ALTA® Letter John Rosotti - RE: Reporting Requirements for Payments to Attorneys (8/19/00)
August 19, 2000
August 19, 1999
Chairman John Rosotti
Internal Revenue Service
1111 Constitution Avenue
Washington, DC 20044
Dear Sir or Madam:
The American Land Title Association ("ALTA") is pleased to submit comments on Proposed Reg. § 1.6045-5, which addresses new information reporting requirements for payments to attorneys /1. ALTA also requests the opportunity to testify on this proposed regulation at the public hearing scheduled for September 22, 1999.
As described in more detail below, two modifications to the regulations are critical in order to clarify the scope of the reporting requirement and to prevent the reporting of useless and misleading information. The two modifications are:
Identifying the payor. The standard for identifying the "payor" should be defined as the same standard that applies for purposes of section 6041(a). Consequently, a person acting merely as a paying agent (and not exercising "oversight") is not responsible for reporting either service payments under section 6041(a) or gross payments to attorneys under new section 6045(f).
Exception for disbursements of mortgage loans. To prevent the reporting of useless and misleading information to the IRS which could cause significant disruption to the real estate settlement process, a reporting exception is essential for disbursements of mortgage loans. Although such loan disbursements may be made to an attorney performing real estate settlement functions, the amount of any fee received by the attorney from the disbursement is truly de minimis when compared to the principal amount of the loan and should not be reported.
To understand the need for the two modifications described above, we have outlined the relevant steps of a typical real estate closing transaction.
In a typical real estate closing transaction, a seller (S) wants to sell his home and a purchaser (P) agrees to buy it. The agreement may be negotiated with the assistance of a real estate agent (REA), and a real estate contract is signed. Depending on the jurisdiction, S or P approaches a settlement agent (SA) to perform the settlement function. SA may or may not be an attorney, depending on the state in which the transaction occurs. /2
Disbursements from settlement agent as agent of principals
In performing the settlement, SA receives loan proceeds from P?s mortgage lender and makes disbursements on behalf of the borrower/purchaser to the various parties involved in the real estate sale. The disbursement instructions received by SA are specific, generally in writing, and do not allow SA to exercise any discretion in making the disbursements. SA provides only a ministerial function, following the specific instructions of the borrower/purchaser. Consequently, SA makes the disbursements only as a paying agent for the principals to the transaction.
Relying on the instructions from S, P, and P?s lender, SA may make disbursements to various parties including: (1) the lender of the existing mortgage in order to pay off that loan; (2) REA, for the sales commission; (3) Contractors X, Y, and Z, for inspection services and construction repairs; and (4) Attorney A, for legal services relating to the closing. Attorney A provides these services on behalf of P (the purchaser). SA makes all disbursements by check showing SA as the payor.
Compensation to settlement agent
SA generally receives compensation for settlement services from the pool of funds available at the time of closing. The sources of such funds are typically the buyer and the buyer?s lender (and in some rare cases the seller), and it is generally impossible to determine which source of funds is being used to pay the settlement fee. In more unusual situations, settlement fees may be paid directly from the borrower, or the lender as agent for the borrower, outside of settlement. However paid, the settlement agent?s fee is reflected on the HUD-1 Settlement Statement./3
Identifying the Payor
The first issue for consideration is whether the settlement agent (SA) for the real estate closing transaction described earlier is considered the payor, and is required under section 6045(f) to report the disbursement to the attorney (A).
Application of section 6041(a) guidance
Section 6045(f) states simply that reporting is required by "any person engaged in a trade or business and making a payment (in the course of such trade or business)." In essence, the "payor" is required to report if the payor makes the payment in the course of a trade or business. /4 Unfortunately, the statute itself offers very little guidance to identify the "payor" of disbursements from real estate closing transactions.
However, virtually the identical reporting standard exists in section 6041(a), which applies to "All persons engaged in a trade or business and making payment in the course of such trade or business to another person...." The IRS has issued a fair amount of guidance under section 6041(a) on the issue of identifying the payor.
Since sections 6041(a) and 6045(f) apply the same statutory test to determine who must file information returns, we believe the IRS guidance issued under section 6041(a) should also apply to section 6045(f). Accordingly, if SA acts merely as a paying agent, it would have no responsibility for filing information returns under either section. /5 However, if SA exercises "oversight" with respect to its disbursements, SA would be a "payor" under both sections. /6
Immaterial that section 6045(f) applies even if the payor is not the recipient of legal services
ALTA realizes that section 6045(f)(2)(A) requires reporting for any payment to an attorney in connection with legal services, "whether or not such services are performed for the payor." (Emphasis added). At first blush, this passage could be interpreted as requiring SA to report disbursements to A, since section 6045(f) reporting does not hinge on whether A performed services for SA.
Such an interpretation, however, overlooks the fact that SA still must be the "payor" in order to be subject to section 6045(f). Thus, if SA is not the payor, since it acts merely as a paying agent, it should not be subject to section 6045(f). If SA is the payor due to some "oversight" function, then SA generally would be subject to section 6045(f), even though A did not provide services to SA. We believe the section 6045(f)(2)(A) passage quoted above was added simply to confirm that reporting is required even though the attorney is providing services to another person.
The coordination between sections 6041 and 6045(f) also supports the analysis above. Section 6045(f) does not apply to the extent the payment already is subject to reporting under section 6041. If SA is required to report a disbursement to A under section 6045(f), even though SA is merely a paying agent, the potential risk of double reporting is significant. For example, assume that purchaser P instructs SA to pay attorney A for fees relating to the real estate closing, and that P enters into the real estate sale in the course of its trade or business. If SA acts only as a paying agent for P, then P -- as the true payor -- is required to report the payment to A under section 6041. If P also is treated as the payor under section 6045(f), no additional reporting is required due to the exception noted above. However, if SA is treated as the payor under section 6045(f) (but not under section 6041), SA may be required to report separately the payment to A. The result is two information returns to A for the same amount -- one filed by P (under section 6041), another by SA (under section 6045(f)).
To clarify the definition of payor for purposes of section 6045(f), we recommend that the IRS add the following passage as new Reg. § 1.6045-5(a)(4):
Identity of payor. The identity of the payor required to file information returns under section 6045(f) is determined by section 6041(a).
Reporting exception for disbursements of mortgage loans
According to the preamble of the proposed regulations, reporting exceptions are provided "wherever possible" and that comments on additional exceptions will be considered. We applaud the IRS?s willingness to entertain additional exceptions to those listed in the proposed regulations.
We urge the IRS to add a reporting exception for disbursements of mortgage loans. There are several reasons for such an exception, as outlined below.
Reporting requirement targeted large unreported plaintiff attorney fees
Attorneys representing plaintiffs in personal injury cases and receiving large legal settlements from insurance companies were apparently the targets of the new reporting requirement. /7 Under prior law, such settlements were not subject to reporting on Form 1099-MISC since the amount of the attorney?s fee was unknown, although a typical fee is approximately 1/3 of the settlement. /8
In contrast, settlement agents receiving mortgage loan proceeds earn a fee that is de minimis (generally $250-500) when compared to the principal amount of the mortgage. The enormous disparities in the fee structure for settlement agents and plaintiff attorneys can lead to significant problems if the IRS treats both groups the same for purposes of section 6045(f).
Misleading information for the IRS
Reporting "gross" amounts to attorneys could, potentially, be useful information to the IRS if the IRS can assume that a certain percentage of the gross amount reported represents income to the attorney. Consequently, the IRS?s computer-matching program may expect that 20%-30% of the gross amount reported on the Form 1099-MISC (box 13) should be reported on the attorney?s income tax return as gross income. /9
Such a matching program would prove futile, however, if the IRS required reporting for disbursements of mortgage loans. Identical amounts reported on the Form 1099-MISC may represent completely different levels of taxable income. For example, a personal injury attorney paid $100,000 to settle a claim may earn a fee of approximately $30,000. On the other hand, a settlement agent may earn only a $250 fee for settling a transaction that involves a $100,000 disbursement of a mortgage loan.
Absent a reporting exception for the mortgage lender, both amounts would be reported in box 13 of Form 1099-MISC. The vastly different amount of net income represented in these payments, however, would certainly frustrate any IRS attempt to develop a meaningful computer matching program.
Administrative burdens for settlement agents and lenders
If mortgage lenders are required to treat loan disbursements as "gross" amounts subject to the attorney reporting requirements, the settlement agents and lenders would face significantly higher administrative costs.
In order to file tax returns, and to prepare for eventual IRS correspondence, the settlement agent would need to prepare detailed records reconciling the loan amounts with the fees earned. Even more problematic, if the settlement agent inadvertently failed to provide a TIN to the mortgage lender, or if the TIN was incorrect, 31 percent backup withholding would occur on the entire loan disbursement and the transaction would not go through.
Mortgage lenders also would need to develop systems and procedures for reporting disbursements to settlement agents, adding transactions costs and resulting in potential IRS sanctions for noncompliance.
The extraordinary amount of mortgage loans processed each year ? over $1.5 trillion in 1998 alone /10 ? indicates that unless a reporting exception is adopted for mortgage loans, the IRS, settlement agents, and lenders would face severe administrative problems.
ALTA recommends that proposed regulation section 1.6045-5 be amended to clarify that loan proceeds disbursed by mortgage lenders to real estate settlement agents should not be reportable under section 6045(f). This could be accomplished by adding an exception to proposed regulation section 1.6045-5(c), as follows:
(7) disbursements of mortgage loan proceeds. Conclusion
We respectfully request the IRS to adopt the recommendations set forth in this letter in order to clarify the scope of the new reporting requirement and provide much-needed relief to the real estate industry. Absent this relief, the reporting of mortgage loan disbursements would provide almost useless information to the IRS at the expense of causing great disruptions to the settlement industry.
Thank you for considering these suggestions. Please call me at 296-3671 (x214) with any questions you may have.
Ann vom Eigen Legislative Counsel American Land Title Association
/1 The American Land Title Association membership is composed of more than 2,000 title insurance companies, their agents, independent abstracters and attorneys who search, examine, and insure land titles to protect owners and mortgage lenders against losses from defects in titles and perform real estate settlements. These firms and individuals employ nearly 100,000 individuals and operate in every county in the country.
/2 The practice of attorneys acting as settlement agents is most common in the eastern and southern regions of the U.S.
/3 The lender?s knowledge of the amount of the fee raises the issue that section 6041 controls the reporting of the transaction described above, not section 6045(f). We are concerned, however, that mortgage lenders may not track the amount of settlement agent fees reflected on the HUD-1 and thus feel compelled to report the gross loan disbursement as an attorney fee in box 13 of Form 1099-MISC.
/4 It is clear that the "payor" is the person responsible for reporting payments to attorneys under section 6045(f). The statute specifically requires reporting whether or not legal services are provided to the "payor," indicating that the payor is the person required to report. Code § 6045(f)(2)(A).
/5 See Technical Advice Memorandum (TAM) 9643004 (July 12, 1996) (person who performed only "ministerial act" of making payment on behalf of another was a "mere paying agent" and not required to report under section 6041); PLR 9635012 (May 23, 1996) (no reporting required by person who made disbursements "merely as a paying agent" for the principal); PLR 9225013 (March 17, 1992) (although a person acting solely as a paying agent is not required to report under section 6041, the person described in that ruling had an additional role and therefore was required to report); TAM 9127001 (March 6, 1991) (person not considered a payor of commissions to auto dealership?s designated payees since the person acted merely as a paying or disbursing agent on behalf of the dealership). See also Memorandum for Regional Chief Compliance Officers, from Edward Chavez (acting National Director, Specialty Taxes), February 25, 1997.
/6 See Rev. Rul. 93-70, 1993-2 C.B. 294 (escrow company that acted as a paying agent was nevertheless required to file information returns under section 6041 due to "oversight" function). See also TAM 9744002 (July 3, 1997) (attorney who exercises oversight in hiring private investigators and expert witnesses is required to report payments to those persons).
/7 See General Explanation of the Administration?s Revenue Proposals, Department of the Treasury, February 1997, p. 86 ("Payments of judgments and settlements made by insurance companies to attorneys and their clients jointly can yield large legal fees that are not now reported by any payor and are often underreported by the recipients.").
/8 See PLR 9601035
/9 Brickman, Lester, et. al., "Rethinking Contingency Fees," The Manhattan Institute, p. 1 (January 1994) ("contingency fee rates seldom amount to less than one third (33 1/3%) of recoveries when cases are settled without trial, 40% if cases go to trial and 50% if appeals are necessary to sustain the trial judgments") (footnote omitted).
Sources: U.S. Department of Housing and Urban Development, Federal Housing Finance Board, Mortgage Bankers Association of America.