Providing tax related investment advice to trial lawyers is one of the most rewarding components of our comprehensive practice. Still, few lawyers realize they can defer an unlimited amount of fee income every year. It’s truly a gift. Every other executive profession including doctors would love to have this tax benefit.
What is an Attorney Fee Deferral?
Essentially, any obligation set forth in a release to a qualified settlement fund (QSF) trustee or defendant that creates an irrevocable payment to the attorney of record for the plaintiff. These fees can be paid in this manner in accordance with Childs vs IRS, and 11th Circuit case from 1996. The basic rules are that the lawyer can’t receive the settlement monies and must elect periodic payments prior to executing releases. The attorney or his or her firm can be the “payee.”
The payment stream is an asset of the attorneys estate, and is paid as 1099 ordinary income in the year of receipt. What is the value of unlimited pre-tax growth? With cumulative tax rates in some states and cities over 50 percent, many attorneys are looking for ways to invest their fees before taxes. See Childs v. Commissioner, 103 T.C. 634 (1994, aff’d without op. 89 F.3d 856 (11th Cir. 1996). The ABA discussed this thoroughly here.
“Section 409A, which was added to the Code in 2004, deals with the requirements for deferred compensation arrangements. The Service issued a notice entitled ‘Guidance Under § 409A of the Internal Revenue Code’ on December 20, 2004. The notice’s question-and-answer section provides that the limitations of Section 409A does not extend to this type of fee deferral arrangement.”
So, why don’t more trial lawyers make this part of their practice and wealth management?
Six big reasons include:
- They don’t know it actually works or that they can invest in something other than an fixed annuity.
- Lack of understanding how Qualified Settlement Funds work, and that their income deferral need not be subject to the review of defendants and their attorneys.
- Assumptions that all of a fee must be deferred.
- Complex partnerships, and the assumption that all equity partners must go along.
- Assumption that taxes will be lower, or that pre tax growth isn’t all that financially attractive.
- Assumption that future needs of their law firm require liquidity and accessibility of their money.
These tax deferrals are real for contingency fee practices of attorneys practicing in personal injury, sexual assault, employment discrimination, multi-district litigation (MDL) and class actions.
Areas of Due Diligence and Concern
Be knowledgable about the ownership framework of the deferred fee and the non-qualified assignment (see the relevant PLR here). Our fee program offers a default judgement in the even of insolvency or failure to pay of the account owner, a strategically key security feature.
A sample case was an attorney with 11 other equity partners settled a TVM inventory and established a QSF for the inventory settlement. By talking through the accounting with her partners, a percentage of the $5 million fee on the settlement was paid to the firm directly for all of the partners who did not want to elect a tax deferral, and our client chose periodic payments established between her, her clients and the QSF trustee. With the fees invested in the SP500 and Russell 2000 and other globally diversified portfolios, our client will achieve significant pre tax growth for her future. This money most importantly has also been invested outside the practice of law, so it is no longer at risk.
Are attorney dee deferrals and structured attorney fees like your firm’s 401k? Yes, but better. No limitation on contribution, no restrictions to age 591/2. Younger attorneys would do well to talk to their partners early in their career and start doubling what they put in their 401k. Under 2018 tax law, you can put $17,500 into a 401k.
The fees for these programs can be significant. Do your homework. We simply charge one percent on the assets under management, a fraction of what other firms charge, and what contributions to your profit sharing plans may be costing you.
A key liquidity feature many attorneys look for is “emergency liquidity.” Our contract provides for a one time, no penalty, no fee full liquidation of the account holdings should the circumstances of the attorneys’ finances change drastically. This is supported through traditional structured settlement protection act laws that allow for any recipient to sell their periodic payment obligations.
We think it is just smart business. We can provide a free consultation, a review of your firms profit sharing plan or 401k, and can help you decide wether a deferral in any particular year is the right choice.
A West Point graduate where he served as captain and military aviator, John Bair continues his commitment to our country through his efforts within the settlement planning industry. He has represented families of victims lost in the Flight 3407 crash, offered pro bono services to the families of 9/11 victims and drafted the first consumer protection bill for plaintiffs (H.R. 3699).