Jeffrey Kahn (Santa Clara) has posted Beyond the Little Dutch Boy: An Argument for Structural Change in Tax Deduction Classification on SSRN. Here is the abstract:

One of the most active disputes in tax law today is the question of the proper treatment of a plaintiff, a portion of whose taxable damage award is paid to his attorney pursuant to a contingent fee arrangement. At issue is whether the plaintiff is taxable on the portion of the award that is payable to the attorney. The dispute has attracted considerable attention, particularly because the effect of taxing the plaintiff for the attorney’s portion of the award has been severe and patently inappropriate. Not only does that tax imposition contravene tax policy, but in the case of discrimination suits, it frustrated a major purpose of the civil rights legislation that authorized those causes of action. The civil rights aspect of this problem was resolved prospectively by the adoption of the American Jobs Creation Act of 2004 ("2004 Act"), but the problem continues to exist in other areas.

Prior to the enactment of the 2004 Act, the Supreme Court agreed to resolve a split in the Circuit Courts of Appeals with respect to this tax issue. The Supreme Court case is not mooted by the recent adoption of the 2004 Act for two separate reasons: first, because that provision of the 2004 Act does not apply to judgments and settlements made before the date on which the 2004 Act was enacted; and second, because one of the two consolidated cases being heard by the Supreme Court (the Banaitis case) does not involve discrimination, thus making the 2004 Act inapplicable.

Regardless of how the Supreme Court resolves the discrete issue that is before it, what is alarming is that the current dispute is just one small example of a much larger problem. Instead of dealing with the root cause of the problem, the focus (both in the courts and in Congress) has been on whether to provide a "fix" for the specific plight of the taxpayers who have raised the issue in the context of a suit for damages. The Supreme Court and Congress, like The Little Dutch Boy, may be willing to plug one hole, but the broader problem is a structural fault in the "dam" of the tax law system – namely, the improper classification of a significant number of expenditures as itemized deductions. This Article argues that, instead of plugging one hole at a time, it is time to replace the dam.

The thesis of this Article is that the current list of nonitemized deductions wrongly excludes a number of items, especially some that are directly connected to the production of income. This wrongful exclusion imposes an unwarranted and severe tax burden in far more circumstances than the attorney fee problem on which Congress exclusively focused. The harsh consequences resulting from the misclassification of a number of items are exacerbated by the stringent limitations currently imposed on many itemized deductions; but even the repeal of those limitations, which is unlikely to occur, will not cure all of the harm that a wrongful classification causes. The author hopes that highlighting several examples of misclassification will induce Congress to implement a commission to study the entire classification system rather than to rest on its laurels for solving one small part of the problem in the 2004 Act.