There’s good and bad news with a huge settlement. It’s always good when your bank account gets fatter, but the not-so-good news is you have to share 50% of your legal fee with Uncle Sam (a/k/a the IRS). Ouch! For savvy plaintiffs’ lawyers, there is a unique solution.
Since 1996, the IRS allows plaintiffs’ lawyers to defer their legal fees prior to settlement. Childs v. Commissioner, 103 T.C. 634 (1994), affirmed without opinion, 89 F.3d 856 (11th Cir. 1996). Plaintiffs’ lawyers can defer the receipt of a legal fee by using a structured settlement annuity that provides payments in future years. The legal fee structure is only available to contingent fee plaintiffs’ lawyers. You can structure all, or a portion, of your fee on a given case.
The Benefits of Deferring Legal Fees
The benefits of deferring legal fees in personal injury cases include:
- Providing a source of income to match against future deductible business expenses, i.e., smooth out future cash flow,
- Avoiding massive tax liability on large cases,
- Tax deferral of the payments until actually received, and
- Asset protection for plaintiffs’ lawyers.
This translates into an investment return equal to your tax bracket. Instead of being taxed now on the entire amount, your income payments are reported to the IRS in the year you receive them. For those in a 50% tax bracket, you can save 50% in income taxes in the year of the settlement just by deferring your legal fee. Not a shabby return on investment.
Stretching out payments over time yields a better tax result. Because of the tax-free compounding, the longer you stretch out the payments, the better the financial result.
You can spread out the payments in the future to pay for your firm’s overhead expenses. In essence, you are prepaying expenses and smoothing out your firm’s cash flow. With the right planning, you can ensure that your firm’s overhead is prepaid with predictable income that is guaranteed.
Deferring Legal Fees to Fund Your Retirement
Unlike traditional 401(k) retirement accounts, there are no limits on contributions amounts or required minimum distributions. You can customize a retirement plan that fits your individual needs and construct a kind of unlimited Individual Retirement Account. Structured legal fees can fund retirement in 20 years. This is an exceptional benefit that is available only for plaintiffs’ lawyers.
You may want to structure a particular percentage of every case as a kind of retirement fund. If you structure 10% of every fee and put it away tax-deferred, you get the benefits of tax deferral and retirement planning.
WARNING: Don’t Sign the Settlement Agreement Just Yet
You must elect to defer the fees before they are “earned”. You must agree to a fee structure before your client signs the settlement documents. Once the release agreement is signed, it’s too late to structure fees.