable for his own acts not just through this statute but, anyway, a person is always liable for his own negligent acts whether or not this statute says it, because the person who is injured has the opportunity of suing the person who damages him, and that person's employer which would be the corporation. The corporation would be, of course, liable. There was discussion as to the amount of liability insurance that would be taken, and the statement was made that there would probably be less need for liability insurance and thus less taking. I would definitely disagree with that statement. I think that all lawyers and law firm take just about the maximum of liability insurance that will be sold them. The professional liability insurance is now getting harder and harder to get and I understand in some States they don't even allow it. The insurance companies won't even sell medical malpractice insurance now. The liability of a person, of a personal or malpractice, is an awesome thin, and one that he will insure against generally to the maximum. It has been my experience, and I am counsel to approximately 70 professional service corporations now, and in other States and, as a matter of fact, in some instances, they have more professional liability insurance because the corporation is taking it out and they have taken it out individually themselves, so I don't think there is, in fact, there is a lesson in the insurance aspect of the liability. Any other lessening of the liability is, in my opinion, improper because I don't think there is any logical reason why I, for instance, should be liable as a partner of another lawyer for what he does in his relations with a client that I have absolutely nothing to do with. That is the law of partnership and the fact that this bill might change that would not, in my opinion, be a detrimental factor. The law of partnership applies to partnerships and the law of corporations, I think, should be applied to corporations. Mr. HUNGATE. Does the District of Columbia have one of those funds-I know the State of Illinois does-where a lawyer goes South with the money, and has no money and the Bar Association has a fund to which the client may repair. Mr. DIAMOND. I don't know whether that is in existence for lawyers in the District of Columbia. Another reason why I personally would object to amending or changing the proposed, the draft here, the bill H.R. 3121, so as to change the provisions dealing with the liability, is because of the ground rules set forth by the Internal Revenue Service in determining whether an entity that is a corporation should be taxed as a corporation for federal income tax purposes. The Internal Revenue Service has reviewed the various statutes that have been passed through the State and, as a matter of fact, initially had some problem with the statute in the state of Illinois. Í am not sure what it was but there has been an amendment to that statute and the Internal Revenue Service has published, they have withdrawn their objection to that statute. Basically, the Internal Revenue Service has taken the position that just because you say you are a corporation and even because you had a charter under a State Statute, doesn't necessarily mean that they are going to accept the fact that you are a corporation, unless you have corporate attributes and this statute is well-prepared, this bill is a well-prepared statute and will fit within the ground rules of the Internal Revenue Service to be recognized as a corporation. If you change, if you put an aspect in this bill that is more like a partnership than a corporation, it will greatly complicate the federal tax aspect and, as a matter of fact, will largely encroach upon the reasons why many many persons who would attempt to utilize this statute would want it in the first place. So that I feel, number one, that the preservation of the personal liability between the professional and the client for the patient, as it is stated in this statute is, as it is invirtually all of the other States. I have reviewed the statutes in a number of other States but not, of course, all. I can't speak from memory definitively but I am not aware of one State that has specifically preserved the partnership type personal liability for corporations. They preserve the personal liability as it otherwise would have been had the individual involved not been a corporate employee. I think that is what is most appropriate. There has been some allusion to the fact that the use of a corporation will in some manner adversely affect the attorney-client or the doctorpatient type relationship. I would say again from my experience that this definitely is not the case. I have yet to see the first instance of any adverse patient or client reaction to the fact that the professional they were dealing with was a corporation as opposed to a proprietorship or a partnership. If the relationship is satisfactory, it will be continued; if it is not satisfactory, the person will go elsewhere. I don't feel there is any concern there at all. In effect, I would respectfully urge in this instance that your deliberations focus more upon the question of whether the District of Columbia should continue to be excluded from making a choice that is now available through professionals in all other jurisdictions in the country, and perhaps less on the benefits that are available to corporations that are not otherwise available to individuals. That is the subject matter as was mentioned of perhaps extensive legislation that will be proposed some time to the Ways and Means Committee, and given considerable fruit. In any event, right now the ground rules are such that it is more advantageous to be incorporated and everyone else in all other jurisdictions have access to that, and I think in basic fairness, the professional practicing in the District of Columbia should have that same accesss. That is basically the summary of what I have in the written statement, and all of my presentation, unless you have some questions that you would like to ask. Mr. HUNGATE. Thank you. Mr. Smith? Mr. SMITH. No questions. Mr. MIKVA. You come from a very distinguished firm. Mr. DIAMOND. Thank you. Mr. MIKVA. I assume you spend some time on pro bono publico work? Mr. DIAMOND. I specialize in taxation. I function almost exclusively in taxation, but the only problem is that people who are generally in need of that work, are not in need of tax advice. Mr. MIKVA. I was referring to the firm generally. Mr. DIAMOND. The firm does, yes. Mr. MIKVA. Do you know which plumbing firms engage in pro bono publico work? Mr. DIAMOND. No. Mr. MIKVA. Then I hope that your statement that the only reason lawyers engage in a profession is to make money was an exaggeration |