New Tax Law Changes Affect Trial Lawyers

IN OUR JUDGMENT
Ted Smith and Terri Todd

The New Law. Under the new Internal Revenue Code Section 6045(f), which was passed last summer by Congress and signed into law by President Clinton, the method by which trial lawyers report contingent fees has been changed. The new law requires anyone in business (which includes insurance companies and corporations) who pay attorneys (that is when either the attorney’s name is on the check alone or with the attorney’s client) to report the entire amount to the I.R.S. on Form 1099. The Form 1099 is to be issued to the attorney. The attorney is then required to report the entire amount of the check on a tax return, indicating how much was the attorney’s fee and how much was distributed to others.

For example, if a case is settled for $45,000 and the attorney’s fee was one-third, under prior law, the attorney would report on the tax return a fee of $15,000. Under the new tax law, the attorney must report receipt of $45,000 and show a distribution of $30,000, leaving an adjusted gross revenue of $15,000. In most firms, the annual “gross” of settlements and verdicts collected will be substantial, some well into the millions of dollars. This gross figure will now have to be shown on the tax return for the firm or individual trial lawyer.

Some trial lawyers have already grumbled, indicating that they will continue to do what they have done in the past. That is, they will report what they always have reported: only their fee. The problem is that now, not only is there a requirement to report the gross of settlements and verdicts collected, there is a nearly fool-proof method by which the I.R.S. can determine whether an attorney is in compliance . . . the Form 1099. The I.R.S. almost always runs computer checks to compare the 1099 Forms issued to each taxpayer against the taxpayer’s return. If the amount shown on the gross sales receipt line does not equal or exceed the sum of the 1099 Forms, AUDIT! . . . which may result in underreporting issues.

Chester L. Stewart, C.P.A. summarized the new act affecting trial lawyers as follows:

1) Any person engaged in a trade or business must file an information return (Form 1099) for any payments made to an attorney even if the payment is a single amount and it is not known what portion is the attorney’s fee. Form 1099-B will be used.

2) The present exemption from reporting payments to corporations will not apply to payments made to corporations that provide legal services.

3) The provision to report applies to attorneys even if the attorney is not the exclusive payee.

4) Attorneys (or the corporation) must supply their federal identification number or their payment will be subject to the back-up withholding requirements.

Former ATLA President Howard Twiggs has stated that Congress “singled out” personal injury lawyers with this new law. Former ATLA President Larry Stewart said “the only thing this proposal will do is add another layer of paperwork”.

Despite these protests, the bill was supported by Republicans and President Clinton. Their rationale was that the change was necessary to increase lawyers’ compliance with the tax laws. Some believed that the legal profession was the only profession left that was not required to report its gross earnings. The Joint Committee on Taxation estimates that it would bring in an additional $2-3 million a year in taxes.

How to Comply. Because the law has just been enacted, there are very few regulations which chart exactly what trial lawyers will need to retain as records. Because of the uncertainty, we have started, as of the first of this year, to keep a separate file for all personal injury settlements and verdict recoveries. Contained within this file is a copy of the settlement statement for each client. On the settlement statement we have added the client’s social security number, date of birth, address and telephone number (see a sample of our settlement sheet below). Our judgment is that at the end of the year we will probably be able to claim a total deduction of all payouts from the gross receipts as opposed to detailing each one or putting them into categories. However, we wanted to be prepared just in case something more is required.