ATTORNEY FEE DEFERRAL
Welcome to Synergy’s blog page, dedicated to the topic of attorney fee deferral. Our team of deferral experts share their InSights and knowledge on the latest developments and best practices when it comes to deferring contingent legal fees. Stay up-to-date with the latest trends and strategies to ensure that you have the information you need to make informed decisions about attorney fee deferral. Our blogs provide practical tips and advice for maximizing the benefits of fee deferral and optimizing your cash flow while reducing taxation. Let our experts guide you through the intricacies of attorney fee deferral and help you make the most of this valuable solution.
April 11, 2024
Childs v. Commissioner, 103 T.C. 634 (1994), forms the legal basis for attorney fee deferral and outlined several benefits for attorneys who defer legal fees. The case involved an attorney who had deferred a portion of his contingency fees from representing clients in personal injury cases. The IRS challenged the attorney’s deferral arrangement, but ultimately the Tax Court ruled in favor of the attorney.
Over the past twenty years, the marketplace has expanded greatly. According to the Insurance Information Institute, in 2020, the total losses for liability insurance reached $202.9 billion (inclusive of personal injury, medical malpractice and wrongful death claims). Similarly, the fee deferral programs available have increased and now attorneys have a wide variety of options and investments available. However, the total amount of dollars that have been deferred by attorneys has stayed stagnant.
Why more attorneys defer taxation of their contingent legal fees? Great question when you look at the benefits of doing deferral. But there are important considerations and issues to make sure it is the right choice for a specific fee:
The benefits:
Tax Deferral: By deferring the receipt of income, one can potentially defer taxation in the current year, lower the overall payment of tax and have their fee grow tax-deferred until received.
Income Averaging: This can help attorneys manage their income and tax liability by spreading payments into more equal annual income to reduce the amount taxed at higher rates. It also allows the firm (business) to plan revenue out with more certainty.
Investment Opportunities: The investment options in a deferral program allow all the dollars to potentially earn interest or capital gains without taxation while they are held in the program.
Asset Protection: Depending on the structure of the deferral agreement, the deferred legal fee may be protected from creditors and other claims.
Retirement Planning: Most of the programs do not have deferral caps and integrate well with other traditional retirement planning strategies.
No lImit (amount or age): The benefits are like most retirement plans but do have the added advantage of no cap on the amount you can defer in a single year and allowable withdrawals prior to age 59.5. These are extremely valuable when used in conjunction with other retirement planning programs.
The downside:
Financial Constraints: Attorneys and firms often utilize their personal finances to fund their law firm’s investment in cases. They may prioritize paying down debt or saving for future cases.
Lack of Awareness: The programs available are not widely known in the Tax Attorney, CPA, or Financial Planner markets. These groups are who attorneys typically go to for guidance and advice in their planning. The programs are specific to attorneys working on contingency fees and unique to this profession.
Short-term Thinking: There is always a battle between using funds now and receiving instant gratification versus savings for the long term.
Fear and Uncertainty: Trial lawyers have income that varies from year to year, sometimes with huge swings up and down. This variance often creates a fear of not being able to access the funds in case of an emergency. In addition, many professionals fear the uncertainty of the economic environment and the performance of markets.
Access Limitation: The programs available have limits on the ability to access funds. You typically cannot increase the amount or frequency of the withdrawal schedule for immediate access.
Time: The programs available require decisions and documentation that is more complex than most retirement plans and becomes part of the settlement documentation. It may take a prospective attorney longer to understand and seek advice from their advisors. Typical plans need to be implemented and set in motion prior to a case coming to a resolution.
Conclusion
Like most retirement plans, attorney fee deferral programs have benefits and risks associated with implementation. If the program is used with other retirement plans, you can overcome many of the obstacles listed above. The benefits of deferring legal fees will vary based on the individual circumstances of the attorney and the terms of the program they utilize. Attorneys should consult with tax and financial professionals to review their specific situation and develop strategies that work best for their wants and needs. Attorney fee deferral programs do not work for everyone but should be considered as part of your overall financial strategy. See here how Synergy can assist today.
September 14, 2023
Introduction
Trial lawyers typically have large swings in their income based on the cases that settle in a calendar year. Unfortunately, it is hard to control the day a settlement will occur or when the settlement will be paid. This presents a problem in higher income years which create higher income tax liabilities. Fortunately, an increasing number of programs and processes are available for attorneys to plan for these income fluctuations.
These swings in income make it harder to plan for your retirement. In the past we have consulted with attorneys who were hesitant to use a deferral program because they were unsure about future years’ income. In other instances, they want to use the influx of revenue to offset costs on other cases in their inventory. These difficult decisions arise when there is not enough time to plan. The best plans are created when experts in various strategies work together to meet your specific needs.
Deferral Plans & Tax Financing Programs
Let’s first explore two ways to plan for higher income years: deferral plans and tax financing programs.
The traditional solutions use several different tax deferral programs such as:
- Employer-sponsored plans (401k, Simple IRAs, profit-sharing programs)
- Annuity-based structured attorney fee programs
- Deferred compensation programs
Trial attorneys can invest all or part of their contingent legal fees on a pre-tax and tax deferred basis using employer sponsored plans, annuity-based attorney fee structures or deferred compensation plans. These pre-tax investment options allow attorneys the unique ability to control the timing of their income in any given taxable year.
Benefits of tax deferral programs:
- Tax deferred growth: The full value of the funds put into a tax deferral program are invested on a pre-tax basis. This allows for more funds to be working for you.
- Lower current tax liability: The majority of tax deferred programs lower the amount of current year income. The amount placed in the program is considered income in the withdrawal year, not the deferral year.
- Control over timing: Deferring income to future years allows you more time to plan around the withdrawal years. You can consult with your tax advisors to potentially create a plan that will allow a lower tax liability in the year of withdrawal when compared to what was due in the year of deferral.
- Beneficiary and estate planning: Deferral programs can benefit your heirs (beneficiaries). The beneficiary will be responsible for the taxes, but they can potentially use programs to stretch the growth for a longer time frame.
Tax financing is a new way for an attorney to pay the tax in full through a financed arrangement. As opposed to using your own funds to pay the liability in the year due, you borrow the funds and pay those back on a three-to-five-year schedule. For example, if you have a $1,000,000 fee. We will assume you owe at a combined rate of 35%. The $350,000 tax bill is due for that year which limits the amount of funds you can invest. If you were to take a loan for $350,000, you would invest the full fee and pay the loan back over time. This allows you to have your full $1M fee working for you to potentially create a better monetary outcome.
Benefits of financing tax obligations:
- Cash flow management: The use of a financing vehicle allows you to spread the tax obligation over multiple years vs a one-time immediate year payment. You will pay more overtime but in smaller amounts over a longer period.
- Preserving more liquidity: Financing in general allows you to keep more money now and pay over a longer period. This allows you to keep more of your cash now and maintain a larger amount of liquidity.
- Deployment of capital: The funds that would have been used to pay the current tax liability can be deferred to other investments.
- Retaining assets: The ability to finance might allow you to keep an asset that would have been needed to cover the tax due.
- Credit rating: If you finance a tax liability through a traditional note, you may increase your credit score by making payments on time.
The two strategies can be used in conjunction with each other. For example, you can use them both in one year: You can defer a portion of your fee and finance your remaining tax obligation. This would allow you to lower the current year taxes due by reducing your ordinary income and maintain liquidity by financing a tax obligation.
Third Strategy (Stack with an Insurance Product)
Alternatively, you can stack the strategies together and add in a third layer (leveraging insurance) to create optimal income streams in the future. For example, an attorney could use a deferred compensation program in year one and receive five equal payments in years two through six. The payments can be used to purchase an insurance policy (*life insurance or annuity). Spreading payments over five years might create a lower overall tax rate reducing the amount of tax that will need to be paid. The tax due in years two through six can be financed, allowing for the deployment of more funds into the insurance contract. The funds in the insurance contract can be received as loans (as opposed to income) and do not create a tax liability unless the policy is terminated. This three-tiered approach could minimize the overall taxes paid.
In combination, these three programs could provide the following benefits:
- Potential reduction of income tax due (tax deferral and insurance plan)
- Greater liquidity (tax financing)
- Tax-free cash flows (insurance plan)
- Death benefit protection (life insurance plan)
- Estate planning (tax deferral and insurance plan)
*Life insurance contracts are typically subject to medical underwriting.
Conclusion
The foregoing plans and programs have been used independently to plan. The use of all three may be a solution that works for you and your law practice. Creating a comprehensive plan to protect yourself from paying too much taxes on contingent legal fees while providing sufficient liquidity and cash flow are a prudent part of your overall financial planning process.
Turn to Synergy as trusted partner for your firm in mitigating the impact of taxation of contingent legal fees. Through a consultative process, we can build a strategic plan for reducing the tax burden on a year-to-year basis for fees as well as provide greater control over the timing of income. Consider us your guide to cutting edge tax deferral strategies for your firm. Learn more and contact us here.
IRS CIRCULAR 230 NOTICE: In compliance with IRS requirements, we inform you that any U.S. tax advice contained in this communication (or in any attachment) is not intended or written to be used, and cannot be used, for (a) the purpose of avoiding penalties under the Internal Revenue Code or (b) promoting, marketing or recommending to another party any transaction or matter addressed in this communication (or in any attachment).
November 10, 2022
By Jason D. Lazarus, J.D., LL.M., CSSC, MSCC
An often-overlooked issue for plaintiff attorneys is the management of taxation of their own contingent legal fees. As part of the normal rhythm of their practices, many attorneys experience peaks, and valleys with their own personal income. This leads to concerns for trial attorneys about the unpredictability of their own income. However, attorneys have a unique opportunity, not available to others who earn professional fees, to take their contingent legal fees and invest them on a pre-tax and tax-deferred basis to smooth out income. Attorney fee structures and deferred compensation arrangements allow lawyers to avoid taking income all in one taxable year when they earn a large fee. However, these solutions must be explored and decided upon prior to signing a release. While these financial products may seem complex, they are quite simple. Having an expert advisor who can provide you with different options is critical. The remainder of this chapter answers some frequently asked questions about deferral of contingent legal fees.
The legal foundation for this comes from a 1994 tax court decision Childs v. Commissioner.[1] This decision was the last time the Internal Revenue Service challenged an attorney’s ability to enter into an agreement to defer their contingent legal fees. In Childs, U.S. Court of Appeals for the 11th Circuit affirmed the tax court’s ruling that attorneys may structure their fees, holding that taxes are payable on structured attorney fees at the time the amounts are received.[2] The IRS has now cited the Childs decision favorably and recognized it as binding precedent in a Private Letter Ruling.[3] In that PLR, the IRS described that the “Tax Court held that the fair market value of taxpayer’s right to receive payments under the settlement agreement was not includable income in the year in which the settlement agreement was effected because the promise to pay was neither fixed nor secured.” It went on to state that the “court further held that the doctrine of constructive receipt was not applicable because the taxpayer did not have a right to receive payment before the time fixed in the settlement agreement.”
Since these are “tax-advantaged” plans there are rules and formalities which can be a bit inflexible. It is a well-accepted tax construction that works. A lawyer, who earns a contingent fee, must decide before settlement to have his/her fee paid over time instead of taking it in a lump sum. The fee that is being deferred is paid to a life insurance company which will agree to make future periodic payments. The decision to defer can be made at any point before the settlement agreement is signed, even right up to the moment before the agreement is signed. Even though a fee has been technically earned over the course of representation of the client, the lawyer (according to tax authorities) hasn’t earned the fee for tax purposes until the settlement documents are executed. An attorney has the autonomy to decide whether to defer all or part of their fee in this way.
Attorney Fee Structures
Attorney fee “structures” are annuities and work very much like a non-qualified deferred compensation plan. The taxes that would be otherwise paid on the fee earned at the time the case is settled are deferred, and that money grows without tax on the growth. When distributions are made, the entire amount distributed during a year is taxable for that year. Based upon a taxpayer’s tax bracket, there may be some distinct tax advantages to entering into this type of arrangement as opposed to being taxed on the entire fee in the year it was earned and investing it after tax. Depending on how much the fees are, current tax bracket rates and any other sources of income, stretching out payment of fees can result in potentially a smaller tax burden. This is a challenge in most professions; timing of income but controlling the realization of income is possible for attorneys. Using attorney fee structures, plaintiff attorneys can defer their fees and income taxes on those fees for personal injury cases as well as many other types of cases. An attorney fee structure allows an attorney to set up a personally tailored retirement plan without the monetary and age restrictions or other drawbacks of a qualified plan. The attorney can defer taxes on his or her fees as well as the interest that those fees earn until the year in which a distribution is received from the fee structure.
The fee structure can help a lawyer avoid the highest tax brackets by leveling off income spikes due to large fees and spreading the income out over several years. An attorney who otherwise would have an unusually high income in one taxable year, but elects to spread the income over several years, avoids paying taxes in the highest bracket. Couple the tax savings with guaranteed earnings on the deferred funds, and the benefits of an attorney fee structure become obvious. Fee structures can be done by one attorney in a firm, without the requirement that other attorneys and employees participate, as would be the case in a qualified retirement plan. Also, there is no limit as to the amount of income deferred. By comparison, there are statutory limits to the amount one can defer in a qualified retirement plan. Even if the attorney participates in a qualified retirement plan or individual retirement account (IRA), he or she may still defer additional income through an attorney fee structure. Unlike traditional retirement plans, there is no requirement of annual deferments. A bonus is that the attorney fee structure is exempt from creditor’s claims in most jurisdictions.
When an attorney fee is earned in a personal physical injury case, including mass torts, with all payments to the claimant being eligible for exclusion from taxable income under I.R.C. § 104(a)(2), or workers’ compensation case under section 104(a)(1), the same structured settlement annuities that the personal injury victim obtains can be used and the payment options are greatly expanded. A qualified assignment is done just as in the case of the personal injury victim. Attorney fee structures can also be done on fees from cases that are not personal physical injuries under section 104 (a)(2). These include fees from cases based on claims of discrimination, sexual harassment, employment litigation, defamation, wrongful imprisonment, wrongful termination, other non-physical personal injuries including emotional distress, punitive damages, bad faith, breach of contract and construction defects, to name several.
Since fee structures are pre-tax and tax-deferred investment vehicles, a major benefit is the compounding effect of deferring payments out over longer periods of time. The longer an attorney waits for payments or the longer the duration of the distribution term, the better the financial result and possibly the tax result as well. Payments can start right away, but don’t have to. They can be deferred for any length of time and then can be paid out over a duration of years or for life. There are almost infinite possibilities in terms of the different types of arrangements that can be set up.
While structuring one hundred percent of every contingent fee earned probably doesn’t make sense or even a percentage of every fee, there are some unique benefits to doing so that shouldn’t be ignored. A systematic approach to structuring a portion of every fee can lead to a very attractive end result when an attorney wishes to retire. For example, if an attorney took fifteen to twenty five percent of every contingent fee earned and deferred it out to retirement, then they would have taken advantage of the benefits of a stable retirement income, estate planning advantages and tax benefits that most people in the workforce can’t achieve. With the unpredictability of the contingent fee law practice and life in general, you don’t want to rely on any one solution for retirement and so exploring fee structures is one way to hedge against the uncertainties.
There are some key reasons to do an attorney fee structure:
- It is a pretax investment in a guaranteed high yielding tax deferred annuity.
- Deferring compensation over time results in less being lost to taxes.
- Application of AMT can potentially be avoided.
- Gives you custom cash flow management and allows you to tailor your own income stream.
- Structured fees have enhanced protection from creditors, judgments, and divorce decrees.
There are some frequently asked questions related to structured attorney fees.
- Does the personal injury victim have to structure a portion of their settlement before the attorney fee can be structured? No. The claimant can take one hundred percent cash and the attorney fee can still be structured.
- How does fee structuring work? Structuring an attorney fee works very similarly to structuring the victim’s settlement. The most important thing to remember is you can’t take receipt of the fees.
- Why structure an attorney fee in a fixed interest rate annuity? Every portfolio should have some portion of the investments in fixed income. An attorney fee structure is a fixed income investment but unlike all others an attorney can make, the fee structure is a pre-tax investment. Whether a fee structure is appropriate for you will depend on a variety of factors, including your age, health, risk tolerance, retirement goals, tax bracket as well as your current and long-term needs. However, structuring your attorney fees could provide beneficial tax relief as well as secure and stable tax deferred income up to, and including, your lifetime.
- Can I receive the same types of income streams the victim can with their settlement proceeds? Yes, you can have lifetime benefits. You can have a “period certain” for a defined amount of time or a future lump sum payment as well as a series of lump sum payments. You can select immediate or deferred payments. You can have multiple income streams such as lifetime payments coupled with lump sum payments.
- Can I only structure contingent fees from a personal physical injury or wrongful death settlement? No. You can structure contingent fees from nearly any type of settlement. Companies have developed innovative products to expand the availability of attorney fee structures.
- What do I need to do to prepare for structuring my attorney fees? You should negotiate the inclusion of the fee structure when settling the case since the creation of a tax-deferred fee structure does require the cooperation of the defendant like when the victim’s settlement is structured.
While the foregoing discussion focused on “fixed” attorney fee structure annuities, there are two other potential options that are available. First, there is an equity indexed attorney fee structure product. The equity indexed attorney fee structure ties return to the S&P 500 index. If the index is up, your payments increase. If the index is flat or negative, there is no decrease. So, no downside risk, only upside. The upside though is limited to a maximum ceiling of 5%. As the payments increase, they lock and you can only go up, never down. This type of product provides more upside potential than the traditional “fixed” fee structure while remaining conservative. Second, there is a “non-qualified” attorney fee structure. These products in this type of structure involve an “off-shore” assignment to achieve tax-deferral based on international tax treaties. Instead of using an annuity as the funding vehicle, these are open architecture allowing the attorney to use his own financial advisor to select appropriate investments which typically include stocks, mutual funds, ETFs, bonds and other investments. These types of products are like the deferred compensation plans described immediately below since there are more available investment options but inherently have some additional risk due to the “off-shore” assignment. As with all the decisions associated with fee deferral, you should consult with your own tax advisors to determine what is most suitable.
Deferred Compensation Plans for Attorneys
A non-annuity deferred compensation arrangement is another mechanism that trial lawyers can use to invest the contingent legal fees they earn on a pre-tax and tax-deferred basis. Like Fortune 500 executives who defer their compensation, you can defer all or a portion of your fees until you are ready to start receiving them. Using this kind of solution, you have flexibility with investments as well as more control over timing of income. For example, if you wanted to defer a five hundred-thousand-dollar fee in the current taxable year by splitting the fee plus the investment gains into twenty quarterly payment buckets you could do so. Thirteen months prior to any scheduled quarterly payment, you can elect to withdraw it. However, if you don’t need the payment, the payment bucket will automatically roll forward to the end of the line. By laddering payments in this way, you can effectively manage your cash flow and better control the timing of taxation.
From a legal-tax perspective, fee deferrals are subject to the same body of tax rules that govern Nonqualified Tax-Deferred Compensation (NQDC). So, this means that the deferrals must avoid the application of the constructive receipt and economic benefit doctrines. NQDC has been used for decades by Fortune 500 companies to attract, retain, and further compensate their top-level executives. These deferred compensation plans rely upon the same decision as attorney fee structures, Childs. Since the legal underpinnings are the same and are well established, the risk is relatively like attorney fee structure annuities.
Conclusion
In summary, attorney fee deferral solutions allow a plaintiff lawyer to not only defer receipt of (and tax on) fees until received, he or she can have the deferred fees invested, and have the income produced from it also taxable over time rather than immediately. A lawyer may want to consider deferring fees as part of his or her own income tax planning, financial planning, and estate planning. Tax deferral mechanisms for lawyers are a great way to smooth out those income spikes caused by larger fees or just take better control over timing of income. Due to the variety of options, there is likely something that will best suit an attorney’s needs and investment preferences. Attorneys should explore these options to take back control of timing of income.
[1] Childs v. Commissioner, 103 T.C. 634 (1994) affirmed without opinion 89 F. 3d 56 (11th Cir. 1996).
[2] Id.
[3] PLR-150850-07
March 11, 2021
Trial lawyers have been deferring fees into structured settlement products dating back to the early 1990s. The IRS challenged fee structure arrangements in Childs v. Commissioner.[1] In this seminal 1994 tax case, the IRS argued the fees should be taxed in the year earned; however, the lower court and the 11th Circuit affirmed the decision that the fees are not taxable in the year earned but in the year(s) payments are received from the attorney fee structure. The ruling is more in-depth, but this established the precedent allowing fee deferral solutions to be developed.
The basic concept of these solutions is an irrevocable assignment of a fee before it is earned. This creates separation and keeps the taxpayer from taking constructive receipt of the funds. [2] A portion of the fee (up to 100%) can be used to purchase periodic payments that are taxed in the calendar year that funds are received. The amount deferred is not limited like a traditional 401(k) or IRA program. The age funds can be received is also not limited, so payments can be made before age 59.5.
What does this mean to an attorney? Simply put, with proper planning an attorney can manage the timing of their income. This gives the attorney two ways to generate a return on their fee. The first way is to earn a return via the investment itself. The products available offer a variety of investment choices. An attorney can be as safe or aggressive as they choose from an investment perspective. Products are available that allow an attorney to place a fee in a variety of annuity or investment funds. The variety of options has increased over the last ten years and allows for most people to find a solution that meets their objectives. The return can be fixed or variable in these products. The interest earned is deferred.
The second way to earn return is to receive payments at a lower tax rate in subsequent tax years. Regardless of political views, almost every change in the White House comes with a new tax plan. The tax plan usually involves some changes to the marginal rates on earned income. President Biden has introduced a variety of tax-related items during the past year. One that he frequently referred to during his campaign was an increase on top earners. He has stated that he will seek an increase the marginal tax bracket from 37% to 39.6% for those earning over $400,000. He has also proposed moving the capital gains rate to 39.6% for those earning over $1,000,000. These two changes could allow an attorney to pay a lower amount in taxes if they can defer until tax rates are lower. Any reduction in tax payments creates an added return for the attorney.
If you can combine a positive return on your investments and a reduced tax burden, you have created two ways to benefit from deferring a fee. The products in place create powerful tools that are not available to most taxpayers. It can be used in combination with other retirement plans to create income without a penalty before age 59.5. It can be used to defer excess amounts when you reach your deferral limits, which is $19,500 in 2021.
Attorney fee deferrals have a lot of benefits and with proper planning can create a more comprehensive retirement plan for most attorneys. It is always a good exercise to review the options with your tax and planning advisors to see what plan matches your long-term goals.
[1] A summary of Childs v. Commissioner can be found here: https://www.irs.gov/pub/irs-wd/0836019.pdf
[2] An explanation of constructive receipt can be found here: https://www.law.cornell.edu/cfr/text/26/1.451-2
[3] The IRS’ contribution limits can be found here: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits
May 13, 2020
An often-overlooked issue for plaintiff attorneys is the management of taxation of their own contingent legal fees. As part of the normal rhythm of their practices, many attorneys experience peaks and valleys with their own personal income. This leads to concerns for trial attorneys about the unpredictability of their own income. However, attorneys have a unique opportunity, not available to others who earn professional fees, to take their contingent legal fees and invest them on a pre-tax and tax-deferred basis to smooth out income.
To learn more download at the link below.
Reduce Taxes and Save for Retirement with Attorney Fee Deferrals
A few months ago, a trial attorney in New York City had just settled a big case. He was like a lot of people reading this article; well-respected, successful, hardworking. But while he was excited about the result, he was frustrated with the massive amount of taxes he would have to pay. So, he decided to consider deferring his fee.
He learned that deferring fees is similar to the deferred compensation programs offered to top executives at Fortune 500 companies. Just like in a 401(k), you don’t pay taxes on the fee until you receive it. In the meantime, the money earns the returns of various investments that you or your financial advisor chooses – stocks, bonds, real estate, etc. But unlike a 401(k), there is no limit on how much you can defer.
This can significantly reduce your tax burden in two ways. First, as with a 401(k), when you pay taxes later, your money grows faster. Second, by spreading the income out over time, you can end up in a lower tax bracket.
In addition to reducing his tax burden, this attorney learned that deferring his fee enabled him to better meet his cash-flow needs. While he wasn’t allowed to accelerate his scheduled distribution payments, he could choose to re-defer his payments within the rules of tax-deferred compensation. In addition, fee deferrals can be used as “golden handcuffs” to retain key associates, whereby if they leave too soon their deferred bonus comes back to the firm.
Ultimately this attorney did his due diligence and decided to defer a $1,000,000 of his fee. He ultimately chose to defer to significantly reduce his tax burden and better control his cash-flow needs.
Key Takeaways
- Attorneys can defer compensation like Fortune 500 executives do, to reduce their tax burdens
- Tie your fee to the returns of investments that you select – stocks, bonds, real estate, etc.
- Exercise better control over the timing of payments, and the resulting taxation.
- Use “golden handcuffs” to retain key associates, whereby if they leave too soon their deferred bonus comes back to the firm.
This attorney is one of the hundreds that have deferred fees in recent years. In fact, the concept has been around for decades. A lawyer’s right to defer fees was established by the U.S. Tax Court in Childs v. Commissioner (1994) and affirmed two years later by the 11th Circuit U.S. Federal Appeals Court. The IRS also cited the Childs case favorably in Private Letter Ruling 200836019.
From a legal perspective, fee deferrals are materially subject to the same body of tax rules that govern Nonqualified Deferred Compensation (NQDC), namely the constructive receipt and economic benefit doctrines. As mentioned earlier, Fortune 500 companies have been using NQDC for many decades to attract and retain their top executives.
So, what are the steps to defer? The steps are quite simple – and similar to a traditional fee structure. The attorney must enter into a Deferred Payment Agreement before the final settlement (i.e. before signing the release). Each partner decides how much to defer and for how long. This is the most critical part of the process.
It is also recommended that deferral language is added to the fee agreement with your client providing the client’s consent to fee deferrals and that the defendant is instructed to wire the deferred amount directly to the trustee and custodian. Payment instructions are often included in the release agreements, as well. In some cases, settlement monies are first paid into a Qualified Settlement Fund (QSF) and form there wired to the trustee and custodian. A QSF is basically an escrow account or trust that provides the necessary time for proper settlement planning and liens negotiation. In essence, it gives both the clients and the attorneys more time to figure out what to do with the settlement monies without the involvement of the defendant.
Fee deferrals can offer a range of benefits, from reducing an attorney’s tax burden to increasing their access to cash and helping them retain key associates. Deferring fees is not for everyone, however, particularly if an attorney needs the money now. And if an attorney does want to defer, selecting the right provider is critical to the safety of the deferral.
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