Attorneys provide invaluable services to clients, but like any business, they must comply with tax regulations and recordkeeping requirements. The IRS has developed an Attorneys Audit Technique Guide to help examiners review attorney tax returns effectively. This guide covers key areas such as recordkeeping, income reporting, and attorney-client privilege.

Understanding Attorney Audits

The IRS audits attorney tax returns much like any other business but considers specific issues related to legal practice. This includes examining sources of income, trust accounts, and client-related expenses.

Recordkeeping Requirements

Attorneys are required to maintain accurate records of their financial transactions, including:

• Client ledger cards
• Cash receipts and disbursement journals
• Bank statements
• Trust account records
• Time-tracking logs

Proper documentation ensures compliance with tax laws and supports deductions claimed on tax returns.

Attorney Trust Accounts

Attorneys must handle client funds responsibly. They typically manage two types of trust accounts:

1. General Trust Accounts (IOLTA Accounts) – These hold client funds that generate interest, which is then remitted to state bar associations for legal aid programs.
2. Segregated Trust Accounts – These are set up for specific clients when larger sums of money are involved.

Attorneys should ensure that trust account funds are properly tracked and do not mix with business or personal accounts.

Key Audit Issues for Attorneys

1. Gross Income
   • Income can come from retainers, contingency fees, referral fees, and court awards.
   • Attorneys receiving cash payments must comply with Form 8300 reporting requirements for amounts over $10,000.
2. Unreported Income
   • Some attorneys may fail to report all income sources, especially cash payments or funds deposited directly into personal accounts.
   • The IRS cross-references reported income with financial records and client trust account transactions to ensure full disclosure.
3. Attorney-Client Privilege
   • While legal professionals may claim attorney-client privilege to protect client communications, this privilege does not extend to financial records related to tax compliance.
   • The IRS can issue a summons for financial records if necessary.
4. Expenses and Deductions
   • Business-related expenses such as office supplies, professional dues, and case-related costs are deductible.
   • Travel, meals, and entertainment expenses must meet IRS substantiation rules to qualify.
5. Independent Contractor vs. Employee Classification
   • Law firms must correctly classify workers to ensure proper tax reporting.
   • Misclassification can lead to penalties and additional tax liabilities.

Best Practices for Attorneys

To minimize audit risks, attorneys should:

• Maintain well-organized financial records.
• Separate trust accounts from operating accounts.
• Accurately report all sources of income.
• Properly document deductible expenses.
• Stay updated on IRS tax regulations affecting legal professionals.

Conclusion

The IRS Attorneys Audit Technique Guide provides crucial insights into common tax issues for attorneys. Understanding and following proper tax procedures can help legal professionals avoid potential audit risks and ensure compliance with tax laws.

If you’re an attorney, staying informed and proactive about tax regulations will help you maintain financial health and avoid unnecessary legal complications. Interested on how we can help your firm, contact us today.