By Rose Litvack, CPA, Professor, Kingsborough Community College–CUNY

In a recent decision (Fuchsberg and Fuchsberg, DTA No. 817914, January 10, 2002), it was determined that attorneys (associates) that were full-time employees of a law firm were correctly treated as independent contractors with respect to referral fee income paid to them from the firm. The associates were paid a salary for their work at the law firm, which was reported as wages and subject to withholding taxes. Some of the associates were also given Form 1099s as independent contractors. The income reported on the 1099s was income for referring cases to Fuchsberg and Fuchsberg that the firm took on as clients. The case was decided by an administrative law judge (ALJ), which does not set precedent.

Fuchsberg and Fuchsberg is a law firm that generally represents individuals suffering from personal injuries. Based on New York custom, Fuchsberg and Fuchsberg is paid on a contingency fee basis, which means that the firm retains a portion, if any, of the amount recovered for its clients. The firm obtained some of its clients through referrals from unaffiliated attorneys, and paid such referring attorneys with a share of the contingency fee collected from the referred client. These referring attorneys were treated as independent contractors, and no payroll taxes were withheld. Fuchsberg and Fuchsberg also received referrals of clients from its own associates, who then also received a share of the contingency fee. This referral income was reported to the associate on Form 1099. Associates are paid regular biweekly salaries out of the firm’s payroll account, which are accounted for as wages subject to withholding. Referrals are not a part of associates’ duties. The firm stated that many of its associates have never referred a case to the firm.

The issue was whether this referral fee compensation should be treated as wage income and subject to withholding taxes. In reaching this decision, the ALJ noted the following factors as being significant:

After consideration of all the facts, the ALJ agreed with the taxpayer that, in regard to this aspect of their work (the referral compensation), the associates were independent contractors, and thus their compensation for the referral of cases was not wage income.

The City of New York has appealed the decision.