Eight Tips for Law Firms When Filing 1099s
December 16, 2020
By Jeanne-Marie Waldman
Among the first filings of the tax season are the new Form 1099-NEC and the revised Form 1099-MISC. Not only must you avoid the common pitfalls of 1099 reporting, but you also have to be aware of the changes to these forms.
Ensuring that your firm’s Form 1099s are prepared properly will go a long way toward client satisfaction. Get a head start on the 2020 reporting season by reviewing your firm’s 2020 payments and recipient data now. Asking the right questions and confirming the essential information in advance should put you in the best position to achieve this goal. Of course, reporting the recipient’s proper name and taxpayer identification number are the prerequisites to a correct filing.
Consider whether any of the following concerns apply to a particular reporting situation:
- Make sure that all 1099 payments are actually taxable.
The Form 1099-MISC should report only payments that are taxable to the recipient. The purpose of Form 1099-MISC is to report the income that the IRS will match with the recipient’s returns. Payments not subject to income tax are not reported on a Form 1099. For example, if a litigation recovery is 100% tax-exempt due to being exclusively compensation for physical injuries, the payer is relieved from filing a Form 1099.
All payments are presumed taxable and reportable unless a specific exemption exists. One of the notable exemptions is a recovery for personal physical injuries and emotional distress emanating from those physical injuries. Read the settlement agreement and consult with counsel to determine whether the proceeds are taxable. For further general discussion on taxable litigation recoveries, read https://www.eisneramper.com/legal-disputes-tax-0719/
- Report payments on the correct form and in the correct box.
In the past, parties may have reported payments to attorneys in the wrong box on the Form 1099. Now there are two different forms on which to report attorneys’ fees, a revised Form 1099-MISC and the new Form 1099-NEC. https://www.eisneramper.com/1099-forms-changes-1220/
Report attorneys’ fees of $600 or more paid in the course of your trade or business in Box 1 of Form 1099-NEC. This category of payment includes fees that a business pays to its attorney to draft corporate documents or to defend its own lawsuit, for example.
In a settlement situation, use Box 10 (“gross proceeds paid to attorneys”) of the Form 1099-MISC to report payments to opposing counsel, such as attorneys’ fees included as part of the settlement. For example, if an insurer pays $1 million to settle a claim, that payment should appear in Box 10 of Form 1099-MISC rather than on a Form 1099-NEC.
Conversely, when the issuer makes separate payments to the attorney and the claimant, furnish Form 1099-MISC to the claimant reporting damages in Box 3 (“other income”) and provide Form 1099-MISC to the claimant’s attorney reporting gross proceeds paid in Box 10.
Payments to attorneys require Form 1099 reporting regardless of whether the law firm is an unincorporated entity—partnership or sole proprietorship—or a corporation.
- Issue the payment only if it is your responsibility.
The Form 1099-MISC issuer is the person or entity that has a significant economic interest at stake. Generally, in tort cases, it is the defendant or insurer making the payment that is responsible for the Form 1099. An attorney paying his or her own client out of an escrow account is only performing a “ministerial act” and does not issue a Form 1099.
- Issue a W-2, not a 1099, for a recovery properly characterized as wages.
Report the recovery of wages or any other employee compensation on a Form W-2. Where a litigant recovers wages, including back pay, front pay or severance pay, the payer reports the payment on a Form W-2 with the appropriate payroll taxes withheld. If the payment is reported on a Form 1099 and the IRS subsequently determines that it should have been characterized as wages, both the employee and employer may be subject to payroll tax liability, interest and penalties.
- Confirm that the 1099 Recipient is a “U.S. Person.”
Prior to issuing a Form 1099, it is incumbent upon the payer to determine whether the payee is a U.S. person. Request that the recipient complete Form W-9 or a form in the W-8 series and maintain proper documentation to protect your firm. If the recipient is a non-U.S. person, consider whether it is necessary to withhold tax and/or whether treaty exceptions affect the withholding rate.
- Include attorneys’ fees in the claimant’s Form 1099-MISC (when taxable).
The prevailing party should receive a Form 1099-MISC for 100% of the proceeds, including amounts paid to counsel as attorneys’ fees—even if the fees were paid directly to the law firm rather than directly from the client. Legal fees are gross income to the plaintiff, who reports the entire amount on his or her individual tax return unless the award or settlement itself is excluded statutorily from gross income. If the attorneys’ fees are not included in the Form 1099, the claimant will likely not realize that they are taxable and underreport the taxable recovery on his or her income tax return.
Attorneys’ fees may be deductible from the plaintiff’s adjusted gross income (“AGI”) if the claims upon which he or she ultimately prevailed meet specific statutory criteria. For example, a litigant who prevails on certain claims of employment discrimination may have a deduction to AGI for his or her attorneys’ fees. In that case, the litigant will pay tax on the net rather than the gross recovery.
- Issue a Form 1099-MISC to the litigant’s attorney when fees are awarded.
Anyone making a payment to an attorney “in connection with legal services” or in the course of a trade or business must issue a Form 1099 regardless of whether who actually retained the firm. Fund transfers to co-counsel and referral fees are also subject to 1099 reporting. Even when recoveries are non-taxable to the plaintiff, professional fees paid to attorneys are always subject to income tax and 1099 reporting.
Issuers must file attorney Form 1099s even if the law firm is a corporation, as noted above, because the corporate reporting exemption does not apply to legal service providers.
- File by the appropriate deadline: February 1, 2021, for Form 1099-NEC.
Form 1099-NEC must be filed with the IRS before the deadline of January 31, unless the due date falls on a weekend or holiday and extends to the next business day. For the 2020 reporting season, the 1099-NEC is due February 1, 2021 (January 31, 2021, is a Sunday), whether the payer uses either paper or electronic filing methods.
Distribute the recipient’s copy of both forms, 1099-NEC and 1099-MISC, by February 1, 2021.
Payers have until March 1, 2021, to file Form 1099-MISC (if filing on paper) or March 31, 2021 (if filing electronically).
We have only briefly touched on some of the issues involved in 1099 preparation. We strongly suggest that you consult with your tax advisor to discuss the particular facts of a specific situation.