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The Taxpayer Relief Act of 1997 added Internal Revenue Code �6045(f) requiring that any person engaged in a trade or business and making payments to an attorney file an information return to report the payment to the IRS. In May 2002, the IRS issued new proposed regulation 1.6045-5. It appears many attorneys and law firm administrators are not aware of the requirements and their complexities, or are otherwise not complying. A string of unfavorable media stories (in the late 1990s, before accountants stole the unfavorable media spotlight) shed light on the problem of attorneys not reporting taxable income. Indeed, a House of Representatives’ committee report states that “the provision will have a positive impact on compliance with the tax laws.” But why pick on the law profession? The House report goes on: “Although some might consider it inappropriate to single out payments to one profession for additional information reporting, requiring reporting is appropriate in this instance because attorneys are generally the only professionals who receive � payment[s], a portion of which may be income to them and a portion of which may belong to their client.” Thus, the stage is set, as this concept permeates the proposed regulations. Although payments made to corporations are generally not subject to information reporting (usually made via Form 1099-MISC), Reg. 1.6045-5(c)(1) defines “attorney” as a person engaged in the practice of law, whether as a sole proprietor, partnership, corporation or joint venture.” So the exception generally provided for payments to corporations does not apply, and thus payments made to law corporations are subject to reporting. So what’s out? Generally, if payments are covered by another reporting requirement provision, they are not subject to �6045(f). For example, payments of wages by an attorney’s employer are not subject to the rules; presumably these payments are reportable under �6051 as W-2 wages. Further, payments of compensation or profits by a partnership to a partner are not subject to these rules, nor are payments of dividends by a corporation to its shareholders, as these are all required to be reported under other provisions. Also, checks that are payable to the plaintiff (not to the attorney) are not subject to the reporting requirements even if the check is delivered to the attorney. Example: A check made payable to the claimant, but delivered to the non-payee attorney. Corporation P, a defendant in a suit for damages knows that C, the plaintiff, has been represented by attorney A throughout the proceeding. P settles the suit for $500,000. Pursuant to a request by A, P writes the $500,000 settlement check payable solely to C and delivers it to A at A’s office. P is not required to file an information return with respect to A, because there is no payment to an attorney. SURRENDERING TINS Attorneys are sometimes reluctant to surrender their taxpayer identification numbers. The regulations require attorneys to promptly furnish their TIN to persons subject to the reporting requirements. Failure to do so will subject the attorney to a fine for each such failure and backup withholding. Example: Attorney does not provide TIN. Corporation P, a defendant, settles a suit brought by C for $1 million of damages. C’s attorney, A, did not furnish P with A’s TIN. P is required to deduct and withhold tax from the $1 million. Therefore, P makes the payment by a $720,000 check naming C and C’s attorney, A, as joint payees. P must also file an information return with respect to A in the amount of $1 million. PAYMENTS TO OTHER ATTORNEYS In many situations attorneys engage other outside attorneys to assist with particular aspects of a case, as when a case needs a special type of expertise. Often, the attorney managing the case, the tier 1 attorney, receives the settlement and pays the tier 2 attorney out of those proceeds. If an information return is required to be filed, the attorney with respect to whom the information return is required to be filed (the tier 1 attorney) must in turn file an information return himself for the payment made to the other attorney (the tier 2 attorney). Example: Multiple attorneys listed as payees. Corporation P, a defendant, settles a lost profits suit brought by C for $1 million by paying a check naming C’s attorneys, Y, A and Z, as payees in that order. Y, A and Z are not related parties. P delivers the payment to A’s office. A deposits the check proceeds into a trust account and makes payments by separate checks to Y of $100,000 and to Z of $50,000, for their attorneys fees. A also makes a payment by check of $550,000 to C. P must file an information return for $1 million with respect to A. A, in turn, must file information returns with respect to Y of $100,000 and to Z of $50,000. JOINT OR MULTIPLE PAYEES Unlike most other types of 1099 reporting requirements whereby the income gets reported to only one payee, the regulations under 1.6045-5 provide that in some situations the same income is required to be reported to more than one payee. But how will the IRS 1099 matching program administer this? If more than one attorney payee is listed on the check, the information return must be filed on the attorney to whom the check is delivered. If one or more attorneys are listed as payees on the check, and the check is either delivered to a non-payee or to a non-attorney payee, an information return must be filed on the first-listed payee attorney on the check. Obviously, these rules provide some opportunities for planning to minimize taxes and fees based on gross income, to the extent the payee has influence with the payor. (Given the confrontational nature of most litigation, any such influence must be exercised during the negotiation process.) For example, in California, where a fee is assessed on LLCs based on gross income, it could be preferable to list the order of the payees and make delivery arrangements for the check in such a way that the 1099 would not be filed on the LLC, but rather on one of the other attorney payees. Example 1: One check, joint payees, taxable to claimant. Employee C, who sues employer P for back wages, is represented by attorney A. P settles the suit for $300,000 that represents taxable wages under existing legal principles and writes a settlement check payable jointly to C and A in the amount of $200,000, net of income and FICA tax withholding. P delivers the check to A. A retains $100,000 of the payment and disburses the remaining $100,000 to C. P must file an information return with respect to A for $200,000. P must also furnish an information return to C in the amount of $300,000 under other provisions. (Note: A would report gross income of $200,000 and a deduction for client payment of $100,000; C would report gross income of $300,000 and a deduction for legal fees of $100,000. The issue of “gross” versus “net” reporting is beyond the scope of this article.) Example 2: One check, joint payees, excludable to claimant.C, who sues corporation P for damages on account of personal physical injuries, is represented by attorney A. P settles the suit for a $600,000 damage payment that is excludable from C’s gross income. P writes the $600,000 settlement check payable jointly to C and A, and delivers the check to A. A retains $240,000 of the payment as A’s attorneys fees and remits the remaining $360,000 to C. P must file an information return with respect to A for $600,000. (Note: A would report gross income of $600,000 and a deduction for client payment of $360,000, showing $240,000 net income.) Of final note, attorneys often receive payments on behalf of others for a variety of reasons, in many different situations. The regulations define “legal services” very broadly to include “services that are related to, or supportive of, the practice of law.” The preamble to the regulations states that this definition was intended to be quite broad, as can be seen in the following example taken from the regulations: Example: Bankruptcy trustee — wage garnishment. Individual C files for bankruptcy under Chapter XIII of the Bankruptcy Code, 11 U.S.C. ��1301-1330. Pursuant to a wage garnishment order, C’s employer, P, withholds $800 from C’s earnings. P remits a check for $800 payable to A, an attorney who was appointed by the U.S. Bankruptcy Court to act as the trustee of C’s bankruptcy estate. P is required to file an information return under �6045(f) with respect to the $800 payment made to A. Although there are some specific exclusions provided, payors should be cautious in their application of these rules since they could be broadly applicable. Randy Zamarra is a director specializing in tax services to law firms at CPA and business consulting firm Daoro Zydel & Holland in San Francisco. He can be reached at [email protected]. • Practice Center articles inform readers on developments in substantive law, practice issues or law firm management. Contact News Editor Candice McFarland with submissions or questions at [email protected]or go to www.therecorder.com/submissions.html.

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