The collection of information contained in these final regulations 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.

Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, D.C. 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, D.C. 20224. Comments on the collection of information should be received by September 11, 2006. Comments are specifically requested concerning:

Whether the collection of information is necessary for the proper performance of the functions of the Internal Revenue Service, including whether the information will have practical utility;

The accuracy of the estimated burden associated with the collection of information;

How the quality, utility, and clarity of the information to be collected may be enhanced;

How the burden of complying with the collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

The collections of information in the final regulations are in §§1.6041-3(p) and 1.6045-5(a). Section 1021(a) of the 1997 Act added section 6045(f) to the Internal Revenue Code (Code) and requires the IRS to implement information reporting of certain payments made to attorneys. Section 1021(b) of the 1997 Act provides that the exception to information reporting in the regulations under section 6041 for payments to corporations does not apply to payments to attorneys and requires the IRS to implement information reporting for payments to attorneys. This information will be used to verify compliance with sections 6045(f) and 6041 and to determine that the amount of these payments has been reported correctly. The collections of information are mandatory. The likely respondents (payors) are businesses and other for profit institutions.

Payors provide the information by completing Form 1099-MISC, “Miscellaneous Income,” for each attorney who has received one or more payments aggregating $600 or more from the payor during the calendar year. The burden for this requirement is reflected in the burden estimate for Form 1099-MISC. The estimated burden of information collection for the 2005 Form 1099-MISC is 16 minutes per return.

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 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 return information are confidential, as required by 26 U.S.C. 6103.

This document contains amendments to the 26 CFR Part 1 under sections 6041 and 6045 of the Code. These amendments to the Income Tax Regulations revise existing §§1.6041-1 and 1.6041-3 and add new §1.6045-5. This document finalizes proposed regulations relating to information reporting under section 6045(f) of the Code for gross proceeds paid to attorneys. The proposed regulations were contained in a notice of proposed rulemaking (REG-126024-01, 2002-2 C.B. 64) published in the Federal Register on May 17, 2002 (67 FR 35064).

Section 6045(f) was added to the Code by the 1997 Act (Public Law 105-34, section 1021 (111 Stat. 788)). 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 reporting is required under section 6045(f) for the portion of any payment that is required to be reported under section 6041(a) (relating to payments made in the course of a trade or business) (or that would be required to be reported under section 6041 but for the $600 limitation) or under section 6051 (relating to receipts for employees). The 1997 Act also provides that the general exception in §1.6041-3(p)(1) for reporting payments made to corporations does not apply to payments of attorneys’ fees. Public Law 105-34, section 1021(b).

Proposed regulations under sections 6041 and 6045(f) were first published in the Federal Register on May 21, 1999 (REG-105312-98, 1999-1 C.B. 1193 [64 FR 27730]) (the 1999 proposed regulations). The IRS received written comments on the 1999 proposed regulations, and held a public hearing on September 22, 1999. After considering those comments and the testimony at the public hearing, the IRS and the Treasury Department decided to amend and repropose regulations under sections 6041 and 6045(f). Those proposed regulations (the reproposed regulations) were published in the Federal Register on May 17, 2002 (67 FR 35064), and incorporated the guidance in the 1999 proposed regulations with some modifications. A number of written comments were received in connection with the reproposed regulations. After considering those comments, the IRS is adopting the reproposed regulations with revisions, as discussed below.

Generally, the section 6045(f) information reporting requirement is intended to be broad, and few exceptions are warranted. See H. Conf. Rep. 105-220, at 546 (1997). As suggested by commentators, the final regulations adopt certain exceptions to the information reporting requirement, described below.

Section 6045-5(c) of the reproposed regulations contains an exception to the information reporting requirement relating to payments made to an attorney who conducts settlements for sales or exchanges of real estate. Commentators suggested an expansion of this exception to include payments made in connection with a refinance of a mortgage and certain other loan closings. After consideration of the comments, and the nature of these transactions, these final regulations expand the exception to include payments made to attorneys in connection with the financing of real estate. The exception now covers, for example, payments made to attorneys in connection with refinancings and mortgages, not limited to purchase-money mortgages.

Many commentators on the 1999 proposed regulations requested exceptions to the section 6045(f) information reporting requirements for payments to trustees and other fiduciaries such as administrators of estates and settlement funds. Those commentators suggested that the definition of legal services should be narrowed to except payments to those individuals, as the payments to attorneys acting as fiduciaries have no correlation to their income. The preamble to the reproposed regulations stated that this issue was considered, but reiterated that a broad definition of legal services is appropriate and consistent with the language and purpose of section 6045(f). (67 FR 35064) Although the reproposed regulations made an exception for payments to attorneys acting as real estate settlement agents, the reproposed regulations did not except payments to trustees and administrators. The preamble noted that in many situations, payments are or could be made to an estate or fund, rather than to an attorney acting as a trustee or administrator. If an estate or fund were the payee, information reporting under section 6045(f) would not be required.

With respect to payments to bankruptcy trustees in particular, Example 10 of the reproposed regulations describes a situation in which a bankrupt’s employer withholds amounts from the bankrupt’s earnings pursuant to a wage garnishment order, and forwards that amount to the bankruptcy trustee. Commentators argued that a bankruptcy trustee who receives such payments is not practicing law, and is not receiving these amounts in connection with legal services. They pointed out that many bankruptcy trustees are not attorneys. Commentators also discussed the unique position of a bankruptcy trustee, which would make the bankruptcy trustee reluctant to disclose his or her taxpayer identifying number (TIN). They also described numerous administrative burdens bankruptcy trustees would face in connection with the receipt of a large number of information returns.

Further, numerous commentators stated that it is not always possible to avoid information reporting; in many bankruptcy situations, particularly in a Chapter 13 bankruptcy, a payor must write the check to the bankruptcy trustee and not to the bankrupt’s estate. After considering the comments with respect to payments to bankruptcy trustees, and considering the unique position of attorneys acting in their capacity as bankruptcy trustees, it was determined that an exception for payments to bankruptcy trustees was appropriate. Therefore, the final regulations include an exception in §1.6045-5(c)(7) for payments to attorneys acting in the capacity of bankruptcy trustees, and remove the example contained in the reproposed regulations relating to payments to bankruptcy trustees.

Another commentator recommended that payments of life insurance made to an attorney on behalf of a client not be considered received in connection with legal services and therefore be excepted from the information reporting requirement. The IRS and the Treasury Department continue to believe that a broad definition of legal services is appropriate, and the final regulations do not adopt this suggestion. As in the fiduciary situation, information reporting under section 6045(f) would not be required if the attorney is not the named payee.

Commentators requested additional clarification of the interplay between the information reporting rules in existing §1.6041-1(e) and (f) and the reproposed regulations under section 6045(f). In response, many of the examples in the final regulations include more cross-references to other information reporting rules, and some examples illustrate the correct reporting under sections other than section 6045(f).

Some commentators asked that the IRS develop a new form for reporting settlement payments made to plaintiffs and their attorneys that would show the names and TINs of both plaintiff and attorney, the amounts paid to each, and backup withholding if applicable. The commentators proposed new Form 1099-SET, “Settlement Proceeds,” to satisfy the reporting obligations set forth under both sections 6045 and 6041 with respect to these payments. The IRS already has several different forms in the Form 1099 series that allow for reporting of a variety of types of payments, including payments under section 6045(f). Adding another form to the Form 1099 series limited to only one type of payment would not increase efficiency for the IRS or taxpayers. Moreover, payors could not use the proposed Form 1099-SET in connection with settlement payments that constitute wages reportable on Form W-2, “Wage and Tax Statement.” For these reasons, the final regulations do not adopt this suggestion.

A number of commentators correctly pointed out that under the reproposed regulations, information reporting for amounts paid to attorneys may be required even though the payors also must report these amounts to the attorneys’ clients pursuant to section 6041. Commentators stated that duplicate reporting would be a problem under automated systems for generating information returns. In many cases, their systems are designed to generate only one Form 1099 for a payment. Nevertheless, Congress mandated reporting by a payor under both section 6045(f) (to an attorney) and 6041 (to the attorney’s client) with respect to the same payment. Section 6045(f)(2)(B) provides an exception for payments required to be reported under section 6041. The IRS and the Treasury Department interpret the exception in section 6045(f)(2)(B) as applying only where the section 6045(f) payment otherwise would be required to be reported under section 6041 with respect to the same payee (i.e., the attorney), and not where section 6041 imposes a separate reporting requirement with respect to another payee (i.e., the client). See §1.6045-5(c)(4). In cases in which the payment is made to the attorney for the benefit of the client, section 6041 requires reporting with respect to the client, and section 6045(f) requires reporting with respect to the attorney. Each of these statutory reporting requirements serves an independent purpose — reporting the amount paid for the benefit of the client who has to include that amount in income, and reporting a gross proceeds payment to the attorney. Section 1.6041-1(a)(1) was revised to clarify that there is a requirement to report to both the attorney and client in that situation.

Other commentators discussed the requirement to backup withhold on payments to an attorney if the attorney does not provide an accurate TIN to the payor. The commentators suggested that there are both practical and ethical problems with respect to backup withholding on payments to attorneys. They noted that the amounts paid to the attorney generally belong to the attorney’s client and that there may be difficulty in determining how to claim the withholding on the client’s income tax return. The IRS and the Treasury Department believe that payments to attorneys for legal services are reportable payments under section 3406(b)(3)(C), and are thus subject to backup withholding. The legislative history to section 6045(f) makes clear that Congress intended such payments to be subject to backup withholding. H. Conf. Rep. 105-220, at 546 (1997). As the commentators point out, backup withholding on a payment to an attorney that constitutes the income of the attorney’s client raises some practical concerns, but it is nonetheless required by the statute. Backup withholding can be avoided as long as the attorney provides an accurate TIN to the payor. Furthermore, there are procedures in place affording an opportunity to correct an inaccurate TIN before backup withholding is required. See §31.3406(d)-5; Rev. Proc. 93-37, 1993-2 C.B. 477.

A comment was received with respect to the exception in §1.6045-5(c)(5) of the reproposed regulations for payments to certain non-residents that are not engaged in a trade or business within the United States and that do not perform any labor or personal services within the United States. The commentator stated that, as drafted, the exception is too narrow and will result in unnecessary information reporting. The commentator suggested that the exception should be based solely on whether the payment to the non-resident alien individual, foreign partnership, or foreign corporation is in connection with legal services performed outside the United States. The commentator suggested that a payor be entitled to rely for purposes of making this determination on a signed statement by the attorney or law firm to the effect that the services for which payment is made were performed outside the United States, provided that the payor does not know that the statement is inaccurate. The commentator noted that payments of gross proceeds to non-resident alien attorneys may be reportable under this section although attorneys’ fees paid to such attorneys would not be reportable under section 6041.

The gross proceeds reporting requirement under section 6045(f) is intended to be broad and has a different purpose than information reporting under section 6041 for payments for services. Congress expressed its intent with respect to section 6045(f) “that the IRS will administer this provision so that it will not apply to foreign attorneys who can clearly demonstrate that they are not subject to U.S. tax.” Joint Committee on Taxation Staff, General Explanation of Tax Legislation Enacted in 1997, 105^th Cong., 1^st Sess. 215 (1997). Foreign persons not engaged in trade or business within the United States are subject to U.S. tax on amounts of certain types of income received from sources within the United States (e.g., under section 871(a)). Foreign persons engaged in trade or business within the United States are subject to U.S. tax on taxable income effectively connected with the conduct of such trade or business within the United States (e.g., under section 871(b)). Thus, a foreign person can demonstrate clearly that it is not subject to U.S. tax only if it clearly demonstrates both that the income in question would not be subject to U.S. tax if the foreign person were not engaged in trade or business in the United States and that the income in question is not effectively connected with the conduct of a trade or business within the United States. The commentator’s proposed approach would not produce a clear demonstration that both conditions are satisfied and so would be inconsistent with the intent expressed by Congress. Therefore, the final regulations do not adopt the commentator’s suggestion.

In addition to written comments, a number of telephone calls were received with questions and comments regarding the reproposed regulations. Many of the callers raised questions as to whether an attorney is the payee of a check where the check is made out to the attorney’s client, but “in care of” the attorney, or to the attorney’s client trust account, or other scenarios. Since these questions were raised by a number of callers, the final regulations address them. Generally, an attorney is the payee on a check written to the attorney’s client trust fund, but not on a check which the attorney may not negotiate. (§1.6045-5(d)(4)).

The reproposed regulations indicated in §1.6045-5(h) that the regulations would become effective with payments made during the first calendar year that begins at least two months after the publication of the regulations as final regulations. Consequently, the final regulations will apply to payments made in or after 2007. This delayed effective date affords time to implement any changes required in automated information processing systems.

Section 6724(a) states that no penalty relative to information reporting shall be imposed with respect to a failure that is due to reasonable cause and not to willful neglect. Section 301.6724-1(a) provides in part that a penalty is waived for reasonable cause if the filer establishes that there are significant mitigating factors with respect to the failure, or that the failure arose from events beyond the filer’s control, and that the filer acted in a responsible manner. Under §301.6724-1(b)(1), significant mitigating factors include the fact that prior to the failure the filer was never required to file the particular type of return with respect to which the failure occurred. Under §301.6724-1(d)(1)(i), acting in a responsible manner means that the filer exercised reasonable care, which is that standard of care that a reasonably prudent person would use under the circumstances in the course of its business in determining its filing obligations. Pursuant to these provisions, a penalty waiver may apply, for example, if an information report would have been required under the reproposed regulations, but not under the final regulations.

It has been determined that this Treasury decision 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. Accordingly, a regulatory flexibility analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. This certification is based on the facts that: (1) the time required to prepare and file a 2005 Form 1099-MISC, “Miscellaneous Income,” is minimal (currently estimated at 16 minutes per form); and (2) it is not anticipated that, as a result of these regulations, many small entities will have to prepare and file more than a few forms per year.

Pursuant to section 7805(f) of the Code, the Notice of Proposed Rulemaking preceding this regulation was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

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

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

Par. 2. Section 1.6041-1(a)(1) is amended as follows:

1. In paragraph (a)(1)(ii), the first sentence is removed and two sentences are added in its place.

2. Paragraph (a)(1)(iii) is added.

The revision and addition read as follows: