The Taxpayer Relief Act of 1997 imposes new reporting requirements on certain payments made to attorneys. The primary change in law relates to "gross proceeds payments" received by attorneys, such as a lawsuit settlement paid to an attorney that includes both the clients settlement proceeds and the attorneys fee.

Present and Prior Law

The Internal Revenue Code requires information reporting by persons engaged in a trade or business that make payments in the course of that trade or business of rent, salaries, wages, or other fixed or determinable gains, profits and income. Treasury Regulations apply this rule to attorney fees paid by a trade or business. This reporting is required on Form 1099-MISC, and these provisions are still in effect.

Under prior law, gross proceeds payments, where it was not known what portion of the payment was for an attorneys fee, did not require reporting of any portion of the payment. This reporting exception is no longer available.

New Provision

The 1997 act requires reporting of gross proceeds payments to attorneys by a trade or business. It appears that this reporting will be required on Form 1099-B, which is currently used by brokers to report gross proceeds. There are limited exceptions to these new requirements for payments that must be reported on either Form 1099-MISC (payments of income) or Form W-2 (payments of wages). Similarly, salary or profits paid or distributed by a partnership to its individual partners are exempt from the new requirements because these amounts are already reported to the partners on Form K-1.

Except for these limited exceptions, the new reporting requirements apply to all payments made to attorneys in connection with legal services. These rules apply even if services are not performed for the payor. The new rules also apply regardless of whether or not the attorney is the exclusive payee of a payment. Thus, reporting is required for checks made out jointly to an attorney and client.

Payments to law firms constitute payments to attorneys under the new provision and are subject to these reporting requirements. The general exception in the Regulations exempting payments made to corporations from reporting does not apply to corporations that provide legal services.

Effect and Possible Alternative

These new reporting requirements will force payors to request taxpayer identification numbers from attorneys, and attorneys must promptly supply their taxpayer identification numbers for purposes of this information reporting. Failure to comply with these requirements can result in penalties for the attorney and require the payor to impose backup withholding on the payments.

There does appear to be an alternative to receiving Form 1099-B for the full amount of a gross proceeds payment. Congress has directed the Internal Revenue Service to administer the new requirements so that there is no overlap of reporting between payments on Form 1099-MISC and gross proceeds payments on Form 1099-B. Based on this direction, the Joint Committee on Taxation, in its explanation of the new provision, offers the following example:

"If two payments are simultaneously made to an attorney, one of which represents the attorneys fee and the second of which represents the settlement with the attorneys client, the first payment would be reported under Section 6041 [Form 1099-MISC], and the second payment would not be reported under either Section 6041 or Section 6045 [new provision requiring reporting on Form 1099-B], since it is known that the entire second payment represents the settlement with the client (and therefore no portion of it represents income to the attorney)."

This example may encourage attorneys to request that payors issue separate checks for the attorneys fees and for the clients portion of a settlement.

Purpose of Provisions

Congress believes these new provisions will have a positive impact on compliance by requiring additional information reporting. The Joint Committee on Taxation further states that addressing payments made to one profession is justified because attorneys are generally the only professionals who receive this type of payment, which includes both income and client funds. The Joint Committee estimates that this new provision will increase budget receipts by $3,000,000 to $4,000,000 per year over the next 10 years.

Effective Date

The new provision is effective for payments made after December 31, 1997. Therefore, the first information reports required under this new provision will be for the 1998 tax year.