An IRS penalty that kicked in at the first of the year could cause ethical problems for attorneys.

Starting on Jan. 1, the Internal Revenue Service will penalize businesses that fail to comply with a law that governs the reporting of payments made by credit card.

Companies that process the payments can be required to withhold 28 percent of the revenues for noncomplying businesses. For lawyers, that could result in a shortfall in their attorney trust accounts, exposing them to disciplinary action.

The crux of the problem is that the law requires an exact match between the name and tax identification number used by the payment processor and what the IRS has on file.

The mismatch can occur, for example, when a law firm reorganizes or the partnership otherwise changes its name.

Attorneys and other merchants had to start complying with the law last year, for 2011 revenues, but the IRS delayed the penalty until 2013 to give people time to adjust.

The law, section 6050W, was added to the Internal Revenue Code as part of the Housing Assistance Tax Act of 2008 and was intended to help plug the tax gap by catching unreported income.

The tax gap, estimated by the IRS at $385 billion for 2006, the most recent year for which a figure is available, represents tax revenue that goes uncollected each year, in part because of businesses that fail to report some or all of their income.

Section 6050W requires the companies that process the payments to send to their merchant customers a Form 1099-K that reports the annual gross dollar amount of transactions during the prior calendar year.

Aggregators such as PayPal need only report proceeds for businesses with more than 200 transactions that bring in at least $20,000 in revenue.

The first Form 1099-Ks went out in January 2012 and a new round will be arriving in mailboxes this month. The IRS requires they be mailed no later than Jan. 31, and merchants who receive them are expected to file them with their tax returns.

Amy Porter, the CEO of AffiniPay in Austin, Texas, whose LawPay service processes payments for about 15,000 law firm accounts around the country, says 6050W was primarily aimed at businesses such as restaurants that are more likely to underreport income.

But it can ensnare attorneys because it requires the name and tax identification number match exactly, she says.

Peggy Gruenke, who has been warning lawyers of the 28 percent penalty on her lawbizcoo blog, says that when she started working as chief operating officer for a new firm last year, she checked and discovered a discrepancy. The firm was Cincinnati’s Godbey & Associates and in one place, the name of owner Mark E. Godbey had the middle initial while in the other, it didn’t.

Porter says use of credit cards to pay legal fees is becoming more and more the norm. “Clients don’t carry around checkbooks,” she says.

Usually, payment processors like LawPay will deposit funds in a lawyer’s account within 24 or 28 hours, she says.

But if a mismatch is found, the processor will now have to hold back 28 percent of the monies and send them to the IRS.

It is too early to know for certain how the IRS will handle things but it appears that an attorney or other merchant who is entitled to the money will have to wait until the next year to get it back, by way of a tax credit, Porter says.

In the meantime, the lawyer is out the money and potentially exposed to disciplinary action over funds that were meant for the trust account.

LawPay, which promises on its website “No debits are allowed from your IOLTA at any time … for any reason,” has taken steps to ensure that doesn’t happen.

Porter says the company has checked every account against the IRS databases and, where a mismatch is found, deactivated it until the problem is fixed.

Attorneys who contact LawPay seeking assurance about their own information are sent screen shots from the IRS database so they can see for themselves, rather than just being told things are correct. All it takes is a small, easily overlooked typo to trigger the penalty, notes Porter.

LawPay found discrepancies with fewer than 1 percent of its accounts, leading Porter to predict that “at the end of the day, I don’t think it’s going to be a big deal,” just “a minor housekeeping issue.”

Still, given the consequences, she would advise lawyers to contact their processors and confirm they have a match.

Gruenke advises similar steps, adding, “it’s a simple thing to do.”

In addition to blog postings, she has been getting the word out through a local LinkedIn forum she runs for solos and small firms in Cincinnati and says many lawyers thank her because they were unaware of the risk.

Since last summer, the American Bar Association’s Commission on Interest on Lawyer Trust Accounts has sent notices to all U.S. IOLTA programs, the National Organization of Bar Counsel and all state and local bar associations warning about the potential of the 6050W penalty “to negatively impact IOLTA accounts and lead to ethical violations by lawyers.”

The commission suggested that instead of relying on their credit-card processing companies, lawyers should check for themselves to make sure their information matches.

Andy Baharlias, of the Pepper Law Group in Flemington, who has written about 6050W in his firm’s technology law blog,, questions whether the IRS has the resources to enforce the law. •