4/4/2012. IRS 1099 Reporting of Settlements and Payments to Attorneys

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Marianne Couch, JD

Cokala Tax Information Reporting Solutions, LLC

PO Box 2224

Ann Arbor, MI 48106

Phone 734-629-5155

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

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Form 1099 Tax Reporting Compliance:

IRS 1099 Reporting of Settlements and Payments to Attorneys

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COKALA Tax Information Reporting Solutions

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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

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IRS 1099 Reporting of

Settlements

Settlements and

and Payments to Attorneys

Payments to Attorneys

Marianne Couch J D

Marianne Couch, J.D.

www.cokala.com

Agenda



Information

Information reports

reports



Legal damages



Gross proceeds reporting



Multiple 1099s



The danger



Getting the information you need



Exceptions

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



The rules discussed herein do not apply to

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2 Information Reports

Information Reports

 

Forms 1099

 

Form 1042

Form 1042--SS



Form W

Form W--2, etc.

2, etc.

Information Reports



Filed by third

Filed by third--parties (you) reporting

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

Dollar--for

for--dollar match often not possible.

dollar match often not possible.



Forms 1099 INT, DIV, OID

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

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Legal Damages Paid to

Claimants



 Reportable if taxableReportable if taxable 

 Not taxable:Not taxable: 

 Personal physical injury or sicknessPersonal physical injury or sickness 

 Medical expense Medical expense reimbursementreimbursement 

 Possibly taxable, but not reportable:Possibly taxable, but not reportable:

y p



 NonNon--fixed and determinable amounts of income (i.e., property fixed and determinable amounts of income (i.e., property damages)

damages) 

 Taxable payments reported Taxable payments reported to claimants in to claimants in box 3 of the box 3 of the

Form 1099 Form 1099--MISC.MISC.



 Taxable Taxable back payback pay == Form WForm W--22

Punitive Damages



Punitive damages are always reportable (box 3

of the MISC), even if the underlying claim is

based on physical injury.

Emotional Damages/Pain and

Suffering



Payments to compensate for emotional

damages/pain and suffering are taxable and

reportable to the claimant,

reportable to the claimant, unless they arise

unless they arise

from an underlying claim alleging personal

physical injury.

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4 Legal Damages Payments

Legal Damages Payments



 Payments to compensate a person for an “injury.”Payments to compensate a person for an “injury.” 

Injury can, but does not have to be, physicalInjury can, but does not have to be, physical 

 Defamation Defamation –– nonphysicalnonphysical 

 Wrongful Termination Wrongful Termination –– nonphysicalnonphysical 

 Discrimination Discrimination –– nonphysicalnonphysical W f l d h

W f l d h h i lh i l



 Wrongful death Wrongful death –– physicalphysical 

 Breach of contract (not involving a physical injury) Breach of contract (not involving a physical injury) –– nonphysical

nonphysical 

 Lost profits Lost profits –– non physical, and considered determinable (so non physical, and considered determinable (so reportable)

reportable) 

 Physical injury, etc.Physical injury, etc. 

 Claim just needs to be Claim just needs to be made made 

No court action or legal suit required.No court action or legal suit required.

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



He has assigned payment to someone else.



Because Sam remains the beneficial owner, he

receives a 1099, if one is

receives a 1099, if one is required (i.e., if the

required (i.e., if the

damages payment constitutes taxable income to

him.



Because of the attorney gross proceeds reporting

requirement, Sam’s attorney

requirement, Sam’s attorney also gets

also gets a 1099.

a 1099.

Attorney Gross Proceeds



Reported in box 14 of the Form 1099

Reported in box 14 of the Form 1099--MISC

MISC



$600 aggregate

$600 aggregate threshold

threshold



Box 7 v Box

Box 7 v Box 14 (no corporate exemption for

14 (no corporate exemption for

ith t

f

t)

ith t

f

t)

either type of payment)



If attorney/law firm performed services for your

organization, report these payments in box 7



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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

the claimant in box 3 –– even if the claimant's

even if the claimant's

name is not on the check.



This means you may be issuing two (or more)

Forms 1099

Forms 1099--MISC for a single check.

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.

Legal Damages Reporting and

Attorney Payments



Can become very complicated.



Several 1099s (and maybe a WSeveral 1099s (and maybe a W--2) may need to be issued 2) may need to be issued

for a single check. 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,

appropriate information is not obtained, payer

payer can

can

be held liable for large sums of tax, interest, and

penalties.

Reporting to the Claimant



 If taxable to claimant, If taxable to claimant, payer payer must obtain claimant’s must obtain claimant’s TIN prior to TIN prior to payment;

payment; otherwise, it must withhold 28% from the 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 If you don’t know if the payment is taxable, assume that it is, obtain the

TIN and plan to report. TIN and plan to report. 

 This requirement exists This requirement exists even if the claimant’s name is not on the even if the claimant’s name is not on the check

check (e g check is made payable to claimant’s attorney or law (e g check is made payable to claimant’s attorney or law check

check (e.g., check is made payable to claimant s attorney or law (e.g., check is made payable to claimant s attorney or law firm or trust account, etc.)

firm or trust account, etc.) 

 For tax purposes, the claimant is the beneficial owner of the For tax purposes, the claimant is the beneficial owner of the income, and will receive a 1099 reporting the payment income, and will receive a 1099 reporting the payment.. 

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6 Reporting to the Attorney

Reporting to the Attorney



 The IRS has an additional reporting requirement for The IRS has an additional reporting requirement for attorneys/law firms.

attorneys/law firms. 

 Even if the payment is reportable to the attorney’s client, the Even if the payment is reportable to the attorney’s client, the payment may also be reportable to the

payment may also be reportable to the attorney/law firm.attorney/law firm. 

If the If the attorney’s or law firm’s attorney’s or law firm’s name is on the check (including name is on the check (including the

the attorney’s or firm’s attorney’s or firm’s trust account for the client), then it is trust account for the client), then it is

yy ))

reportable. reportable. 

 This requirement may mean two 1099s for a single check.This requirement may mean two 1099s for a single check. 

Remember, if taxable, is reportable to the claimant even if the Remember, if taxable, is reportable to the claimant even if the claimant’s name isn’t on the check.

claimant’s name isn’t on the check. 

 If it’s reportable twice, it’s also subject to withholding twice.If it’s reportable twice, it’s also subject to withholding twice. 

So you need the TIN of the attorney/law firm, So you need the TIN of the attorney/law firm, too, prior to too, prior to making the payment.

making the payment.

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

claimant/attorney s client if the damages

payment constitutes taxable income.

Example



Check for $100,000 issued to Attorney A as a result

of the physical injury claim brought by Claimant C

(non

(non--employee).

employee).



Physical injury is not taxable, so no reporting to C.



Attorney A’s name is on check, so must report

y

,

p

y

,

p

$100,000 to Attorney A in box 14.



Must obtain Attorney A’s TIN, or withhold

$28,000.



If check is made payable to attorneyIf check is made payable to attorney, individually , individually need need attorney’s SSN

attorney’s SSN..



Should rarely occur.Should rarely occur. 

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Example



 Check for $100,000 issued to Attorney A as a result of Check for $100,000 issued to Attorney A as a result of

the discrimination claim brought by Claimant C (non the discrimination claim brought by Claimant C (non--employee).

employee).



 Discrimination damages are taxable, so must report Discrimination damages are taxable, so must report

$100,000 to C in box 3 even though C’s name is not on $100,000 to C in box 3 even though C’s name is not on

the check. the check.



Get C’s SSN or withhold $28,000Get C’s SSN or withhold $28,000 

 Attorney A’s name is on check, so must report $100,000 Attorney A’s name is on check, so must report $100,000

to Attorney A on separate 1099 in box 14. to Attorney A on separate 1099 in box 14.



 Must obtain Attorney A’s TIN, or withhold $28,000.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 attorney, need attorney’s SSN. 

If check is made payable to the law firm, need If check is made payable to the law firm, need law law firm’s EIN.firm’s EIN.

Example



 Two checks:Two checks: 

One to former employee for $60,000 to settle wrongful One to former employee for $60,000 to settle wrongful discharge claim.

discharge claim. 

One to employee’s attorney for $40,000.One to employee’s attorney for $40,000. 

 $100,000 is taxable to employee and must be reported.$100,000 is taxable to employee and must be reported. 

WW--2 or 1099?2 or 1099?



Depends on how the payment was characterized in the settlement Depends on how the payment was characterized in the settlement

agreement. agreement.



If any amount is taxable If any amount is taxable back pay back pay that amount is treated as a that amount is treated as a



If any amount is taxable If any amount is taxable back pay, back pay, that amount is treated as a that amount is treated as a

wage payment reported on the W

wage payment reported on the W--2 and subject to wage 2 and subject to wage withholding.

withholding.



Otherwise, report entire $100,000 to employee on the 1099 (box Otherwise, report entire $100,000 to employee on the 1099 (box

3),and 3),and



Need TIN, or withhold $28,000Need TIN, or withhold $28,000



 $40,000 to the attorney on the 1099 (box 14).$40,000 to the attorney on the 1099 (box 14). 

Need TIN or withhold $11,200.Need TIN or withhold $11,200. 

 This might look like $140,000 to us, but it’s not how the This might look like $140,000 to us, but it’s not how the

IRS sees it. IRS sees it.

Former Employees



If any part of the damages payment is

identified as

identified as taxable

taxable back pay,

back pay, severance, or any

severance, or any

other kind of wage payment

other kind of wage payment, it is subject to

, it is subject to

wage withholding and is reported on the

Form W

Form W--2.

2.



If amounts are specifically identified in this

way, the defendant/employer is responsible

for correctly reporting and withholding tax

from them.

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8 Back Pay v Lost Wages

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 “This is what I was paid, this is what I should have been

p , p , paid, pay me the difference.” paid, pay me the difference.” 



Lost wages is a more amorphous term.



Claimant argues it’s what he

Claimant argues it’s what he could have

could have earned had

earned had

defendant not injured him/acted wrongfully.



It’s treated as an “opportunity cost,” (because of It’s treated as an “opportunity cost,” (because of

opportunity allegedly lost). opportunity allegedly lost).

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



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.

Example



 Claimant is a law student in her last year of law school and at 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 the top of her class when she sustains an injury due to the negligent conduct of another.

negligent conduct of another. 

 This injury prevents her from pursuing a legal career.This injury prevents her from pursuing a legal career. 

 She argues that, over the course of her lifetime, she would She argues that, over the course of her lifetime, she would have been able to earn X number of dollars as an attorney have been able to earn X number of dollars as an attorney

have been able to earn X number of dollars as an attorney. have been able to earn X number of dollars as an attorney. 

 This amount is really lost income, but is often referred to as This amount is really lost income, but is often referred to as lost wages.

lost wages. 

 No employer is a party to the suit.No employer is a party to the suit. 

 These amounts are not treated as wages, but reported as These amounts are not treated as wages, but reported as ordinary income (box 3 of the 1099MISC), unless the claim is ordinary income (box 3 of the 1099MISC), unless the claim is based on a physical injury.

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Multiple Payees



If one check with multiple payees:



If more than one attorney is listed, report to the If more than one attorney is listed, report to the

attorney whose name appears on the check and to attorney whose name appears on the check and to whom the check was delivered.

whom the check was delivered.



If the check was delivered to an attorney whose name If the check was delivered to an attorney whose name

li d h fi li d h fi li d li d

was not listed as a payee, report to the first was not listed as a payee, report to the first--listed listed attorney (or, really, whichever attorney for whom you attorney (or, really, whichever attorney for whom you have tax information).

have tax information).



If more than one claimant is listed as a payee, and the If more than one claimant is listed as a payee, and the

payment is reportable, report entire amount to first payment is reportable, report entire amount to first--listed payee (or, really, whichever claimant for whom listed payee (or, really, whichever claimant for whom you have tax information).

you have tax information).



This payee receives the 1099 as a nominee/middleman recipient.This payee receives the 1099 as a nominee/middleman recipient.

Interest



Also watch for interest charges.



Interest is never reported on the Form 1099

Interest is never reported on the Form

1099--MISC.

MISC.



You must “parse” the interest out of any

payment.

p y



Interest, if for $600 or more, is reported on

Form 1099

Form 1099--INT, even if underlying principal

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.

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

underlying claim (e.g., claim is for personal

physical injury) is not.

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10 The Danger

The Danger



Because multiple 1099s, and possibly a W

Because multiple 1099s, and possibly a W--2, may

2, may

need to be issued, multiple withholding obligations

may arise on the payment.



Example: $100,000 reported to claimant and attorney. Example: $100,000 reported to claimant and attorney.

If no TIN for claimant, withhold $28,000; if no TIN for If no TIN for claimant, withhold $28,000; if no TIN for attorney, withhold another $28,000 (on the $100,000 attorney, withhold another $28,000 (on the $100,000

payment). payment). 



If not handled appropriately,

If not handled appropriately, payer

payer becomes liable

becomes liable

for the $56,000 in taxes, plus interest, plus penalties

(likely to amount to about $112,000 when done

(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).

How to Get Info



 Use backup withholding requirement as your leverage.Use backup withholding requirement as your leverage. 

 Someone in your organization or under contract to you Someone in your organization or under contract to you

(i.e., your organization’s law firm) knows how the (i.e., your organization’s law firm) knows how the settlement is identified.

settlement is identified.



 No confidentiality agreements need be broken, as all you No confidentiality agreements need be broken, as all you

need is basic information on the type of damages: need is basic information on the type of damages:



Physical injury, medical expense reimbursement, Physical injury, medical expense reimbursement,

property damages. property damages.



 If the claim has proceeded to a court filing, unless If the claim has proceeded to a court filing, unless

otherwise directed by the court, filed complaints are otherwise directed by the court, filed complaints are matters of public record.

matters of public record.



Complaints Complaints include significant details about the claim.include significant details about the claim.

How to Get Info.



 If push comes to shove:If push comes to shove: 

If you have to backup withhold 28% against the gross proceeds If you have to backup withhold 28% against the gross proceeds payment to the attorney, that amount of tax withholding will payment to the attorney, that amount of tax withholding will be credited to the attorney on the 1099 (box 4).

be credited to the attorney on the 1099 (box 4). 

However, the amount of withheld tax credited to the attorney However, the amount of withheld tax credited to the attorney is actually the attorney’s client’s money.

is actually the attorney’s client’s money. It’ ll th li t’

It’ ll th li t’ /h i j t ti f i th bli ti t /h i j t ti f i th bli ti t



It’s all the client’s money It’s all the client’s money –– s/he is just satisfying the obligation to pay s/he is just satisfying the obligation to pay

the attorney for his or her services out of the proceeds of the the attorney for his or her services out of the proceeds of the claim/litigation.

claim/litigation. 

Ethics rules absolutely prohibit the commingling of a client’s Ethics rules absolutely prohibit the commingling of a client’s and attorney’s funds.

and attorney’s funds. 

Mention “commingling of funds,” and “state bar” to the Mention “commingling of funds,” and “state bar” to the attorney if s/he is being intractable about giving you the attorney if s/he is being intractable about giving you the information you need to report appropriately. information you need to report appropriately. 

(14)

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

d

i

d

i

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 Get the TIN or backup withhold (e.g., use this

requirement as leverage to get the information you requirement as leverage to get the information you need

need))

Additional Points



 Remember that if any of the damages payment Remember that if any of the damages payment

constitutes taxable back pay, this amount must be constitutes taxable back pay, this amount must be reported on a Form W

reported on a Form W--2, and subjected to all applicable 2, and subjected to all applicable wage withholding, even if the employee is no longer on wage withholding, even if the employee is no longer on the employer’s payroll

the employer’s payroll the employer s payroll. the employer s payroll.



 The “standard” exemptions apply to the claimant, so if The “standard” exemptions apply to the claimant, so if

the claimant is a: the claimant is a:



CorporationCorporation 

TaxTax--exempt entityexempt entity 

Government entityGovernment entity 

 No reporting is required.No reporting is required.

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