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John Bair
John Bair
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Attorney Fee Structures? Deferred Compensation? How Attorneys Are Controlling Revenue and Taxes

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Trial attorneys are at a distinct advantage in terms of managing their wealth over business executives and doctors. As the only profession with access to unlimited income deferrals, let’s look at all of the concepts that support wealth accumulation for trial lawyers.

Trial lawyers typically have the typical tools available to invest their fees in:

  • New cases and firm overhead
  • 401k and profit sharing plans
  • Buy/sell/keyman life insurance
  • Defined benefit/contribution qualified retirement plans
  • Structured fees held at TD Ameritrade in an investment account
  • After tax wealth management

Getting a Balanced Plan

The benefits to a legal career comes in the form of a healthy balance sheet. When earnings year after year are invested in expansion, growth, associates, overhead and new cases, the personal balance sheet isn’t affected.

attorney fee planning

Click the image to read Milestone Consulting’s free guide to attorney fee deferrals.

I’ve known many lawyers whose practice is grossing seven-figure fees per year, but they are making less that two partners with low overhead. Investing in the practice is a critical part of any business process, but it’s not part of a balanced plan if it’s the only accumulation attitude. As a dependable rule, 10 percent of a firm’s revenue should be earmarked for investment outside the firm for the equity owners before distributions.

401k and Profit Sharing Plans

Traditional retirement plans such as 401K and profit sharing plans are advantageous, as they leverage the pretax dollar invested principle. However, these plans are lightweight solutions to big tax problems. The 2016 limits for 401K contributions and profit sharing plans is $18,000, and even safe harbor plans that allow heavy shifting to the ownership are limited to about $50,000 per year in pretax contributions. The 59 ½ age limit and 10 percent penalties exist for these qualified plans.*

Life Insurance

Permanent life insurance can be a great accumulation vehicle for a practice. Large mutual companies like Massachusetts Mutual, Guardian, Northwestern or New York Life offer policies with historical dividends rates of six percent and higher.  These types of policies are cash efficient and provide death benefits simultaneous with the cash management, but they are primarily useful as a cash vehicle. These investments are not tax efficient though, as the premiums are not deductible in a practice, so you are investing after tax dollars with this strategy.

Defined Benefit and Contribution Qualified Retirement Plans

Furthermore, traditional defined benefit and contribution plans give practices the ability to defer up to $250,000 and $53,000 respectively a year,** and more given the age of the equity group. However, they come with significant limitations like all qualified plans do. On the contribution side, partners must decide how much they can afford each year, which for most practices is very difficult to do. Defined benefit plans are well suited, but they carry the cost of census testing, and it can cost roughly 20 percent on average to contribute to these plans due to mandatory contributions toward employees and staff.

Structured Attorney Fees

Structured fees have grown up. With tax precedence since 1996, and published guidance for equity based periodic payments (MetLife received the PLR in 2003), structured fees have enjoyed growth due to the ability to be invested in equities rather than just fixed income or fixed guaranteed annuities. On a national scale, many firms are now promoting the use of offshore assignment companies to facilitate the creation of periodic payments, or structured payments, that meet all necessary tax guidance and rulings. Our program custodies assets are held at TD Ameritrade, and the investment accounts can and should act like another sleeve in the portfolio of the trail lawyer.

What’s the Catch? 

The distribution design must be irrevocable at the time of settlement, so leveraging this concept requires a comprehensive strategy long term.  The nature of the periodic payment is by design illiquid – although state protection act laws allow for hardship liquidation on a one-time basis. Taxation on the income or revenue from fees does not occur until the year of receipt. So, an attorney receiving a referral fee, or a contingency fee of $500,000 can place all or some of that fee for that particular case into this deferral strategy. The tough decision is designing the distribution.

Lawyers considering the strategies should be very cautious about schemes that purport to provide a line of credit or access to capital against the deferred assets. These strategies are in clear conflict of the economic benefit doctrine and will guarantee a negative tax law for all. Trial attorneys availing themselves of this particular strategy can work with an investment advisor yearly to make changes to the strategy to the degree of risk in which they choose to engage. Our assignment company in Barbados, Global Periodic Payment Assignment Company (GPPAC) is a worldwide company that will accept assignments on cases involving taxable damages and attorneys fee structures. There is no limit to how much you can contribute in any one year, which is a huge advantage over other qualified plans available to successful attorneys.

Taking it Home

Although expensive, every balanced plan will include significant amounts of liquid, after tax investment holdings. A good rule of thumb: roughly 50 percent of your net worth should be liquid and after tax. The goal in your practice should be to grow these two conceptual accounts of assets equally over the course of your career. Sufficient cash will allow you to better manage your practice and your quality of life. Trial lawyers in their 20s, 30s and 40s should lean more heavily on their tax deferred accounts, as the benefits of time and accumulation pretax will be a game changer later on in their career.

So, assuming you can afford to start making deferrals, even in small increments of $25 or $50 or $100,000 increments, the deferred fee is the safer, more efficient long term investment with lower risk. When done in conjunction with all of the available strategies discussed, it’s a valuable tool for trial attorneys to consider.

Making good money isn’t enough to obtain financial success into the future. When you are in the peak of your career – and 50 cents on the dollar is going to the IRS every April – looking at the strategies that support your accumulation and wealth building are critical activities in your legal career. Just like in trial, it’s about mitigating risks.

 


 

* Retirement Topics – 401(k) and Profit-Sharing Plan Contribution Limits. Internal Revenue Service. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits

** Choosing a Retirement Plan: Profit-Sharing Plan. Internal Revenue Service. https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-profit-sharing-plan