I. Introduction
On May 20, 1999, the Internal Revenue Service issued proposed regulations (the "Proposed Regulations") concerning reporting certain payments to attorneys to the IRS that would apply to payments made after December 31, 1999. These Proposed Regulations will affect a defendant in a lawsuit who pays a judgment or settlement amount to the plaintiff’s attorney.
There are a few surprises in this proposal. For example, in many cases a defendant who pays a judgment or settlement amount to an attorney will have to file two information returns with the IRS for the same payment, one for the attorney and the other for the plaintiff.
II. Specifics of Payments to Attorneys
A. General Rule of Reporting
Generally, any person (including an individual or business) that makes a payment in the course of its business to an attorney for legal services must file an IRS Form 1099-MISC, "Miscellaneous Income," with the IRS for the calendar year of the payment.
For example, reporting is required –
- Whether payment is made in cash or by check;
B. Special Reporting Rules
The Proposed Regulations also deal with some special cases:
- Amount Reportable for Attorney. If a check is made payable to an attorney and the payer does not know how much of the payment is the legal fee, the entire payment is reported for the attorney. If the payer knows how much of the payment is the legal fee, the payer reports only the legal fee for the attorney.
- Check Delivered to Attorney Who is Not a Payee of the Check. If a check is delivered to an attorney who is not a payee of the check, the payer still has to file an information report if he reasonably believes that he is delivering the check for legal services. This is true even if state law requires that the client be the only payee of the check.
- Check Payable to More Than One Attorney. If the check names more than one attorney, the payer must file an information return only for the attorney who received the check.
- Payee Attorney Shares Payment With Other Attorneys. If the attorney shares the payment by making payments to other attorneys, the first attorney must file information returns for the other attorneys.
C. Exceptions to Reporting
The Proposed Regulations contain a few exceptions to reporting payments to attorneys. The exceptions are:
- Payments of wages to an attorney by his employer;
- Payments of partnership profits or dividends to an attorney who is a partner or shareholder in a law firm or accounting firm;
- The balance of a payment of gross settlement or judgment proceeds to an attorney if the payer knows how much of the payment is the legal fee; and
- Payments made to a foreign attorney who shows he is not subject to U.S. tax.
D. Specifics of Information Report
The information return required under the Proposed Regulations must include the following information:
- The name, address and taxpayer identification number ("TIN") of the payer;
- The name, address and TIN of the attorney;
- The total amount of payments made to the attorney by the payer during the calendar year; and
- The other information required by Form 1099-MISC.
A copy of the Form 1099-MISC filed with the IRS also must be sent to the attorney by January 31 of the year following the payment year.
An attorney must provide the payer with his TIN. Failure to provide the TIN could result in a civil penalty against the attorney as well as 31% withholding on the payment made to the attorney.
E. Examples of Information Reporting
In all three examples below, Attorney is Plaintiff’s attorney.
Example 1 – Plaintiff sues Defendant for lost wages. The suit is settled for $300,000 paid by check payable jointly to Plaintiff and Attorney. Defendant does not know the amount the Attorney will be paid. Attorney keeps $100,000 as his fee and pays the other $200,000 to Plaintiff. Defendant is not liable by law to pay Plaintiff’s legal fee.
Defendant (Plaintiff’s employer) must file Form W-2 for $300,000 for Plaintiff (with taxes withheld), and also file Form 1099-MISC for Attorney for $300,000.
Example 1 demonstrates that two information reports may be required for the same payment.
Example 2 – Same as Example 1, except Defendant knows that $100,000 is the legal fee. Defendant must file the same Form W-2 for Plaintiff for $300,000, and a Form 1099-MISC for Attorney for $100,000, the known amount of his legal fee.
Example 2 demonstrates that if the payer knows the amount of the legal fee, only the legal fee must be reported for the attorney. The balance paid to the attorney (the other $200,000) is not required to be reported for the attorney. Second, the amount reported for the plaintiff is not reduced by the legal fee, unless the defendant is liable by law to pay the plaintiff’s legal fee. Therefore, if in Example 2 Defendant were liable by law to pay Plaintiff’s legal fee, then only the $200,000 recovery net of the legal fee would be included in the information report filed for Plaintiff.
Example 3 – Plaintiff sues Defendant for personal physical injuries and any damages recovered by Plaintiff will not be taxable. Defendant’s check in settlement is made out to Attorney. Defendant must file an information report for Attorney in the amount of the entire settlement check. No information report is required for Plaintiff.
Example 3 demonstrates that information reporting of payments to attorneys does not depend on whether the settlement is taxable to the plaintiff.
III. Conclusion
The Proposed Regulations impose additional reporting requirements on payers of litigation settlements or judgments to attorneys. Litigation defendants must pay close attention to the Proposed Regulations, and plaintiff’s attorneys should not only expect to receive more Forms 1099-MISC than they had before, but should also be prepared to disclose their TINs to defendants who pay judgments or settlement amounts to them.