Summer is here, and it’s hard to believe we are halfway through 2018! Do not take a vacation from your financial health. NOW is the time to dive into some proactive tax planning and to ensure you are utilizing the available tools to reduce your future taxes (especially in light of the new tax law).
Attorney Fee Deferrals: What are They and How do They Work?
Structured attorney fees are arrangements whereby an attorney chooses to defer the tax liability on their contingent fees. By placing a portion of attorney fees into a structured annuity, the fees are then received over time in a series of periodic payments. More often than not, attorney fee deferrals utilize a fixed annuity as the financial vehicle to fund future payments. The defendant (or insurance company) directs the attorney’s fees to an assignment company, which then purchases a fixed annuity that provides the attorney with regularly scheduled payments. Payments can be direct deposited into your account and will be reported on a 1099-MISC as income only during the years in which you receive them.
Unlike most traditional investment options, traditional fixed attorney fee deferrals do not have any ongoing administrative or maintenance fees, which allows you to keep more of your hard-earned money. You can choose to structure your fees even if the claimant does not take advantage of a structured settlement annuity.
IRS Guidance and Tax Consequences
One of the questions that we frequently receive in regards to attorney fee deferrals is whether the IRS has released guidance on the subject. In fact, the Tax Court in Childs v. Commissioner, 103 T.C. 634 (1994), aff’d, 89 F. 3d 856 (Table)(11th Cir. 1996) ruled that the attorney did not have constructive receipt of the fees since they were transferred directly from the defendant to the assignment company. As a result, the fees did not count as taxable income until the annuity payments were received.
By spreading the payments over multiple years, attorneys can take advantage of pre-tax growth, while reducing their tax liability within a given year. There is also an option to have the income stream paid directly to the law firm, rather than to an individual attorney. If that’s the case, then the law firm will have to report the payments as taxable income during the years in which the payments are received.
Flexibility is Key
In addition to pre-tax growth, another major benefit of leveraging an attorney fee deferral is flexibility in terms of:
- Timing and amount: With a Fixed annuity, payments can be scheduled to be received monthly, semi-annually, annually, or in a series of a few larger lump sums. Depending on the issuing insurance company, you can elect to have your payments start right away or at a specified future date.
- How the money is used: Once you receive your payments, you can use your money as you wish. This provides a huge advantage over certain other financial vehicles that may only allow the funds to be spent on qualified expenses (as is the case with 529 college savings plans for example). Whether you want to use the payments to help your children pay for higher education, to help fund your retirement, or simply to provide a stable source of income to fill in gaps throughout your working years, you have the flexibility to do so. There are no limits to the amount you can structure in an attorney fee deferral.
- Multiple Payment Streams: Some issuing insurance companies will allow the payment streams to be split among individual attorneys and the law firm.
A Few Caveats
If you are interested in structuring your fees, there are a few things you’ll need to remember:
- Settlement Agreement: The decision to defer fees must be made prior to finalizing the settlement and appropriate language indicating the fee structure must be included in the settlement agreement.
- Modest Return: Fixed annuities are not aggressive investments, but what they may lack in double-digit returns, they make up for in reliability. The rate of return is fixed and guaranteed, so even if the market takes a dive like it did in 2008, your fee deferral payments will remain constant. They provide a stable bedrock for a low-risk, diversified investment portfolio.
- What’s Done is Done: Unfortunately, attorneys cannot utilize fixed annuities for fees that have already been received. Again—make sure you have the required language in the settlement agreement!
Alternative Options to Fixed Annuities
For years, fixed annuities have been the most commonly used financial vehicle for attorney fee deferrals. However, many other deferral options now exist in the marketplace, offering attorneys a range of financial solutions. It is important to note that minimum investment requirements may vary depending on the product, and non-fixed annuity options may include setup and/or annual administration costs.
Contact Us Before Your Next Case Settles