Attorneys: Are You Minimizing Your Tax Obligations?

Today is the deadline to file 2016 tax returns and once again, you may have found yourself stuck with a large tax obligation.  Every year, thousands of attorneys pay more in taxes than they need to because they haven’t explored all of their tax minimization strategies. But did you know that lawyers who earn contingent legal fees have the unique ability to control when and how their income is taxed by utilizing attorney fee deferral strategies?

Unpredictable Income = Unpredictable Tax Burden

Before we look at the deferral options, it’s important to note that the option to defer fees has to be included in the settlement agreement. There is no requirement that the claimant structure their settlement proceeds and regardless of whether the claimant’s settlement is taxable or non-taxable, attorney fees are structured on a tax-deferred basis.

An attorney fee deferral allows you to defer all or a portion of your fees and only pay taxes in the year the funds are received. The ability to control the timing of your income offers a huge advantage over other professions where it can’t be controlled. Each payment is fixed and determined at the time the structure is established during settlement, providing you with a reliable, consistent source of tax-deferred income.  Most often, the funding vehicle is an annuity offered by a highly rated life insurance company.

Here’s an illustration of how a fee deferral could help you retain more of your hard-earned money:

Thomas, an attorney, and his wife Beth file a joint tax return every year. Their combined annual income is about $400,000, putting them in the 33% tax bracket. In December, Thomas settles a case that nets him a $150,000 fee.

This fee makes Thomas and Beth’s joint taxable income $550,000 and bumps them into the highest federal tax bracket of 39.6%. At a tax rate of almost 40%, Thomas will be paying Uncle Sam virtually all of the last fee he earned.

On the other hand, if Thomas sets up a deferral for his $150,000 fee, he could potentially stay in the 33% tax bracket, or at the very most, the 35% tax bracket. By spreading his payments out over time, Thomas can keep more of his money in his pocket.

In fact, for states like California that also charge a state income tax, there is even more room for potential savings by diverting some of the income to future years.

More Than Just Tax Benefits

Attorney fee deferrals offer a number of advantages in addition to potentially lowering your personal tax liability, including:

• Reliable source of future income. Your structured fees can provide you with a predictable source of income whether business is up or down. You can schedule larger lump sum payouts for future life events, such as college tuition for your children, large purchases or retirement.  The periodic payments can also be paid in the short term to provide immediate cash flow.
• Retirement supplement. Attorney fee deferrals offer benefits similar to traditional qualified retirement programs and IRAs in terms of taxation, but do not share contribution limits or restrictions on distributions like qualified retirement plans.
• Investment upside. Attorney fee deferrals have an added return on investment with compounding on a pre-tax basis.  Fees are invested pre-tax, allowing your money to earn interest and no tax is due until distributions begin.

Are Fixed Annuities the Only Option?

While fixed annuities are the most commonly used financial instruments for attorney fee deferrals, the landscape has changed since their inception. Many other deferral options now exist in the marketplace, offering a range of solutions. Minimums for investment can vary depending on the product and there may be set-up and/or annual administration costs.

Contact us to learn more

Our experienced team assists the nation’s top attorneys in developing fee deferral strategies to lower their overall tax burden and meet their financial goals. Contact Traci Kaas today at 800-354-2258 or info@tracikaas.com to learn more.

Note: The Settlement Traci Kaas does not provide legal or tax advice.