Articles & Alerts
1099 Reporting for the Legal Industry – Navigating the Complexities
Justine Jones, CPA, Senior Tax Manager
1099 reporting is never easy for the business community at large, but the legal industry has its own set of unique challenges. In response to these challenges, the IRS has provided guidance in the form of audit technique guides to help navigate those issues unique to the legal industry. Unfortunately, the complex 1099 reporting requirements for legal services and settlements have still left much confusion. So, it is critically important to understand the issues for successful navigation of the following 1099 reporting requirements:
Why is 1099 reporting required?
1099 reporting is a critical component of the U.S. tax system. 1099 reporting serves a crucial role in income reporting and documents deductions, among other tax compliance functions. These forms serve as a major source of information for the IRS and state tax authorities.
Lawyers and law firms receive and send more 1099s than most businesses due to the extensive reporting requirements specific to the legal industry. The handling of client funds including settlements by firms, often involving significant amounts, also attracts greater scrutiny.
1099-MISC versus 1099-NEC
In 2020, Treasury introduced the 1099-NEC in an attempt to clear up confusion surrounding the 1099-MISC and self-employment income reporting. The general use of each form is outlined below as it applies to legal services:
- 1099-MISC – Use this form if your business is paying another lawyer or law firm for items such as taxable damages (box 3) or settlement proceeds (box 10) in a legal dispute. Note: The amount reported in either box should not be reduced by attorney’s fees. The deductibility of attorney fees is a separate discussion beyond the scope of this article, but often, the deductibility of an item is predicated upon the issuance of a 1099. Additionally, while box 3 indicates taxable income, box 10 is more informational as it represents gross proceeds, not necessarily taxable income.
- 1099-NEC – Use this form if your business is paying an attorney or law firm for its legal services provided to you. This includes co-counsel arrangements, fee splitting, or expert witness fees.
Who is responsible for reporting?
A key reason for the overreporting of Forms 1099 is that the IRS is unlikely to penalize anyone for issuing more 1099s than required. Generally, the defendant (whether person or, entity) or its insurer, not the plaintiff’s attorney, is responsible for determining whether payments are taxable and need to be reported on a 1099. All payments are presumed reportable on a 1099 unless a specific taxability exemption applies, e.g. – physical injuries. Given that law firms are often intermediaries of legal settlement payments, some possibility of being considered the payor exists and may not always be clear in either the guidelines or, regulations. The tax regulations are not incredibly clear in defining the oversight and management functions that would make the law firm the payor. Thus, many tax advisors look to be conservative and advise that a 1099 be issued when in doubt, especially in cases where it is uncertain to the defendant if, and to whom, the 1099 will be issued and unless there is a clear exemption from taxability. If duplication does occur, then it can always be corrected via subtraction on the recipient’s return rather than the issuance of a corrected 1099.
Despite IRS guidance, Form 1099 reporting challenges persist due to the intricate requirements for the legal industry. Special attention to these reporting intricacies is essential for successful tax compliance and record keeping. Law firms should work with practitioners to strategically navigate the Form 1099 reporting nuances and uncertainties.
For more information on 1099 Reporting, please contact Steve Lando, Co-leader – Law Firm Group, at [email protected], or your Anchin Relationship Partner.
As Seen in Anchin’s Law Firm Year-End Planning Guide: