Tax Implications of Revenue Ruling 83-65

Revenue Ruling 83-65 is an Internal Revenue Service (IRS) interpretation of tax law that addresses the tax treatment of a payment from a title insurance company to an attorney for a client referral. This is a common scenario in real estate, and the ruling clarifies how such payments are characterized for tax purposes. This guidance affects both the company making the payment and the professional receiving it.

The Core Ruling Explained

Revenue Ruling 83-65 was established to address a scenario where a title company made payments to an attorney as compensation for referring a client who purchased a title insurance policy. The IRS concluded that the payment represented a fee for services rendered by the attorney for the referral of business.

This characterization is important because it distinguishes the payment from a discount or a reduction in the premium for the homeowner. The ruling determined that the payment was a separate transaction between the title company and the attorney, not an adjustment to the policy’s cost. This means the full premium is income to the title company, and the payment to the attorney is a distinct expense.

A key element of this ruling is the condition that the payment was not illegal under applicable state or local laws at the time. The legality of the referral fee was a presumption for the tax conclusion. If the payment were an illegal kickback, its tax treatment would be different, a factor that is relevant under modern regulations.

Tax Implications for the Recipient

For the recipient of the payment, such as the attorney in the ruling’s example, the fee must be included in their gross income for the tax year it was received. This income is considered earnings from their trade or business, not a gift or a non-taxable rebate.

The payer is required to issue a Form 1099-NEC, Nonemployee Compensation, to the recipient if total payments for the year are $600 or more. The recipient then uses this form to report the income on their tax return. This is often done on Schedule C (Form 1040), Profit or Loss from Business, for sole proprietors or single-member LLCs.

This income classification can also subject the recipient to self-employment taxes, which consist of Social Security and Medicare taxes for individuals who work for themselves. Since the referral fee is business income, it contributes to the net earnings from self-employment, which are taxed accordingly. This is in addition to any regular income tax owed.

Tax Implications for the Payer

From the perspective of the entity making the payment, the tax treatment is also defined by the ruling. The title company can generally deduct this payment as an ordinary and necessary business expense under Section 162 of the Internal Revenue Code. This allows the company to reduce its taxable income by the amount of the fee.

An ordinary expense is one that is common in a trade or business, while a necessary expense is one that is helpful and appropriate. In the context of the 1983 ruling, referral fees were considered to meet this standard as the payment helps the business generate revenue by securing a new client.

The ability to deduct the payment is contingent on its legality. The tax code disallows deductions for illegal payments, bribes, or kickbacks. Therefore, if the referral fee violates any federal or state law, the payer loses the ability to claim it as a business expense.

Interaction with Modern Real Estate Regulations

The landscape of real estate transactions has changed since 1983, primarily due to the Real Estate Settlement Procedures Act (RESPA). This federal law protects consumers from unnecessarily high settlement costs and abusive practices. A provision of RESPA, Section 8, prohibits giving or accepting any fee or kickback for the referral of settlement service business involving a federally related mortgage loan.

This prohibition directly impacts the applicability of Revenue Ruling 83-65. The type of referral fee described in the ruling is often illegal under RESPA in most residential mortgage transactions today. Since RESPA can make the payment illegal, the tax implications for the payer are reversed from the original ruling’s conclusion.

While the recipient of an illegal kickback must still report it as income, the payer is denied the corresponding tax deduction. This creates a tax penalty for the payer and highlights how regulatory compliance is intertwined with tax obligations. Consequently, the practical application of Revenue Ruling 83-65 is limited in the modern real estate environment.