[Federal Register Volume 67, Number 96 (Friday, May 17, 2002)]
[Proposed Rules]
[Pages 35064-35070]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-12464]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-126024-01]
RIN 1545-AW72


Reporting of Gross Proceeds Payments to Attorneys

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the 
reporting of payments of gross proceeds to attorneys. The regulations 
reflect changes to the law made by the Taxpayer Relief Act of 1997 
(1997 Act). The regulations will affect attorneys who receive payments 
of gross proceeds on behalf of their clients and certain payors (for 
example, defendants in lawsuits and their insurance companies and 
agents) that, in the course of their trades or businesses, make 
payments to these attorneys. This document also provides notice of a 
public hearing on these proposed regulations.

DATES: Written and electronic comments must be received by August 15, 
2002. Requests to speak (with outlines of topics to be discussed) at 
the public hearing scheduled for September 30, 2002, at 10 a.m., must 
be received by September 9, 2002.

ADDRESSES: Send submissions to: CC:ITA:RU (REG-126024-01), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered Monday through Friday 
between the hours of 8 a.m. and 5 p.m. to: CC:ITA:RU (REG-126024-01), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, 
NW., Washington, DC. Alternatively, taxpayers may submit comments 
electronically by submitting comments directly to the IRS Internet site 
at www.irs.gov/regs. The public hearing will be held in the Auditorium 
on the Seventh Floor of the Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Nancy Rose (202) 622-4910; concerning submissions of comments, the 
hearing, and/or to be placed on the building access list to attend the 
hearing, Treena Garrett at (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been reviewed and approved by the Office of Management 
and Budget in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)) under control number 1545-1644.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid OMB control number assigned by the Office 
of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR Part 1) under sections 6041 and 6045 of the 
Internal Revenue Code (Code). These proposed amendments to the Income 
Tax Regulations would (a) revise existing Sec. 1.6041-1 and 1.6041-3 
and (b) add a new Sec. 1.6045-5.
    A new reporting requirement, section 6045(f), was added to the Code 
by section 1021 of the Taxpayer Relief Act of 1997 (1997-4 (Vol. 1) 
C.B. 1, 136). Section 6045(f) generally requires information reporting 
for payments of gross proceeds made in the course of a trade or 
business to attorneys in connection with legal services (whether or not 
the services are performed for the payor). No information return is 
required under section 6045(f) for the portion of any payment that is 
required to be reported under section 6041(a) (or that would be 
required to be reported under section 6041 but for the $600 limitation) 
or under section 6051. The 1997 Act also provides that the general 
exception in Sec. 1.6041-3(q)(1) for reporting payments made to 
corporations does not apply to payments of attorneys' fees.
    Proposed regulations under sections 6041 and 6045(f) were 
previously published in the Federal Register on May 21, 1999 (64 FR 
27730)(the 1999 proposed regulations). Many individuals and 
organizations provided written comments on the 1999 proposed 
regulations. Several individuals spoke at a public hearing held on 
September 22, 1999.
    After considering all of the comments, the IRS and the Treasury 
Department have decided to amend and repropose the regulations under 
sections 6041 and 6045(f), incorporating the guidance in the 1999 
proposed regulations with some modifications. All comments received in 
connection with the 1999 proposed regulations will continue to be 
considered in finalizing these reproposed regulations (the proposed 
regulations). The IRS and the Treasury Department welcome any 
additional comments from taxpayers on the issues discussed below or on 
other issues relating to section 6045(f).

Explanation of Revisions

Delivery Rule

    Section 1.6045-5(b)(1) of the 1999 proposed regulations (the 
delivery rule) elicited numerous comments. The delivery rule required 
information reporting of payments delivered to a nonpayee attorney, if 
under the circumstances, it was reasonable for the payor to believe 
that the attorney received the check in connection with legal services. 
Most of the comments urged the IRS and the Treasury Department to 
eliminate the delivery rule for a variety of reasons.
    First, commentators suggested that the benefits the IRS would 
derive from receiving information regarding payments of gross proceeds 
to nonpayee attorneys would be outweighed by the burdens payors would 
encounter in collecting and reporting that information. Several 
commentators stated that their automated information collection and 
processing systems cannot prepare returns for nonpayee recipients. 
Consequently, they would incur substantial costs to accommodate 
reporting to nonpayee attorneys, either by modifying those systems or 
by manually preparing information returns for nonpayee attorneys.
    Second, commentators stated that the delivery rule creates the 
potential for unintentional noncompliance because

[[Page 35065]]

the department of a payor's business that delivers checks to nonpayee 
attorneys is separate from, and may be in a different location from, 
the department that prepares the information returns. Due to this 
business structure, the reporting department may not receive the 
required information from the delivery department.
    Other commentators stated that the delivery rule unnecessarily 
complicates the requirement to backup withhold on payments made to an 
attorney who does not provide a taxpayer identification number (TIN). 
Many commentators also argued that delivering a check to a nonpayee 
does not constitute ``making a payment'' to that person under section 
6045(f) or other information reporting provisions of the Code.
    Due to the substantial burdens that the delivery rule would impose 
on payors, the IRS and the Treasury Department have adopted the 
suggestion to eliminate it. Thus, the proposed regulations provide that 
a payment to an attorney, in the case of a payment by check, means a 
check on which the attorney is named as a sole, joint, or alternative 
payee.

Identity of the Payor

    Several commentators suggested that the proposed regulations define 
the term ``payor'' under section 6045(f). Specifically, these 
commentators suggested that the section 6041(a) payor standard should 
also be used under section 6045(f), principally for three reasons. 
First, the language in both Code sections regarding who is required to 
report is virtually identical, that is, a person engaged in a trade or 
business and making payments in the course of that trade or business. 
Second, using different standards could lead to confusion. Third, 
commentators from the banking and mortgage lending industry were 
concerned that they would incur substantial costs of reporting payments 
made to lawyer-owned title insurance companies and settlement attorneys 
unless the regulations under section 6045(f) adopted the section 
6041(a) payor standard.
    The IRS and the Treasury Department agree that defining the term 
payor would be helpful. The proposed regulations define a payor as a 
person who makes a payment if that person is an obligor on the payment, 
or the obligor's insurer or guarantor. For example, a payor includes 
(a) a person who pays a settlement amount to an attorney of a client 
who has asserted a tort, contract, violation of law, or workers' 
compensation claim against that person; and (b) the person's insurer if 
the insurer pays the settlement amount to the attorney.
    The IRS and the Treasury Department believe that the payor 
standards under sections 6041 and 6045(f) should not be identical 
because the nature and the purpose of the reporting requirements under 
each Code section are different. The legislative history of the 1997 
Act, describing the law regarding information reporting of payments to 
attorneys before enactment of section 6045(f), states that if ``the 
payment [to the attorney] is a gross amount and it is not known what 
portion is the attorney's fee, no reporting is required on any portion 
of the payment.'' H.R. Rep. No. 148, 105th Cong., 1st Sess. 474 (1997). 
The Committee Report then states that section 6045(f) ``will have a 
positive impact on compliance with the tax laws by requiring additional 
information reporting.'' H.R. Rep. No. 148, at 474 (1997). A specific 
concern was that there was no reporting by payors (and underreporting 
by recipients) of payments of judgments and settlements made by 
insurance companies to attorneys that yielded large legal fees. See 
Department of the Treasury, General Explanations of the 
Administration's Revenue Proposals 86 (February 1997).
    The additional reporting that Congress contemplated, and about 
which the Treasury Department was concerned, will not occur if the 
section 6041 payor standard is used under section 6045(f). Generally 
under section 6041, a person who makes a payment on behalf of a third 
person reports the payment only if the first person exercises 
management or oversight in connection with, or has a significant 
economic interest in, the payment. See Rev. Rul. 93-70 (1993-2 C.B. 
294). Under the proposed section 6041 middleman regulations published 
in the Federal Register on October 17, 2000 (65 FR 61292), a defendant 
or its insurer that pays tort damages to a claimant's attorney 
generally does not exercise management or oversight in connection with, 
or have a significant economic interest in, the payment to the 
attorney. The preamble to those proposed regulations explains that 
neither the defendant nor the insurer is required to file an 
information return under section 6041(a) for the payment made to the 
attorney. 65 FR 61293-61294. If the section 6041 middleman rules were 
used under section 6045(f), the defendant and the insurer would not be 
required to report the payments to the attorney under section 6045(f) 
either. The large payments by insurers to attorneys in judgments and 
settlements would go unreported by any payor, as was the case prior to 
the enactment of section 6045(f). The IRS and the Treasury Department 
believe that Congress did not intend this result. Thus, the suggestion 
to use the section 6041 payor standard for section 6045(f) has not been 
adopted.

Scope of the Section 6045(f)(2)(B) Exception

    Section 6045(f)(2)(B) states that section 6045(f) ``shall not apply 
to the portion of any payment that is required to be reported under 
section 6041(a) (or would be so required but for the $600 limitation 
contained therein) or section 6051.'' The use of different standards 
under sections 6041 and 6045(f) for determining who is required to file 
and furnish an information return affects the scope of the exception to 
reporting in section 6045(f)(2)(B). For example, assume that a 
defendant's insurer, to settle a claimant's lawsuit for taxable 
damages, wrote a check for $100,000 jointly to the claimant and the 
claimant's attorney and that the insurer knew that the attorney's fees 
were $40,000. Under section 6045(f), the insurer is required to report 
the $100,000 payment to the attorney. The exception in section 
6045(f)(2)(B) does not apply because the insurer has no information 
reporting obligation under section 6041 with respect to the payment to 
the attorney.
    Some commentators suggested a very broad reading of the exception 
to reporting contained in section 6045(f)(2)(B). Under the approach 
suggested by these commentators, this exception would apply if the 
payment to the attorney is subject to reporting under section 6041 or 
section 6051 by any person. For example, under this view, if a claimant 
in a lawsuit is required to report under section 6041 the portion of a 
damage award that his attorney retained as a contingent fee, then the 
defendant's insurance company, which paid those damages to the 
claimant's attorney, would not report the payment under section 
6045(f). The IRS and the Treasury Department believe, however, that 
Congress intended the exception in section 6045(f)(2)(B) to provide 
relief only to the person who is required (or would be so required but 
for the dollar limitation) to report the payment to the attorney under 
section 6041 or section 6051. First, a payor is best able to determine 
whether it is required to report a payment based on its relationship to 
the payment rather than that of an unrelated (and possibly adversarial) 
third party. Second, requiring a payor to determine whether

[[Page 35066]]

a third party is required to report a payment could introduce 
inconsistency into the reporting process if the payor and the third 
party disagree on whether the third party is required to report a 
payment under section 6041 or section 6051.
    On a related matter, one commentator noted that some practitioners 
believe that if a payment (or portion of a payment) is reportable under 
section 6045(f), then under Sec. 1.6041-1(a)(1)(ii) it is not subject 
to reporting under section 6041 with respect to another payee. This 
view contradicts Congress' purpose in enacting section 6045(f), which 
is to ``have a positive impact on compliance with tax laws by requiring 
additional information reporting.'' H.R. Rep. No. 148, at 474 (1997). 
Therefore, Sec. 1.6041-1(a)(1)(ii) has been clarified to provide 
explicitly that the exception applies to a payment with respect to 
which information returns are required under section 6041(a) and 
another Code section (e.g., section 6045) for the same payee. For 
example, a person who pays $600 of taxable damages to a claimant and 
the claimant's attorney may be required to file an information return 
under section 6041 with respect to the claimant and another information 
return under section 6045(f) with respect to the claimant's attorney.

De Minimis Payments

    Many commentators suggested that the statutory $600 annual 
threshold for reporting payments under section 6041 should also apply 
under section 6045(f). Many payors who are required to report payments 
under section 6045(f) also are required to report payments under 
section 6041. In many cases, payments under both Code sections are 
reported on Forms 1099-MISC. Commentators stressed that payors would 
incur substantial costs to report payments that aggregated less than 
$600 annually, because they would have to either modify their automated 
processing systems or manually prepare returns reporting these 
payments. They argued that this burden far outweighs any benefit to be 
derived from collecting information for the relatively few payments 
made to attorneys that do not aggregate at least $600 during a calendar 
year. In light of these circumstances, the proposed regulations adopt a 
$600 annual reporting threshold because such a threshold strikes a 
reasonable balance between the objectives of section 6045(f) and the 
potential burden of compliance.

Form 1099-MISC and Payee Statement

    Most commentators approved of using Form 1099-MISC to report 
payments under section 6045(f) because their existing automated 
information processing systems are programmed to complete this form. 
However, a few commentators suggested that, because Form 1099-MISC is 
used to report income payments, it should not be used to report 
payments of gross proceeds. Some of these commentators also noted that 
some payors had improperly reported gross proceeds payments in an 
income box on Form 1099-MISC.
    Beginning in 2001, the Form 1099-MISC was revised to add a separate 
and distinctly labeled box for reporting gross proceeds payments made 
to attorneys. Therefore, payments under section 6045(f) will continue 
to be reported on Form 1099-MISC. However, so that the IRS can easily 
change to another form if the need arises, the proposed regulations do 
not specify the form to be used.

Separate or Aggregate Reporting

    Some commentators believed that, for each reportable payment under 
section 6045(f), payors should be required to file and furnish a 
separate Form 1099 listing the name of the attorney's client. These 
commentators were concerned that attorneys would have difficulty 
reconciling payee statements containing aggregate annual payments with 
their other records, an exercise that might be necessary if their 
income tax returns were examined by the IRS. However, other 
commentators asserted that requiring such detailed payee statements 
would impose an enormous burden on payors. These commentators urged 
that providing such detailed information should be voluntary, and noted 
that many payors provide such information to payees upon request. On 
balance, the IRS and the Treasury Department believe that the potential 
burden on payors that would result if separate payee statements were 
made mandatory outweighs the potential benefit of such statements to 
payees. Accordingly, under the proposed regulations, payors may file 
either one Form 1099-MISC that aggregates annual payments or separate 
Forms 1099-MISC for each payment. However, further comments on this 
question are welcome.

Joint or Multiple Payees

    Section 1.6045-5(b)(2)(i) of the 1999 proposed regulations provided 
that if more than one attorney is listed as a payee on a check, the 
information return is required to be filed with respect to the attorney 
who received the check (the payee-recipient rule). For some of the same 
reasons that the delivery rule was criticized, several commentators 
suggested that if more than one attorney's name is listed on a check, 
the payor should be required to issue an information return with 
respect to the first-listed attorney (the first-listed rule). In 
addition, one commentator suggested that where joint or multiple payees 
are listed on a check, the payor should be required to report with 
respect to each attorney listed as a payee on the check (the all-payee 
rule).
    The IRS and the Treasury Department carefully considered whether 
the payee-recipient rule raises the same problems as the delivery rule 
and believe that it does not. Commentators' principal objection to the 
delivery rule was that their automated information reporting systems 
are designed to capture information about check payees, not mere 
addressees or deliverees. The payee-recipient rule, however, requires 
that the recipient of the check also be named as a payee and thus does 
not raise the same concerns as the delivery rule. The IRS and the 
Treasury Department considered and rejected the first-listed payee rule 
because it would result in no information reporting with respect to an 
attorney who receives the check and is not the first-listed payee 
attorney. Finally, the IRS and the Treasury Department considered and 
rejected the all-payee rule because, as between the two, the payee-
recipient rule appears to be less burdensome for most payors. 
Therefore, the proposed regulations retain the payee-recipient rule. 
The IRS and the Treasury Department, however, request comments on the 
effectiveness of, and the relative burdens imposed by, each of these 
three approaches.

Exceptions for Certain Types of Payments

    Many commentators suggested that the definition of the term legal 
services in Sec. 1.6045-5(d)(2) of the 1999 proposed regulations was 
too broad. These commentators requested an exception to the section 
6045(f) information reporting requirement in certain circumstances 
where they believed the specific payment bears little or no correlation 
to the taxable income of the attorney or the attorney's client. 
Specifically, they suggested exceptions to reporting for payments to 
payee attorneys who were acting as (i) settlement attorneys or title 
insurers in real estate transactions, (ii) executors or administrators 
of estates (for example, those receiving payments of life insurance 
proceeds), (iii) trustees of trusts (such as pension plans and 
bankruptcy estates), and (iv) administrators of qualified settlement 
funds described in Sec. 1.468B-1.

[[Page 35067]]

    Consistent with the language and purpose of section 6045(f), the 
IRS and the Treasury Department continue to believe that a broad 
definition of legal services is appropriate. However, it should be 
noted that other features of the proposed regulations, such as the 
elimination of the delivery rule, may provide a result equivalent to an 
exception in many cases. For example, the IRS and the Treasury 
Department understand that it is unusual for an attorney who is the 
executor or administrator of an estate to be named as the payee on a 
check. Similarly, in many bankruptcy situations the estate of the 
bankrupt, rather than the trustee, is the named payee. Further, under 
these proposed regulations, many payors will be able to avoid reporting 
under section 6045(f) simply by naming the attorney's client as payee 
on the check even if the check is delivered to the attorney's office. 
Finally, the proposed regulations provide that payments made to an 
attorney acting in the capacity as a settlement agent in connection 
with the closing of a real estate transaction are not subject to 
reporting under section 6045(f). The IRS and the Treasury Department 
believe that the flexibility provided by these rules should reduce the 
need for many of the requested exceptions from the term legal services. 
However, comments on additional exceptions where such flexibility is 
not practical are welcome.
    The proposed regulations also provide a clearer and more objective 
standard for determining whether a payment made to a foreign attorney 
is subject to reporting under section 6045(f). Under the proposed 
regulations, a return of information is not required under section 
6045(f) with respect to payments made to a nonresident alien 
individual, foreign partnership, or foreign corporation that does not 
engage in a trade or business in the United States and does not perform 
any labor or personal services in the United States. The proposed 
regulations provide that the rules provided in Sec. 1.6041-4(a)(1) are 
used to determine whether a payment is subject to this exception. Thus, 
the payor makes this determination by obtaining from the payee a Form 
W-8, a Form W-9, or other documentation conforming in substance to 
those forms, or by relying on the presumptions provided under 
Sec. 1.1441-1(b)(3).
    Other commentators asked for exceptions for situations in which 
attorneys who, after collecting their fees for legal services rendered, 
continue to serve as mere clearinghouses or delivery conduits to their 
clients. For example, attorneys sometimes collect and disburse payments 
intact for: (1) A transient or homeless client; (2) a client whose 
address is intentionally not disclosed to the payee; or (3) a client 
who is entitled to recurring payments in satisfaction of the client's 
workers' compensation claim. In addition, sometimes a payor is required 
to make payments to third-party service providers through an attorney 
to monitor payor compliance, even though the attorney does not charge a 
separate fee for this service. The IRS and the Treasury Department have 
not adopted this suggested exception to the section 6045(f) reporting 
requirement, because it is too burdensome to require a payor to 
determine whether any portion of a specific payment is being retained 
by the attorney as a fee.
    Therefore, the proposed regulations adopt, with a minor 
clarification, the definition of the term legal services used in the 
1999 proposed regulations. Under the proposed regulations, the term 
legal services means all services related to, or supportive of, the 
practice of law performed by, or under the supervision of, an attorney. 
Including services that are related to, or supportive of, the practice 
of law in the definition of legal services continues the broad 
definition in the 1999 proposed regulations. It also clarifies that 
payments to an attorney for services that are clearly unrelated to the 
practice of law are not subject to reporting under section 6045(f). For 
example, a payment to an individual for refurbishing an antique 
automobile is not subject to reporting under section 6045(f) merely 
because that individual is a tax lawyer.

Backup Withholding

    Some commentators suggested either eliminating the requirement for 
a payor to backup withhold on a payment made to an attorney who does 
not furnish a TIN or, if such withholding is required, permitting the 
withheld amounts to be credited to the account of the attorney's 
client. The IRS and the Treasury Department believe that payments to 
attorneys for legal services are reportable payments under section 
3406(b)(3)(C), and thus are subject to the backup withholding 
requirements. Further, the following statement in the legislative 
history of section 6045(f) shows that Congress specifically intended 
payments to attorneys that are reportable under section 6045(f) to be 
subject to backup withholding:

    Third, attorneys are required to promptly supply their TINs to 
persons required to file these information reports, pursuant to 
section 6109. Failure to do so could result in the attorney being 
subject to penalty under section 6723 and the payments being subject 
to backup withholding under section 3406.

H.R. Conf. Rep. No. 220, at 546 (1997). Accordingly, this suggestion 
has not been adopted in the proposed regulations. However, eliminating 
the delivery rule may alleviate many concerns regarding backup 
withholding on payments to attorneys who do not supply their TINs.

Revision of Examples

    Several comments were received regarding the examples in 
Sec. 1.6045-5(f) of the 1999 proposed regulations. Commentators 
suggested that Example 1 be revised to clarify that the defendant in 
the lawsuit was the claimant's employer and that the amount disbursed 
by the defendant to the claimant's attorneys should be reduced to 
reflect payments of income and Federal Insurance Contributions Act tax 
withholdings. These revisions have been adopted.
    Some commentators expressed concern that the examples imply that 
all damages in a lawsuit against an employer are back wages reportable 
under Forms W-2. Example 1 has been clarified to explain that, under 
its particular facts, the damages received are taxable wages under 
existing legal principles. Further, the examples are not intended to 
state or imply any substantive conclusion on the tax treatment of any 
particular type of damage award.
    Some commentators stated that the examples did not provide 
sufficient guidance on the reporting of damages under sections 6041 and 
6051. The IRS and the Treasury Department understand taxpayers' 
interest in additional guidance in this area, due in part to 
significant changes in the law under section 104(a)(2). However, 
regulations under section 6045(f) are not the appropriate place to 
address legal issues involving concerns under sections 6041 and 6051. 
Thus, these proposed regulations address issues under sections 6041 and 
6051 only to the extent they are integral or closely related to 
providing guidance regarding section 6045(f).
    Finally, in response to numerous requests, the 1999 proposed 
regulations have been expanded to provide additional examples of 
required reporting.

Amendment to Sec. 1.6041-3(q)

    Section 1.6041-3(q) of the 1999 proposed regulations provided that 
payments to a corporation engaged in providing legal services did not 
qualify for the exception for reporting payments to corporations. These 
proposed

[[Page 35068]]

regulations conform the language of section 1.6041-3(q) to that of 
section 1021(b) of the 1997 Act by providing that payments of 
attorneys' fees made to a corporation do not qualify for the exception 
for reporting payments to corporations under section 6041.

Effective Date of Proposed Regulations Under Section 6045(f)

    In response to several comments received concerning the amount of 
time needed to implement automated processing systems changes, the 
effective date of the regulations has been delayed. The regulations 
will apply to payments made during the first calendar year that begins 
at least two months after the date of publication of the final 
regulations in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. Chapter 5) does not apply to these regulations.
    It is hereby certified that the collection of information in these 
regulations will not have a significant economic impact on a 
substantial number of small entities. This certification is based on 
the facts that: (1) The time required to prepare and file a 2002 Form 
1099-MISC is minimal (currently estimated at 16 minutes per form); and 
(2) it is not anticipated that, as a result of these regulations, small 
entities will have to prepare and file more than a few, at most, forms 
per year. Therefore, a Regulatory Flexibility Analysis under the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. 
Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely (in the manner 
described in the ADDRESSES portion of this preamble) to the IRS. The 
IRS and the Treasury Department request comments on the clarity of the 
proposed rules and how they can be made easier to understand. All 
comments will be available for public inspection and copying. Written 
comments on the proposed regulations are due by August 15, 2002.
    A public hearing has been scheduled for September 30, 2002, 
beginning at 10 a.m. in the Auditorium on the Seventh Floor of the 
Internal Revenue Building, 1111 Constitution Avenue, NW., Washington, 
DC. In addition, all visitors must present photo identification to 
enter the building. Because of access restrictions, visitors will not 
be admitted beyond the immediate entrance area more than 30 minutes 
before the hearing starts. For information about having your name 
placed on the building access list to attend the hearing, see the FOR 
FURTHER INFORMATION CONTACT portion of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments must submit written comments and an 
outline of the topics to be discussed and the time to be devoted to 
each topic (a signed original and eight (8) copies) by September 9, 
2002. A period of 10 minutes will be allotted to each person for making 
comments. An agenda showing the scheduling of the speakers will be 
prepared after the deadline for reviewing outlines has passed. Copies 
of the agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these proposed regulations is A. Katharine 
Jacob Kiss, Office of Associate Chief Counsel (Income Tax and 
Accounting). However, other personnel from the IRS and the Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. In Sec. 1.6041-1(a)(1)(ii), the first sentence is removed 
and three sentences are added in its place to read as follows:


Sec. 1.6041-1  Return of information as to payments of $600 or more.

    (a) * * *
    (1) * * *
    (ii) The payments described in paragraphs (a)(1)(i)(A) and (B) of 
this section shall not include any payments of amounts with respect to 
which an information return is required by, or may be required under 
authority of, section 6042(a) (relating to dividends), section 
6043(a)(2) (relating to distributions in liquidation), section 6044(a) 
(relating to patronage dividends), section 6045(relating to brokers' 
transactions with customers), sections 6049(a) (1) and (2) (relating to 
interest), section 6050N(a) (relating to royalties), or section 6050P 
(a) or (b) (relating to cancellation of indebtedness) with respect to 
the same payee. For example, a person who pays $600 of taxable damages 
to a claimant and the claimant's attorney may be required to file an 
information return under section 6041 with respect to the claimant and 
another information return under section 6045(f) with respect to the 
claimant's attorney. In addition, notwithstanding anything in the 
preceding two sentences, payments to an attorney that are described in 
paragraph (a)(1)(i) of this section are reported under this section and 
not section 6045(f). For provisions relating to information reporting 
on payments to attorneys, see Sec. 1.6045-5. * * *
* * * * *
    Par. 3. Section 1.6041-3 is amended by revising the first sentence 
of paragraph (q)(1) to read as follows:


Sec. 1.6041-3  Payments for which no return of information is required 
under section 6041.

* * * * *
    (q) * * *
    (1) A corporation described in Sec. 1.6049-4(c)(1)(ii)(A), except 
to a corporation for payments of attorneys' fees made after December 
31, 1997, and except to a corporation engaged in providing medical and 
health care services or engaged in the billing and collecting of 
payments in respect to the providing of medical and health care 
services. * * *
* * * * *
    Par. 4. Section 1.6045-5 is added to read as follows:


Sec. 1.6045-5  Information reporting on payments to attorneys.

    (a) Requirement of reporting--(1) In general. Except as provided in 
paragraph (c) of this section, every payor engaged in a trade or 
business who, in the course of that trade or business, makes payments 
aggregating $600 or more during a calendar year to an attorney in 
connection with legal services (whether or not the services are 
performed for the payor) must file an information return for such 
payments. The information return must be filed on the form and in

[[Page 35069]]

the manner required by the Commissioner. For the time and place of 
filing the form, see Sec. 1.6041-6. For definitions of the terms under 
this section, see paragraph (d) of this section. The requirements of 
this paragraph (a)(1) apply whether or not--
    (i) A portion of a payment is kept by the attorney as compensation 
for legal services rendered; or
    (ii) Other information returns are required with respect to some or 
all of a payment under other provisions of the Internal Revenue Code 
and the regulations thereunder.
    (2) Information required. The information return required under 
paragraph (a)(1) of this section must include the following 
information--
    (i) The name, address, and taxpayer identification number (TIN) (as 
defined in section 7701(a)) of the payor;
    (ii) The name, address, and TIN of the payee attorney;
    (iii) The amount of the payment or payments (as defined in 
paragraph (d)(5) of this section); and
    (iv) Any other information required by the Commissioner.
    (3) Requirement to furnish statement. A person required to file an 
information return under paragraph (a)(1) of this section must furnish 
to the attorney a written statement of the information required to be 
shown on the return. This requirement may be met by furnishing a copy 
of the return to the attorney. The written statement must be furnished 
to the attorney on or before January 31 of the year following the 
calendar year in which the payment was made.
    (b) Special rules--(1) Joint or multiple payees--(i) Check 
delivered to payee attorney. If more than one attorney is listed as a 
payee on a check, an information return must be filed under paragraph 
(a)(1) of this section with respect to the payee attorney, if any, who 
received the check.
    (ii) Check delivered to nonpayee or to payee nonattorney. If one or 
more than one attorney is listed as a payee on a check and the check is 
delivered to a person who is not a payee on the check, or to a payee 
who is not an attorney, an information return must be filed under 
paragraph (a)(1) of this section with respect to the first-listed payee 
attorney on the check.
    (2) Attorney required to report payments made to other attorneys. 
If, due to the payment of a check, an information return is required to 
be filed under paragraph (b)(1) of this section, the attorney with 
respect to whom the information return is required to be filed (tier-
one attorney) must file an information return, as required under this 
section, for any payment that the tier-one attorney makes to other 
attorneys with respect to that check, regardless of whether the tier-
one attorney is a payor under paragraph (d)(3) of this section.
    (c) Exceptions. Notwithstanding paragraphs (a) and (b) of this 
section, a return of information is not required under section 6045(f) 
with respect to the following payments--
    (1) Payments of wages or other compensation paid to an attorney by 
the attorney's employer.
    (2) Payments of compensation or profits paid or distributed to its 
partners by a partnership engaged in providing legal services.
    (3) Payments of dividends or corporate earnings and profits paid to 
its shareholders by a corporation engaged in providing legal services.
    (4) Payments made by a person to the extent that the person is 
required to report with respect to the same payee the payments or 
portions thereof under section 6041(a) and Sec. 1.6041-1(a) (or would 
be required to so report the payments or portions thereof but for the 
dollar amount limitation contained in section 6041(a) and Sec. 1.6041-
1(a)).
    (5) Payments made to a nonresident alien individual, foreign 
partnership, or foreign corporation that does not engage in a trade or 
business in the United States and does not perform any labor or 
personal services in the United States. For how a payor determines 
whether a payment is subject to this exception, see Sec. 1.6041-
4(a)(1).
    (6) Payments made to an attorney in the attorney's capacity as the 
person responsible for closing a transaction within the meaning of 
Sec. 1.6045-4(e)(3) for the sale or exchange of any present or future 
ownership interest in real estate described in Sec. 1.6045-4(b)(2)(i) 
through (iv).
    (d) Definitions. The following definitions apply for purposes of 
this section:
    (1) Attorney means a person engaged in the practice of law, whether 
as a sole proprietor, partnership, corporation, or joint venture.
    (2) Legal services means all services related to, or supportive of, 
the practice of law performed by, or under the supervision of, an 
attorney.
    (3) Payor means a person who makes a payment if that person is an 
obligor on the payment, or the obligor's insurer or guarantor. For 
example, a payor includes a person who pays a settlement amount to an 
attorney of a client who has asserted a tort, contract, violation of 
law, or workers' compensation claim against that person; and the 
person's insurer if the insurer pays the settlement amount to the 
attorney.
    (4) Payments to an attorney in the case of a payment by check means 
a check on which the attorney is named as a sole, joint, or alternative 
payee.
    (5) Amount of the payment in the case of a check means the amount 
of the check plus the amount required to be withheld from the payment 
under section 3406(a)(1), because a condition for withholding exists 
with respect to the attorney for whom an information return is required 
to be filed under paragraph (a)(1) of this section.
    (e) Attorney to furnish TIN. A payor that is required to file an 
information return under this section must solicit a TIN from the 
attorney at or before the time the payor makes a payment to the 
attorney. Any attorney must furnish the TIN to the payor, but is not 
required to certify that the TIN is correct. See, however, paragraph 
(c)(5) of this section regarding payments to certain foreign attorneys. 
A payment for which a return of information is required under this 
section is subject to backup withholding under section 3406 and the 
regulations thereunder.
    (f) Examples. The provisions of this section are illustrated by the 
following examples. The examples assume that P is not a payor with 
respect to A, the attorney, under section 6041. See section 6041 and 
the regulations thereunder for rules regarding whether P is required 
under section 6041 to file information returns with respect to C.

    Example 1. One check--joint payees--taxable to claimant. 
Employee C, who sues employer P for back wages, is represented by 
attorney A. P settles the suit for $300,000 that represents taxable 
wages under existing legal principles and writes a settlement check 
payable jointly to C and A in the amount of $200,000, net of income 
and FICA tax withholding. P delivers the check to A. A retains 
$100,000 of the payment and disburses the remaining $100,000 to C. P 
must file an information return with respect to A for $200,000 under 
paragraph (a)(1) of this section. P must also furnish an information 
return to C under section 6051 in the amount of $300,000.
    Example 2. One check--joint payees--excludable to claimant. C, 
who sues corporation P for damages on account of personal physical 
injuries, is represented by attorney A. P settles the suit for a 
$600,000 damage payment that is excludable from C's gross income 
under section 104(a)(2). P writes the $600,000 settlement check 
payable jointly to C and A and delivers the check to A. A retains 
$240,000 of the payment as A's attorney's fees and remits the 
remaining $360,000 to C. P must file an information return with 
respect to A for $600,000 under paragraph (a)(1) of this section.
    Example 3. Separate checks--taxable to claimant. C, a plaintiff 
in a suit for lost profits against corporation P, is represented by 
attorney A. P settles the suit for $300,000. A requests P to write 
two checks, one payable

[[Page 35070]]

to A in the amount of $100,000 for A's attorney's fees and the other 
payable to C in the amount of $200,000. P writes the checks in 
accordance with A's instructions and delivers both checks to A. P 
must file an information return with respect to A for $100,000 under 
paragraph (a)(1) of this section.
    Example 4. Check made payable to claimant, but delivered to 
nonpayee attorney. Corporation P, a defendant in a suit for damages 
knows that C, the plaintiff, has been represented by attorney A 
throughout the proceeding. P settles the suit for $500,000. Pursuant 
to a request by A, P writes the $500,000 settlement check payable 
solely to C and delivers it to A at A's office. P is not required to 
file an information return under paragraph (a)(1) of this section 
with respect to A, because there is no payment to an attorney within 
the meaning of paragraph (d)(4) of this section.
    Example 5. Multiple attorneys listed as payees. Corporation P, a 
defendant, settles a lost profits suit brought by C, for $1,000,000 
by paying a check naming C's attorneys, Y, A, and Z, as payees in 
that order. Y, A, and Z are not related parties. P delivers the 
payment to A's office. A deposits the check proceeds into a trust 
account and makes payments by separate checks to Y of $100,000 and 
to Z of $50,000, for their attorneys' fees. A also makes a payment 
by check of $550,000 to C. P must file an information return for 
$1,000,000 with respect to A under paragraphs (a)(1) and (b)(1)(i) 
of this section. A, in turn, must file information returns with 
respect to Y of $100,000 and to Z of $50,000 under paragraphs (a)(1) 
and (b)(2) of this section if A is not required to file information 
returns under section 6041 with respect to A's payments to Y and to 
Z.
    Example 6. Amount of the payment--attorney does not provide TIN. 
Corporation P, a defendant, settles a suit brought by C for 
$1,000,000 of damages. C's attorney, A, did not furnish P with A's 
TIN. P is required to deduct and withhold tax from the $1,000,000 
under section 3406(a)(1)(A) and paragraph (e) of this section. 
Therefore, P makes the payment by a $720,000 check naming C and C's 
attorney, A, as joint payees. P must also file an information return 
with respect to A under paragraph (a)(1) of this section in the 
amount of $1,000,000, as prescribed in paragraph (d)(5) of this 
section.
    Example 7. Home mortgage lending transaction. (i) Individual P 
agrees to purchase a house that P will use solely as a residence. P 
obtains a loan from lender L to finance a portion of the cost of 
acquiring the house. L disburses loan proceeds of $325,000 to 
attorney A, who is the settlement agent, by a check naming A as the 
sole payee. A, in turn, writes checks from the loan proceeds and 
from other funds provided by P to the persons involved in the 
purchase of the house, including a check for $800 to attorney B, 
whom P hired to provide P with legal services relating to the 
closing.
    (ii) P, not L, is the payor of the payment to A under paragraph 
(d)(3) of this section. P, however, is not required to file an 
information return with respect to A under paragraph (a)(1) of this 
section because the payment was not made in the course of P's trade 
or business. Even if P made the payment in the course of P's trade 
or business, P would not be required to file an information return 
under section 6045(f) with respect to A because P is excepted under 
paragraph (c)(6) of this section.
    (iii) A is not required to file an information return under 
paragraph (a)(1) of this section with respect to the payment to B 
because A is not the payor as that term is defined under paragraph 
(d)(3) of this section. Also A is not required to file an 
information return under paragraph (b)(2) with respect to the 
payment to B because A was listed as sole payee on the check it 
received from P. See section 6041 and its regulations for whether A 
or L must file information returns under that section. See section 
6045(e) and Sec. 1.6045-4 for whether A is required to file an 
information return under that section.
    Example 8. Business mortgage lending transaction. The facts are 
the same as in Example 7 except that P buys real property that P 
will use in a trade or business. P, not L, is the payor of the 
payment to A under paragraph (d)(3) of this section. P, however, is 
not required to file an information return under section 6045(f) 
with respect to A because P is excepted under paragraph (c)(6) of 
this section. A is not required to file an information return under 
paragraphs (a) or (b)(2) of this section with respect to the payment 
to B. See section 6041 and its regulations for whether P or L must 
file information returns under that section. See sections 6041 and 
6045(e) for rules regarding whether A is required to file 
information returns under those sections.
    Example 9. Qualified settlement fund. Corporation P agrees to 
settle for $100,000,000 a class action lawsuit brought by attorney A 
on behalf of a claimant class. Pursuant to the settlement agreement 
and a preliminary order of approval by a court, A establishes a bank 
account in the name of Q Settlement Fund, which is a qualified 
settlement fund (QSF) under Sec. 1.468B-1. A is also designated by 
the court as the administrator of the QSF. Corporation P writes a 
$100,000,000 check in 2003 to A, who deposits the check proceeds 
into the Q Settlement Fund. In 2004, the court approves an award of 
attorneys' fees of $35,000,000 for A. In 2004, Q Settlement Fund 
delivers a $35,000,000 check payable to A. P is required to file an 
information return under paragraph (a) of this section with respect 
to A for the year 2003 for the $100,000,000 payment it made to A. 
The Q Settlement Fund is required to file an information return 
under section 6041(a) and Sec. 1.468B-2(l)(2) with respect to A for 
the year 2004 for the $35,000,000 payment it made to A.
    Example 10. Bankruptcy trustee--wage garnishment. Individual C 
files for bankruptcy under Chapter XIII of the Bankruptcy Code, 11 
U.S.C. sections 1301-1330. Pursuant to a wage garnishment order, C's 
employer, P, withholds $800 from C's earnings. P remits a check for 
$800 payable to A, an attorney who was appointed by the United 
States Bankruptcy Court to act as the trustee of C's bankruptcy 
estate. P is required to file an information return under section 
6045(f) with respect to the $800 payment it made to A.

    (g) Cross reference to penalties. See the following sections 
regarding penalties for failure to comply with the requirements of 
section 6045(f) and this section:
    (1) Section 6721 for failure to file a correct information return.
    (2) Section 6722 for failure to furnish a correct payee statement.
    (3) Section 6723 for failure to comply with other information 
reporting requirements (including the requirement to furnish a TIN).
    (4) Section 7203 for willful failure to supply information 
(including a taxpayer identification number).
    (h) Effective date. The rules in this section apply to payments 
made during the first calendar year that begins at least two months 
after the date of publication of these regulations as final regulations 
in the Federal Register.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 02-12464 Filed 5-16-02; 8:45 am]
BILLING CODE 4830-01-P