With tax season nearly upon us, many lawyers are now asking themselves (and their CPAs) whether they have accurately reported funds received on a client’s behalf. This issue is particularly relevant to attorneys who earn their fees on a contingency basis and who withdraw fees and costs from a check made payable to the law firm in trust for the client. In this article, we hope to provide some answers.
In addition to the $600.00 rule, anyone making a payment to an attorney in “connection with legal services,” or in the course of business must issue a 1099, regardless of whether the legal services were performed for the payor. IRC § 6045. This includes, for example, payments by attorneys to other attorneys for co-counsel, fee splitting, or referral fees. This rule also applies to client settlements paid by the defendant or the defendant’s insurer to an attorney and plaintiff jointly.
Whether the payor (here, the defendant or the defendant’s insurer) is required to issue a 1099 under these circumstances depends partly on whether the settlement proceeds are taxable or nontaxable to the claimant (here, the plaintiff).
Taxable v. Nontaxable
Consequently, defendants issuing a settlement payment, or insurance companies issuing a settlement payment on behalf of the defendant, are required to issue a 1099 to the plaintiff unless the settlement qualifies for one of the tax exceptions. See IRC § 6041. In some cases, a tax provision in the settlement agreement characterizing the payments can result in their exclusion from income. Although tax provisions are not controlling, the IRS is generally reluctant to override the intent of the parties. Accordingly, any settlement payments made expressly for nontaxable damages are excluded from the 1099 reporting requirements.
On the other hand, if the settlement agreement is silent as to whether the damages are taxable, the IRS will look to the “intent of the payor” to characterize the payments and determine the 1099 reporting requirements.
Attorney or Client?
About the authors:
James Hastings is a San Francisco tax lawyer and CPA specializing in tax planning, tax compliance, and tax controversy. His practice includes advising high net worth families; complex tax preparation services; and tax consulting with respect to business and estate transactions.
Eric L. Toscano is a San Francisco-based trial lawyer passionate about representing tenants in disputes with landlords and individuals who have been injured. He is the Managing Attorney at Toscano Law Group, where he represents tenants in disputes arising out of wrongful evictions, harassment by landlords, and substandard living conditions; individuals who have suffered personal injuries; and businesses involved in commercial disputes.