Scott E. Vincent
Shughart, Thomson & Kilroy
Kansas City

The Internal Revenue Service recently released its second effort to interpret a section of the Taxpayer Relief Act of 1997 that imposed new reporting requirements on payments made to attorneys. The provision in question deals, among other things, with "gross proceeds payments" received by attorneys, such as lawsuit settlements including both a client's settlement proceeds and the attorney's fee. The recently issued proposed regulations address many of the comments received by the IRS, and actually provide some relief from the reporting obligations previously suggested by the IRS for payments sent to attorneys but made payable directly to claimants.

1997 Statutory Provision

The Taxpayer Relief Act of 1997 enacted Internal Revenue Code § 6045(f) effective for payments made after December 31, 1997. Section 6045(f) generally imposes a reporting requirement on any person engaged in a trade or business that makes payments to an attorney in connection with legal services. This general rule applies even if services are not performed for the payor. The new rule also applies regardless of whether or not the attorney is the exclusive payee of the payment, so reporting is required for payments made jointly to an attorney and a client.

Payments to law firms constitute payments to attorneys under the new provision and are subject to the statutory reporting requirements. The general exception from reporting requirements for payments made to corporations does not apply to corporations that provide legal services under § 6045(f).

Section 6045(f)(2)(B) provides limited exceptions to these statutory provisions for payments that must be reported under § 6041(a) (trade or business payments reported on Form 1099-MISC) or payments that must be reported under § 6051(b) (wages reported on Form W-2).

Previously Proposed Regulations

The IRS originally issued proposed regulations on § 6045(f) in May of 1999. These prior regulations took an expansive view regarding payments to attorneys who are subject to § 6045(f) reporting requirements. The previously proposed regulations provided the following guidance, which is similarly incorporated in the newly proposed regulations with certain noted exceptions:

"Legal services" includes all services performed by or under the supervision of an attorney. Obviously, this language could be interpreted to include non-legal services performed under the supervision of an attorney, which would be a significant expansion of the statutory language.

The information return required under § 6045(f) is Form 1099-MISC. The IRS had initially indicated that the payments would be reportable on Form 1099-B (typically used by brokers to report transaction proceeds).

The reporting requirements do apply to corporations engaged in providing legal services, and the general exception for reporting payments to corporations does not apply.

The previously proposed regulations specifically indicate that there is no "de minimis exception." Thus, even payments of less than $600 were subject to the reporting requirements. The IRS is now proposing a $600 de minimus exception.

The new reporting requirements apply whether or not part of the payment is kept by the attorney as compensation for legal services rendered and whether or not other information returns must be filed under other provisions for a portion of the payment.

The previously proposed regulations also require that Form 1099-MISC be filed for a check delivered to an attorney who is not even the payee, if it is reasonable for the payor to believe that the attorney is receiving the check in connection with legal services. This was the so called "delivery rule" that has been modified in the new proposed regulations, as discussed in more detail below.

For checks with multiple attorney payees, an information return must be filed with respect to the attorney who receives the check. Further, the attorney with respect to whom an information return is filed must then file information returns for payments that attorney makes to other attorneys, except for certain special payments such as wages and partnership distributions.

Finally, where a multiple payee check is delivered to a non-attorney, and is payable to multiple attorneys as well as a non-attorney, the Proposed Regulations require an information return with respect to the first attorney listed on the check.

New Proposed Regulations - Elimination of the Delivery Rule

The new proposed regulations eliminate the "delivery rule" that drew many comments. This rule would have required information reporting of payments made to non-payee attorneys, imposing administrative burdens and expenses both on those attorneys and on the payors. The new rules do maintain the expansive definition of legal services, so that in addition to settlements and judgments it will continue to include payments to real estate settlement attorneys, trustees and estate executors, and administrators of settlement funds. However, if the client is named as the payee on the check, rather than the attorney, no reporting will be required to the attorney under § 6045(f), even if the attorney receives delivery of the payment (changing the prior "delivery rule").

There is still potential for confusion between § 6045(f) for attorneys and § 6041 covering other payments. For example, a $600 payment of taxable damages made jointly to a claimant and a claimant's attorney may be reportable to the claimant under § 6041 and also reportable to the claimant's attorney under § 6045(f), according to the IRS. The IRS does plan to reduce the reporting burden (in a very limited way) by proposing a de minimus rule that would not require payors to report aggregate payments under $600.

Revised Form 1099-MISC

The proposed regulations do not identify a form for the reporting obligations, so that the IRS can use a specific form in the future. For now, the IRS is revising Form 1099-MISC to allow its use for reporting gross proceeds, as well as income payments. Also note, the IRS has not required separate reporting for each payment to an attorney by a payor. Thus, payors can issue an aggregate Form 1099-MISC to an attorney who received multiple payments; this places the burden on the attorney to separately identify the payments aggregated on the information form issued. The IRS recognizes this burden and has requested comments.

Effective Date

As with the previous IRS issuance, these proposed regulations are not final. The new proposed regulations are drafted to apply to payments made in the first calendar year that begins at least two months after their publication as final regulations in the Federal Register, so the new rules will not be in effect any sooner than the 2003 calendar year. Until finalized, the proposed regulations do at least provide guidance and insight into IRS intent pending issuance of final regulations.