4/4/2012 IRS 1099 Reporting of Settlements and Payments to Attorneys PROGRAM PRESENTED APRIL 10, 2012 1 1
Marianne Couch, JD Cokala Tax Information Reporting Solutions, LLC PO Box 2224 Ann Arbor, MI 48106 Phone 734-629-5155 mcouch@cokala.com Marianne Couch, JD, a Principal in the Cokala tax group since its founding early in 2007, is an experienced and well-known advisor on U.S. federal and state tax information reporting compliance. She is a frequent lecturer at major tax conferences and the author of The Master Guide to Form 1099 Compliance and numerous published articles. She is a founding partner of Cokala. Previously, she was for many years the Research Director of the tax reporting specialty firm Balance Consulting, and chaired special training and advisory services provided to large organizations and academic and nonprofit institutions. She also formerly served as the executive director of the National Association of Form 1099 Filers, Inc. Marianne was an appointee for three years to the IRS Information Reporting Program Advisory Committee (IRPAC), where she was Chair of the IRPAC Subcommittee on Small Business and Self-Employed (SBSE) tax issues. In this capacity, she testified annually before the IRS Commissioner on issues of concern to the information reporting community. Marianne has previously worked as a litigator for a large Michigan law firm, where she represented individuals and large clients in many types of civil actions, and formerly served as a Research Attorney for the Michigan Court of Appeals. She received her JD, cum laude, from the Michigan State University School of Law, and is a member of the State Bar of Michigan. Cokala Tax Information Reporting Solutions, LLC PO Box 2224 Ann Arbor, MI 48106 tel. 734.629.5155 www.cokala.com
Form 1099 Tax Reporting Compliance: IRS 1099 Reporting of Settlements and Payments to Attorneys PROGRAM EVALUATION Please complete this brief evaluation, sign below, and fax it to Cokala at 734-428-0702, or scan and save it as a PFD file and email to clientservice@cokala.com. Your comments are an important part of our process of improving our training programs, and we thank you for taking the time to provide your comments. To receive CPE credits, sign and date the certification below. Your credit certificate will be mailed to you. Please circle the number that best indicates your evaluation, with 5 representing the highest evaluation, and 1 representing the lowest. 1. Were the stated learning objectives met? 2. Were the program materials relevant and sufficient to contribute to achieving the learning objectives? 3. To the best of your knowledge, were the program materials accurate? 4. Was the time allocated to the learning activity appropriate? 5. Was instructor Marianne Couch an effective instructor? 6. Was the web and audio technical service satisfactory? 7. Were facilities and/or technological equipment appropriate? 8. Were the handout materials (the PDF you received in advance) satisfactory? 9. If applicable, were prerequisites appropriate? NA 10. Do you have followup questions we should contact you about? I certify that I attended the IRS 1099 Reporting of Settlements and Payments to Attorneys program by webcast on April 10, 2012, from o clock to o clock and I wish to receive the total recommended number of CPE credit hours for this continuing education program. Signature: Thank you! COKALA Tax Information Reporting Solutions Tel. 734.629.5155 www.cokala.com
IRS 1099 Reporting of Settlements and Payments to Attorneys Marianne Couch, J.D. www.cokala.com info@cokala.com Agenda Information reports Legal damages Gross proceeds reporting Multiple 1099s The danger Getting the information you need Exceptions 2 Important Note This discussion assumes that both the claimant and the attorney/law firm are U.S. persons. The rules discussed herein do not apply to non U.S. persons. 3 1
Forms 1099 Form 1042-S Form W-2, etc. Information Reports 4 Information Reports Filed by third-parties (you) reporting payments made to recipients/service providers. In general, IRS uses information on reports to match against income reported on taxpayer's return. Dollar-for-dollar match often not possible. Forms 1099 INT, DIV, OID 5 Reportable v Taxable Usually, payments are reportable because they are taxable, but not always. Sometimes, payments are taxable, but not reportable. For example, taxable scholarship payments made to U.S. Individuals. Sometimes, payments are reportable, but possibly not taxable. For example, gross proceeds paid to attorneys, reported in box 14 of the Form 1099-MISC. 6 2
Legal Damages Paid to Claimants Reportable if taxable Not taxable: Personal physical injury or sickness Medical expense reimbursement Possibly taxable, but not reportable: Non-fixed and determinable amounts of income (i.e., property damages) Taxable payments reported to claimants in box 3 of the Form 1099-MISC. Taxable back pay = Form W-2 7 Punitive Damages Punitive damages are always reportable (box 3 of the MISC), even if the underlying claim is based on physical injury. 8 Emotional Damages/Pain and Suffering Payments to compensate for emotional damages/pain and suffering are taxable and reportable to the claimant, unless they arise from an underlying claim alleging personal physical injury. 9 3
Legal Damages Payments Payments to compensate a person for an injury. Injury can, but does not have to be, physical Defamation nonphysical Wrongful Termination nonphysical Discrimination nonphysical Wrongful death physical Breach of contract (not involving a physical injury) nonphysical Lost profits non physical, and considered determinable (so reportable) Physical injury, etc. Claim just needs to be made No court action or legal suit required. 10 Beneficial Owner Payment of legal damages to settle a claim brought by Sam Smith. Check is made payable to Sam Smith s attorney, but Sam is the beneficial owner of the income. He has assigned payment to someone else. Because Sam remains the beneficial owner, he receives a 1099, if one is required (i.e., if the damages payment constitutes taxable income to him. Because of the attorney gross proceeds reporting requirement, Sam s attorney also gets a 1099. 11 Attorney Gross Proceeds Reported in box 14 of the Form 1099-MISC $600 aggregate threshold Box 7 v Box 14 (no corporate exemption for either type of payment) If attorney/law firm performed services for your organization, report these payments in box 7 If attorney/law firm performed services for someone else, report these payments in box 14 12 4
Box 3 and Box 14 If attorney's/law firm's name is on the check, report the total amount of the check in box 14. If the legal damages payment to the claimant is taxable, you must also report this amount to the claimant in box 3 even if the claimant's name is not on the check. This means you may be issuing two (or more) Forms 1099-MISC for a single check. For example, one to the attorney, reporting the amount in box 14, and one to the claimant, reporting the amount in box 3. 13 Legal Damages Reporting and Attorney Payments Can become very complicated. Several 1099s (and maybe a W-2) may need to be issued for a single check. Need certain information to report appropriately. These payments are subject to the TIN and backup withholding requirements. If payments are for large dollar amounts, tax withholding liability will also be large and, if the appropriate information is not obtained, payer can be held liable for large sums of tax, interest, and penalties. 14 Reporting to the Claimant If taxable to claimant, payer must obtain claimant s TIN prior to payment; otherwise, it must withhold 28% from the payment. If you don t know if the payment is taxable, assume that it is, obtain the TIN and plan to report. This requirement exists even if the claimant s name is not on the check (e.g., check is made payable to claimant s attorney or law firm or trust account, etc.) For tax purposes, the claimant is the beneficial owner of the income, and will receive a 1099 reporting the payment. Note: you may not be permitted to contact the claimant directly, and may have to work through counsel to obtain the information necessary to fulfill your organization s reporting obligations. 15 5
Reporting to the Attorney The IRS has an additional reporting requirement for attorneys/law firms. Even if the payment is reportable to the attorney s client, the payment may also be reportable to the attorney/law firm. If the attorney s or law firm s name is on the check (including the attorney s or firm s trust account for the client), then it is reportable. This requirement may mean two 1099s for a single check. Remember, if taxable, is reportable to the claimant even if the claimant s name isn t on the check. If it s reportable twice, it s also subject to withholding twice. So you need the TIN of the attorney/law firm, too, prior to making the payment. 16 Reporting to the Attorney Checks made payable in care of the attorney are NOT reportable to the attorney. The amount may still be reportable to the claimant/attorney s client if the damages payment constitutes taxable income. 17 Example Check for $100,000 issued to Attorney A as a result of the physical injury claim brought by Claimant C (non-employee). Physical injury is not taxable, so no reporting to C. Attorney A s name is on check, so must report $100,000 to Attorney A in box 14. Must obtain Attorney A s TIN, or withhold $28,000. If check is made payable to attorney, individually need attorney s SSN. Should rarely occur. If check is made payable to the law firm, need law firm s EIN. 18 6
Example Check for $100,000 issued to Attorney A as a result of the discrimination claim brought by Claimant C (non- employee). Discrimination damages are taxable, so must report $100,000 to C in box 3 even though C s name is not on the check. Get C s SSN or withhold $28,000 Attorney A s name is on check, so must report $100,000 to Attorney A on separate 1099 in box 14. Must obtain Attorney A s TIN, or withhold $28,000. If check is made payable to attorney, need attorney s SSN. If check is made payable to the law firm, need law firm s EIN. 19 Example Two checks: One to former employee for $60,000 to settle wrongful discharge claim. One to employee s attorney for $40,000. $100,000 is taxable to employee and must be reported. W-2 or 1099? Depends on how the payment was characterized in the settlement agreement. If any amount is taxable back pay, that amount is treated as a wage payment reported on the W-2 and subject to wage withholding. Otherwise, report entire $100,000 to employee on the 1099 (box 3),and Need TIN, or withhold $28,000 $40,000 to the attorney on the 1099 (box 14). Need TIN or withhold $11,200. This might look like $140,000 to us, but it s not how the IRS sees it. 20 Former Employees If any part of the damages payment is identified as taxable back pay, severance, or any other kind of wage payment,, it is subject to wage withholding and is reported on the Form W-2. If amounts are specifically identified in this way, the defendant/employer is responsible for correctly reporting and withholding tax from them. 21 7
Back Pay v Lost Wages Back pay is a definitively determined amount. Usually arises in wrongful termination or discrimination claims. This is what I was paid, this is what I should have been paid, pay me the difference. Lost wages is a more amorphous term. Claimant argues it s what he could have earned had defendant not injured him/acted wrongfully. It s treated as an opportunity cost, (because of opportunity allegedly lost). 22 Example Claimant sues employer for unlawful gender discrimination. Supervisor A, a man, was paid $100,000.00. Claimant, a woman, with the same amount of education and experience, was paid $75,000. Court awards $25,000 in back pay. This amount is wages. An employer will always be involved as a party in a suit that involves back pay. 23 Example Claimant is a law student in her last year of law school and at the top of her class when she sustains an injury due to the negligent conduct of another. This injury prevents her from pursuing a legal career. She argues that, over the course of her lifetime, she would have been able to earn X number of dollars as an attorney. This amount is really lost income, but is often referred to as lost wages. No employer is a party to the suit. These amounts are not treated as wages, but reported as ordinary income (box 3 of the 1099MISC), unless the claim is based on a physical injury. 24 8
Multiple Payees If one check with multiple payees: If more than one attorney is listed, report to the attorney whose name appears on the check and to whom the check was delivered. If the check was delivered to an attorney whose name was not listed as a payee, report to the first-listed attorney (or, really, whichever attorney for whom you have tax information). If more than one claimant is listed as a payee, and the payment is reportable, report entire amount to first- listed payee (or, really, whichever claimant for whom you have tax information). This payee receives the 1099 as a nominee/middleman recipient. 25 Interest Also watch for interest charges. Interest is never reported on the Form 1099- MISC. You must parse the interest out of any payment. py Interest, if for $600 or more, is reported on Form 1099-INT, even if underlying principal is not. E.g., claim is for physical injury, so principal amount of compensation is not reportable to claimant, but interest is. 26 Punitive Damages Punitive damages are always taxable and reportable to the claimant, even if the principal amount paid to satisfy he underlying claim (e.g., claim is for personal physical injury) is not. 27 9
The Danger Because multiple 1099s, and possibly a W-2, may need to be issued, multiple withholding obligations may arise on the payment. Example: $100,000 reported to claimant and attorney. If no TIN for claimant, withhold $28,000; if no TIN for attorney, withhold another $28,000 (on the $100,000 payment). If not handled appropriately, payer becomes liable for the $56,000 in taxes, plus interest, plus penalties (likely to amount to about $112,000 when done rule of thumb: double amount of withholding to estimate total payment, including interest and penalties, due to IRS). 28 How to Get Info Use backup withholding requirement as your leverage. Someone in your organization or under contract to you (i.e., your organization s law firm) knows how the settlement is identified. No confidentiality agreements need be broken, as all you need is basic information on the type of damages: Physical injury, medical expense reimbursement, property damages. If the claim has proceeded to a court filing, unless otherwise directed by the court, filed complaints are matters of public record. Complaints include significant details about the claim. 29 How to Get Info. If push comes to shove: If you have to backup withhold 28% against the gross proceeds payment to the attorney, that amount of tax withholding will be credited to the attorney on the 1099 (box 4). However, the amount of withheld tax credited to the attorney is actually the attorney s client s money. It s all the client s money s/he is just satisfying i the obligation to pay the attorney for his or her services out of the proceeds of the claim/litigation. Ethics rules absolutely prohibit the commingling of a client s and attorney s funds. Mention commingling of funds, and state bar to the attorney if s/he is being intractable about giving you the information you need to report appropriately. May need to get your company s counsel involved at this point. 30 10
Additional Points Attorneys acting as closing agents in real estate transactions are not subject to box 14 gross proceeds reporting requirement. Attorneys appointed by the federal bankruptcy court acting as trustees are not subject to box 14 gross proceeds reporting requirement. Attorneys named as payees on checks for amounts garnisheed from an employee s wages ARE subject to box 14 reporting requirement. Get the TIN or backup withhold (e.g., use this requirement as leverage to get the information you need) 31 Additional Points Remember that if any of the damages payment constitutes taxable back pay, this amount must be reported on a Form W-2, and subjected to all applicable wage withholding, even if the employee is no longer on the employer s payroll. The standard exemptions apply to the claimant, so if the claimant is a: Corporation Tax-exempt entity Government entity No reporting is required. 32 Please fill out your evaluation form for today s program and email it to clientservice@cokala.com To receive credit, be sure to fill in the day and time and sign at the bottom of the evaluation form. 33 11
Questions? Q uestions Q? Questions? Questions? 34 Any tax advice included in this written or electronic communication was not intended or written to be used, and it cannot be used by the taxpayer, for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency. 35 12