Summit Home • About Us • Services • Life Markets • Information • FAQs • Resources • Contact

Attorney fees may be deferred either as part of a "qualified assignment" of the future payments due to the client, as a convenience to the client and to satisfy the attorney fee debt, or in a non-qualified assignment. The use of the non-qualified option gives the attorney flexibility to structure fees due from other than personal physical injury or physical sickness cases. For an attorney who does not practice in physical injury tort law or workers' compensation, the non-qualified assignment option opens up the opportunity to structure fees due from many other types of cases. An attorney fee structure can be a personal discriminatory retirement plan.

Advantages of converting an attorney fee receivable into a deferred compensation plan are:

• There is no limit on the amount an attorney can defer in any year
• There is no requirement to contribute to the plan in future years
• It can supplement qualified retirement plans, again with no deferment amount limits, unaffected by the amount contributed to the qualified plan
• It can be done in addition to a SEP or an IRA, with allowed deferments unaffected by the amount contributed to the SEP or IRA
• Each time you defer a fee constitutes a separate plan, and you can have as many deferred compensation plans as you wish
• You can layer income from different plans over the same payment period and, if the funding assets are issued by different companies, you achieve portfolio diversity
• There are no annual plan evaluations required, as there are in qualified plans
• There is no requirement to include law partners, and non-attorney employees cannot participate except through separate deferred compensation agreements with the attorney
• There is no necessity to wait until age 59 1/2 for distribution from the plan
• You can set up lump sum payments to cover known future needs such as college education for children or to build a retirement home
• The money inside the plan, whether invested in an annuity or funded with a reinsurance assumption agreement, is guaranteed to grow at a rate specified at the time the plan is established - unaffected by the future performance of the investment marketplace. The guarantee is made by a venerable financial institution - a highly rated life insurance company by the independent analysts, i.e. Moody's, S&P, Fitch, A.M. Best - which holds the asset
• You can avoid the highest tax bracket in an extraordinary year by spreading out income
• The plan can survive bankruptcy or divorce

It is easy to see why a client whose damage recovery for a physical injury or physical sickness is excluded from gross income would want to receive periodic payments. The benefit is obvious. All growth of the funding asset is tax-free to the payee as long as the payee never had actual or constructive receipt of the funds used to purchase the asset, and has no ownership rights to the asset. Not only does the client receive the amount paid by the defense free of income taxes, the client can also receive future growth of that money tax-free.

In contrast, attorney fees are always taxable to the attorney as income in the years in which the fees are paid, constructively received or if the attorney is deemed to have economic benefit of an amount set aside to make future payments. The benefit of structuring taxable payments may not be so obvious, but they are significant. The taxes that would be otherwise paid by the attorney on the income earned at the time the case is settled are deferred. That money grows along with the money that ordinarily would be left after taxes. When distributions are made, the entire amount distributed during a year is taxable for that year. Because the deferred taxes have grown for the benefit of the payee, there will be more left over after taxes than there would have been if the taxes had been withheld on the original amount earned and taxes paid each year on the entire growth - assuming tax rates do not increase. This is the principle behind qualified and nonqualified defined contribution retirement plans.

An attorney due to receive a large taxable cash sum can benefit from periodic payments by avoiding the highest tax brackets. This is a legitimate reduction in income tax liability. The highest marginal federal income tax bracket in 2001 under the law for a married couple filing jointly was 38.6 percent on any amount over $288,350, and 30 percent on the amount between $105,950 and $161,450. By spreading the income out over several years - including the growth that would occur - the recipient levels income spikes and avoids paying taxes in the highest bracket. That is equivalent to guaranteed earnings. The earnings are more, if the overall tax rates are lowered - such as what happened in 2001 - and income is shifted to future years when the tax liability is less.

Nonqualified deferred compensation plans are very common in the corporate world and are well settled in tax law. Traditionally, deferred compensation plans involve an agreement between the company and its higher compensated executives. However, the concept of deferred compensation plans between employer and employee extends to the relationship between client and attorney. If a fee is due to the attorney from a client - whether fee-based or from a contingent fee agreement - that fee can be deferred. The obligation of the client to make the future payments can be assigned by novation - agreed substitution of parties - to a third-party obligor holding a funding asset issued by a venerable financial institution highly rated by the independent analysts.

The IRS once challenged the attorney fee structure concept in Childs v. Commissioner, arguing that the attorneys should have recognized income that they chose to defer at a time when their fees remained contingent on the future execution of settlement agreements and entry of a final court order approving them. However, the U.S. Tax Court rejected the IRS argument, confirming that traditional deferred compensation plans extended to lawyers and their clients. US Tax Court is a federal court that hears appeals by taxpayers from adverse IRS decisions about tax deficiencies. On appeal by the IRS, the Eleventh circuit affirmed the Tax Court's ruling, and that case remains the nationwide precedent for tax treatment of attorney fee structures. See Childs v. Commissioner, 103 T.C. 634 (1994), aff'd without opinion, 89F3d 856 (11th Cir. 1996).

Surviving Bankruptcy and Divorce

*This article was written by Richard B. Risk, JD
**This article does not purport to give legal or tax advice.