Revenge Is Now a Lot Less Sweet

Many of you have heard me at least once present a seminar on how to increase the likelihood of getting paid. It concludes with a methodology to exact revenge when all the right moves on your part don’t motivate clients to pay. Originally suggested by a Montgomery County, PA solo practitioner and passed along by me for many years now (over 10 to be exact) was the suggestion that one let the statute of limitations run on a possible malpractice action. Then, around November, send a letter to the client informing him/her/them that you will have no alternative other than to forgive the debt, and will accordingly send a 1099 at year-end to reflect that. Very often the very thought of the receipt of a 1099 which might throw a monkey-wrench into year-end tax filing prompts an otherwise recalcitrant client to pay. But of course by that point you’re going to get more satisfaction from the revenge than the actual receipt of the money. Such is life.

Lots of questions often arise about this process. Mostly, attorneys wonder what exactly they are writing off, since law firms operate on a cash basis, and therefore there is really no actual balance sheet receivable item to write off. That’s true, in that fees are not earned by the firm until paid. However, that doesn’t mean that the client doesn’t owe the money. You must also take into consideration that the costs expended on behalf of the client, if properly tracked, are actually booked to a balance sheet liability account often labeled “loan / advance to clients.” The posting of client cost advances are “washed” from the account upon receipt of the client’s payment.

The only way to get those costs off the balance sheet and expensed on your profit and loss is for the firm to actually recognize it as bad debt. So writing off the receivable as a bad debt accomplishes that, even though no deduction can be made for the unpaid fees.

I recently presented my Getting Paid seminar at the Illinois State Bar Solo & Small Firm Conference. The seminar was very favorably received, and especially the closing suggestion of the “Revenge Is Sweet” methodology. However, that may have come to a screeching halt.

I received a call from Chicago attorney Donna Hartl of the law firm of Golan & Christie. One of her firm’s attorneys came to her asking whether they could in fact start sending 1099’s to non-paying clients. Donna is a member of the Illinois State Bar Federal Taxation Council. She contacted me because her research into this methodology led her to conclude she could not recommend it to her firm.

After our conversation I understood her reticence. When I started recommending this strategy, there was a 1099-MISC form which would be filed with the IRS, and that is what the “revenge” methodology called for. However, at some time between 1996 and 2005 — Donna was unable to determine exactly when — there was a new 1099-C introduced by the IRS. This 1099-C was to be used specifically for cancellation of indebtedness. Ok, so far no problem . . . just use the 1099-C instead of the 1099-MISC. Unfortunately, on 1/1/05 the IRS determined that the 1099-C was to be used only by financial institutions to report bad debt. And therein lies the problem.

It seems in their infinite wisdom, the IRS decided that people like you and I are not intelligent enough to know when to report cancellation of indebtedness, and what qualifies as such, and therefore they withdrew the ability to do so. Talk about a lot of potential unreported income for goods and services ultimately obtained for free — but counterbalance that with the labor shortage to follow up at the IRS. It’s understandable.

Now of course, the average client, even the highly educated client, probably has no clue that the 1099-C is designated for use only by financial institutions. They also have no clue that the 1099-MISC is an inappropriate form to use. So theoretically, the method can still intimidate many clients into paying. The real question, Donna raised, is whether or not a law firm can knowingly file an inappropriate tax form, and what the IRS might do about it.

Donna will be throwing this question up to the ABA Tax Section members, and promised to get back to me, so stay tuned for the final word. But in the meanwhile, I must sadly and reluctantly withhold this advice from future seminar attendees. And it’s a shame, because there are so few real points of leverage any more for a law firm to use to collect on rightly owed debt. Clients know that any threat of a lawsuit can usually be deflated with a counter-threat of a malpractice action. Lien on the file? Forget it. Any good replacement attorney will make an argument that any important parts of the file, the only parts which provide you with some modicum of leverage, will create a disadvantage for the client if not turned over. Again, the possible legal repercussions aren’t usually worth the debt. So lawyers have so few tools in their bag to deal with clients who can but just will not pay. This is now another tool, even if it only provides emotional relief to the attorney, which has become unavailable. It’s a shame.

My appreciation to Donna Hartl for taking the time to contact me and talk this through in language I readily understood. Because tax law is complex. Donna, you’re a mensch!

==========

To return to the main page of the blog, click here. To return to the blog Index, click here.

Other Links to this Post

  1. Law Practice Management » Blog Archive » A Quick Return to Sweet, Sweet Revenge — November 14, 2008 @ 6:47 pm

WordPress Themes