IRS has released its Attorneys Audit Technique Guide (ATG) to help auditors sniff out what are perceived potential problems with the way attorneys complete their income tax returns.

Some of the highlights:

1. Unreported income – Generally an attorney will deposit a litigation award into his trust account, later disbursing the client’s share and paying the attorney his fees. Sometimes, he may simply cash the award check, or deposit the check directly into a personal or investment account, which could lead to omission (intentionally or by mistake) of the income from the eventual tax return.

2. Deferral of income – After resolution of a case, an attorney may attempt to defer income truly earned by allowing the legal fees to remain in the trust account until the next year. To do so would clearly be a tax avoidance move under the “constructive receipt” doctrine.

3. Noncash payments instead of fees for services rendered – The ATG suggests, for example, that an attorney might borrow a large sum of money from a client, and then pay it off by performing legal services. While the loan may be shown on the attorney’s books, the income resulting from the obvious relief of debt may somehow escape the bookkeeper’s attention! Also, bartering may find its way into the relationship between the attorney and the client. Auditors are told by the ATG to be on the lookout for situations in which the attorney’s workload has not decreased from one year to the next, but reported fees has declined — a possible indication that the attorney is rendering services in exchange for noncash payments.

4. Advanced client costs – Often, attorneys who take cases on a contingency basis may pay litigation costs on behalf of clients, only to later recover those costs when the eventual award comes in the door. Attorneys on the cash basis of accounting may be inclined to deduct these advanced costs when paid. ATG concludes, however, that courts have determined that costs paid on behalf of a client are more properly treated as loans for tax purposes, thus not deductible as a current year cost of doing business. The expectation of reimbursement is the issue here.