As 2017 comes to an end, we’ve rounded up our most frequently asked questions about attorney fee deferrals. From choosing a payee to determining the tax consequences, here is everything you need to know to take advantage of a financial opportunity available only to contingent fee attorneys.
How does an attorney fee deferral work?
Attorney fee deferrals typically utilize a fixed annuity to fund future payments. The defendant (or insurance company) directs the attorney’s fees to an assignment company. The assignment company then uses the funds to purchase a fixed annuity that provides the attorney with payments based on a pre-determined schedule. Payments are eligible to be electronically deposited into your account and will be reported on a 1099-MISC as income only during the years in which you receive them.
If my client does not structure their settlement, can I still defer my fees?
Yes, attorney fees may be accepted individually or in conjunction with a claimant’s settlement. However, the decision to defer fees must be made before finalizing the settlement, and the appropriate language must be included in the settlement agreement.
Can the payments be made to the law firm, or do they have to be made to an individual attorney?
Attorney fee deferrals are flexible in design, so you can choose to have the payments made to your law firm (to stabilize payroll and overhead expenses, for example), or you can choose to have the payments made directly to you. Some issuing insurance companies also allow you to split the payment streams between individual attorneys and the law firm.
Are there overhead fees associated with structured attorney fees?
Most traditional investment options are laden with fees. Structured attorney fees do not have any ongoing administrative or maintenance fees, so more money stays in the attorney’s pocket. There are alternative fee deferral programs in the marketplace; however, those products typically have upfront or ongoing fees associated.
What are the tax consequences?
Attorney fee deferral payments are considered taxable income during the year in which the payments are received; this holds true regardless of the payee. The benefit is pre-tax growth. If the income stream is paid to the law firm, then the payments are considered taxable income to the firm. If the payments are made directly to the attorney, then the attorney will have to report the payments as taxable income. The tax-favored treatment may help lower your tax obligation by reducing your taxable income and potentially allowing you to remain in a lower tax bracket.
Is there any written guidance on how the IRS views structured settlement annuities for attorney fees?
Much like a structured settlement annuity for injured claimants, the tax treatment hinges on constructive receipt (or rather, the lack thereof). In Childs v. Commissioner, 103 T.C. 634 (1994), aff’d, 89 F. 3d 856 (Table)(11th Cir. 1996), the Tax Court ruled that because the attorney’s fees were transferred from the defendant directly to the assignment company, the attorney did not have constructive receipt of the fees. Therefore, the fees did not yet count as taxable income.
Do I have to begin receiving payments immediately, or can I elect to begin receiving them in the future?
You are in control over the timing and the size of your payments. You can schedule payments to be received monthly, semi-annually, annually, or in a series of a few larger lump sums. You can elect to have your payments start right away, or you can defer them to pay in the future (note: start date restrictions may vary depending on the issuing insurance company). Any decisions regarding the payment schedule must be made before finalizing the settlement.
Can I structure fees that I’ve already received?
If you’ve already received your fees, you’ve missed the opportunity to use a structured annuity product. The option to defer fees must be included in the settlement agreement.
What sort of return can I expect?
If you are looking for an aggressive investment that will provide you with a double-digit rate of return, a structured attorney fee is not the best option. However, what the fee deferral lacks in an aggressive return, it makes up for in reliability. The rate of return is fixed and guaranteed—that means that even if the market takes a dip, your fee deferral payments remain constant. Any experienced financial planner will tell you that the best route to wealth is a diversified portfolio, and an attorney fee deferral can serve as the bedrock for your investment plan.
Are there restrictions on how I can use the money?
No. Once the payments are received, you are free to use the money as you wish. For instance, you could set up annual payments to be made during the years your children are in college. If you use a traditional college investment vehicle, such as a 529 plan, the funds must be spent on qualified educational expenses as laid out by the IRS. On the other hand, if you use structured attorney fees, you can choose how much of the payment goes towards college, while reserving the remainder of the funds for other goals. You may also choose to use deferred fees as a method of funding your retirement plan. While the IRS places limits on traditional retirement plan contributions, there are no limits to the amount you can structure. You can also layer several structured attorney fee payment streams from multiple cases to build an income portfolio, or fill income gaps.
Are fixed annuities the only option for deferred fees?
To date, 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 minimums for investment may vary depending on the product, and non-fixed annuity options may include setup and/or annual administration costs.
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