Dec. 19, 2012 – Are you a lawyer or law firm allowing clients to pay by credit card? If so, read on for instructions on avoiding an IRS penalty with potential ethical implications.
In 2013, the IRS will impose a 28 percent withholding penalty on all credit card transactions if the lawyer or law firm’s tax ID number and entity name on file with the credit card processing company do not match, exactly, the tax ID number and entity name on file with the IRS.
This means lawyers and law firms should contact their credit card processing company to ensure that tax ID numbers and entity names match IRS records. However, if LawPay is your credit card processing company, don’t worry about contacting LawPay about this issue.
LawPay, which partners with the State Bar of Wisconsin to provide reduced-fee credit card processing services while complying with ABA and state requirements for managing client funds, is taking proactive steps to ensure their clients’ tax IDs and entity names match.
“If you are a LawPay client, you don’t need to call us,” said Amy Porter, LawPay’s chief executive officer. Porter says LawPay does quarterly validation checks with the IRS’s tax database to ensure tax ID numbers and entity names match LawPay accounts.
If the IRS reports a mismatch, LawPay deactivates the account until the problem is resolved, Porter says. This avoids the 28 percent penalty and potential ethical issues that could arise if a 28 percent withholding penalty is assessed on a transaction (see ethics discussion below).
Lawyers and law firms not using LawPay are advised to call the processing company for confirmation that tax IDs and entity names match IRS records. If you’re unsure, Porter advises lawyers and law firms to stop accepting credit cards until the match is verified.
The New IRS Rules Impact Lawyers, Too
In 2008, Congress tightened credit card reporting requirements to close tax gaps under the Housing Assistance Tax Act of 2008. Internal Revenue Code (IRC) section 6050W now requires credit card processing companies to report credit card transactions through Form 1099-K.
Former IRS Commissioner Doug Shulman said the law “will help improve voluntary tax compliance by business taxpayers and help the IRS determine whether their tax returns are correct and complete” by matching bank and tax return figures.
Specifically, each “payment settlement entity” must issue a 1099-K setting forth the name, address, and Taxpayer Identification Number (TIN) of each participating payee (including lawyers or law firms) and the gross amount of reportable credit card payment transactions.
If the tax ID and entity name information provided to a credit card processing company do not match IRS records, the IRS notifies the credit card processing company to take a 28 percent “backup” withholding on future credit card transactions until mismatches are resolved.
The reporting rules are particularly problematic for law firms and lawyers. First, lawyers and law firms often change business operating names, or use acronyms or abbreviated firm or entity names for merchant accounts with credit card processors, says Porter. Lawyers also have obligations to safeguard client property under the Rules of Professional Conduct (Rules).
Ethical Implications of Noncompliance
Under trust accounting rules effective in 2007, lawyers can establish trust accounts to receive advanced or unearned fees and costs by credit card. Prior to 2007, lawyers could only accept credit cards for earned fees that were deposited into the lawyer’s business account.
Specifically, under SCR 20: 1.15(e)(4)h, a lawyer may establish a “credit card trust account” for the purpose of receiving legal fees and costs by credit or debit card, or other electronic deposit.
The “credit card trust account” must be separate from the lawyer's Interest on Lawyer Trust Account (IOLTA), and each credit card payment “shall be transferred from the credit card trust account to the IOLTA trust account immediately upon becoming available for disbursement.”1
IRC section 6050W does not distinguish between credit card trust accounts and IOLTA accounts. Reportedly, lawyers in some states have mistakenly given their credit card processors tax ID numbers relating to their IOLTA accounts, which can trigger a mismatch with the IRS.
The mismatch could require the credit card processor to impose the 28 percent penalty on future credit card payments for legal fees and costs headed for the credit card trust account.
“Lawyers have a responsibility to safeguard the client’s property, and the lawyer would be responsible if someone comes along and unilaterally takes 28 percent of the client’s payment that was supposed to be held in trust,” said State Bar Ethics Counsel Tim Pierce.
The trust accounting rules specify that lawyers must replace funds withdrawn by a financial institution or reimburse chargeback or surcharge amounts against the credit card trust account.2 Presumably, the rule would require reimbursement of any 28 percent penalty.
LawPay helps lawyers avoid this scenario by taking all credit card transaction fees from the lawyer or law firm’s business operating account, not the trust account. But not all credit card processors are attuned to the special accounting requirements that lawyers must follow.
Porter says it’s not yet clear how lawyers or law firms would reclaim any 28 percent withholding once tax ID and entity name mismatches are corrected.
Lawyers or law firms that use credit card processors other than LawPay to receive credit or debit card payments from clients for advanced or unearned legal fees and costs should ensure that the tax ID and entity name on file with the credit card processor matches IRS records.
Starting in 2013, any mismatch could trigger a 28 percent withholding fee on future credit card transactions that could have ethical implications under lawyer trust accounting rules.
LawPay is recommended by more than 60 bar associations, including the State Bar of Wisconsin, and allows attorneys to correctly safeguard and separate client funds into trust and operating accounts. State Bar members save up to 25 percent on credit card processing fees.
Joe Forward is the legal writer for the State Bar of Wisconsin State Bar of Wisconsin.
1 SCR 20: 1.15(e)(4)h3.
2 SCR 20: 1.15(e)(4)h4.