Reporting of gross-proceeds payments to attorneys.

The IRS has reissued proposed regulations under Secs. 6041 and 6045 that clarify the reporting obligation for payments to attorneys. The effective date will apply to payments made during the first calendar year that begins at least two months after the final regulations' publication date. A formal hearing was set for Sept. 30, 2002; thus a strong possibility exists that the final regulations will be issued and effective for 2003.

Sec. 6045(f) was added to the Code by Section 1021 of the Taxpayer Relief Act of 1997. It generally requires information reporting for payments of gross proceeds made in the course of a trade or business to attorneys, for legal services (whether or not the services are performed for the payor). The following briefly outlines the changes in the new proposed regulations.

Rules, Definitions and Procedures

The delivery rule under the original proposed regulations required information reporting for payments delivered to a nonpayee attorney, if, under the circumstances, the payor reasonably believed that the attorney would receive the check for legal services. The IRS and Treasury have eliminated the delivery rule, because it would place a substantial burden on payors. Thus, the proposed regulations provide that a payment made to an attorney by check means a check on which an attorney is named as a sole, joint or alternative payee.

The proposed regulations define the term "payor" under Prop. Regs. Sec. 1.6045-5(d)(3) as the person who makes a payment, if that person is an obligor on the payment or the obligor's insurer or guarantor. A payor includes a person who pays a settlement amount to an attorney of a client who has asserted a tort, contract, violation of law or workers' compensation claim against that person and the person's insurer, if the insurer pays the settlement amount to the attorney.

An exception in Sec. 6045(f)(2)(B) states that Sec. 6045(f)"shall not apply to the portion of any payment which is required to be reported under section 6041(a) (or would be so required but for the $600 limitation contained therein) or section 6051." The exception is available only if a payor has a reporting obligation under Sec. 6041 or 6051. The use of different standards under Secs. 6041 and 6045(f) for determining who is required to file and furnish an information return affects the scope of the Sec. 6045(f)(2)(B) reporting exception. The Service and Treasury believe that Congress intended for that exception to provide relief only to a person required (or would be so required, but for the dollar limit) to report payments to an attorney under Sec. 6041 or 6051.

Prop. Regs. Sec. 1.6041-1(a)(1)(ii) has been clarified to provide explicitly that the exception applies to a payment for which information returns are required under Secs. 6041(a) and 6045, for the same payee. For example, a person who pays $600 of taxable damages to a claimant and the claimant's attorney may be required to file an information return under Sec. 6041 for the claimant, and another under Sec. 6045(f) for the claimant's attorney.

The IRS agreed to implement a $600 annual threshold for reporting payments under Sec. 6045(f), similar to that under Sec. 6041.

Form 1099-MISC is used to report payments under Sec. 6045(f). Beginning in 2001, that form was revised to add a separate labeled box for reporting gross proceeds paid to attorneys. There was concern that some payors had improperly reported gross-proceeds payments in an income box on Form 1099-MISC. However, the Service noted that the proposed regulations do not specify the form to be used and could change it at some future point if the need arises.

Under the proposed regulations, payors may file either one Form 1099-MISC. that aggregates annual payments, or separate Forms 1099-MISC for each payment.

Prop. Regs. Sec. 1.6045-5(b) provides that if more than one attorney is listed as a payee on a check, the payor would be required to file an information return for the attorney who received the check (the payee-recipient rule).

The definition in the 1999 proposed regulations (Prop. Regs. Sec. 1.60455(d)(2)) of the term "legal services" as "all services performed by, or under the supervision of, an attorney," was believed by many to be too broad. The term has been redefined in Prop. Regs. Sec. 1.6045-5(d)(2) as "all services related to, or supportive of, the practice of law performed by, or under the supervision of, an attorney." Thus, payments to an attorney for services clearly unrelated to the practice of law are not subject to reporting under Sec. 6045(f).

In addition, many requested an exception to the Sec. 6045(f) information reporting requirement if the specific payment bears little or no correlation to the taxable income of an attorney or his or her client. Specifically, this includes exceptions to reporting of payments to payee attorneys who were acting as (1) settlement attorneys or title insurers in real estate trasactions, (2) executors or estate administrators (e.g., those receiving payments of life insurance proceeds), (3) trust trustees (e.g., pension plans and bankrupt estates) and (4) administrators of qualified settlement funds.

The IRS and Treasury rejected the exception approach and stated that the elimination of the delivery rule may provide a result equivalent to an exception. Many payors will be able to avoid Sec. 6045(f) reporting simply by naming an attorney's client as payee on a check, even if the check is delivered to the attorney's office. The proposed regulations provide an exception that payments made to an attorney acting as a settlement agent in a real estate closing are not subject to reporting under Sec. 6045(f).

The Service and Treasury believe that payments to attorneys for legal services are reportable under Sec. 3406(b)(3)(C) and, thus, are subject to backup withholding requirements. In addition, the legislative history of Sec. 6045(f) shows Congress specifically intended this treatment for payments to attorneys reportable under that provision.

Conclusion

The Service has taken a more practical approach in revising the proposed regulations. One of the key distinctions under the new proposed rules is that an attorney has to be named as a payee for the reporting rule to apply. There are different requirements for payors under Sec. 6041 than for payors under Sec. 6045; thus, both sets of rules should be examined to determine the appropriate reporting requirement.

FROM JOHN W. HALORAN, CPA, MBA, PKF, NEW YORK, NY