New reporting requirements on payments made to attorneys leave practitioners wondering why.

• Author: Blatt, Peter
• Position: Taxation

In attempting to catch those attorneys who sometimes understate their income, Congress has created a potential compliance burden on attorneys and their clients. In the Taxpayer Relief Act of 1997, Congress enacted IRC [sections] 6045(f). This statute imposed a new reporting requirement on payments made to attorneys for legal services in the normal course of business. In an attempt to clarify this requirement, the IRS enacted proposed regulations in May 1999.(1) Congress felt that it was appropriate to single out payments to one profession for additional reporting, because generally attorneys are the only profession to receive these types of bifurcated payments. There was an immediate outcry by practitioners who felt this requirement was too onerous of a burden on small corporations and was unsuitably vague.(2) Not only did Congress not repeal this code provision, but in May 1999, the IRS promulgated proposed regulations on how to comply with [sections] 6045(f). Due to the already onerous task of becoming Y2K compliant, the IRS has delayed the effective date of the Regulations for one year to allow taxpayers to be able to make the required systems modifications for this additional reporting burden.

Pre-[sections] 6045(f) Reporting Requirements for Payments to Attorneys

The reporting of payments made in the ordinary course of business has historically been controlled by [sections] 6041. Reporting is required in situations in which a person makes a payment in the course of his or her trade or business to another person, of rent, salaries, compensations, remunerations, attorneys' fees, etc., or other forms of income in excess of $600.(3) There were only three instances in which payments to attorneys could be excepted from reporting. The first exception was where the payor could not determine how much of a payment was for the plaintiff and how much was for attorneys' fees. In such instances, the common trend was, "when in doubt, don't report." The second exception was for payments that were made to attorneys who were part of a professional corporation. The third exception was for nonbusiness payments made by an individual for personal matters such as divorce or a nonbusiness lawsuit settlement paid by an individual on his own behalf. Currently, this third category of payments is still exempt from reporting.

There has never been any formal reporting, requirements for disbursements to the client of funds from the attorney-maintained trust account. Typically, the right to recover a judgment or settlement lies within the party to a suit, rather than an attorney. Thus, where a party receives a judgment which includes attorneys' fees, the fees are treated as if paid directly to the prevailing party and then followed by payment by that party to his or her attorney. Even though an attorney is not required to report disbursements made to a client, the rules of professional conduct require that an attorney should be able to provide an accurate accounting for any client-held funds.(4)

Current Law [sections] 6045(f) -- Return Requirement for Payments to Attorneys

Section 1021 of the Taxpayer Relief Act of 1997 enacted the new IRC provision [sections] 6045(f).(5) Section 6045(f) became effective for payments made after December 31, 1997. The first information reports were required to be filed with the IRS by February 28, 1999, for payments made in 1998. The provision requires reporting of payments made to attorneys within the course of a taxpayer's trade or business. The statute requires that the payment be made for legal services. However, the statute is silent as to what legal services encompass. If a taxpayer has to report under IRC [sections] 6041 or [sections] 6051, no additional reporting is required under [sections] 6045(f). This new requirement imposed by Congress was met with apprehension as to whether this measure was actually needed and exactly what this statute requires.(6)

The Proposed Regulations

In May of 1999, the IRS issued proposed regulations in an effort to provide more guidance for taxpayers, tax practitioners, and IRS employees. Katherine Jacob Kiss, who is a senior attorney advisor in the IRS income tax and accounting branch within the Office of Assistant Chief Counsel at the IRS and also the author of the proposed regulations, explains:

For a proposed regulation, it is enacted in proposed format. So, it is our public announcement of what we think a reasonable interpretation of the statute is. In the absence of final regulations, it is incumbent on all taxpayers to comply with the statute in a reasonable fashion. So, if I was a taxpayer who had a recording obligation, I would look to the proposed regulations as a safe harbor.

The proposed regulations require:

* Any payments made to an attorney within the course of one's trade or business must be reported on a Form 1099-MISC, box 13, with an "A" next to the amount.

* The attorney must provide his or her Taxpayer Identification Number, which does not have to be certified, to avoid backup withholding by the payor of 31 percent.

* If a check is delivered to an attorney who is not a payee, that...