The tax savings available via structured attorneys fees are known to most personal injury attorneys, and rightfully so. The tax savings can be significant due to the deferred income taxation on the principal (the amount of the attorney fee placed into the structured settlement annuity) and the interest earned on the principal. In other words, neither the principal nor the interest earned on the principal are taxed as ordinary income until the year payments are received.
However, the myriad advantages and opportunities available to personal injury attorneys through structured legal fees do not end with tax savings. Structured attorneys fees may also provide the following benefits:
- Asset protection – assets in annuities are often not recoverable assets in litigation
- Medical underwriting – attorneys that have health issues such as high blood pressure, diabetes, high cholesterol, or other medical impairments can get higher annuity payouts on lifetime annuities.
- Guaranteed income – structured fees can reduce the stress that often comes with contingency fee based income
- Flexible design – unlike typical annuities, structured fees can be set up and designed to meet the unique needs of attorneys (lump sums, monthly income, deferred income, etc)
- No restrictions on amount – unlike typical retirement planning options, there is no limit to the amount deferred via a structured fee in a given calendar year.
- Distributions can start before 59.5 – unlike typical retirement planning options, distributions can start at any time. There is no need to wait until age 59.5 to start receiving payments
- No mandatory employee participation – unlike typical retirement planning options, there is no requirement that employees participate, adding tremendous flexibility to retirement planning
- Case by case – unlike typical retirement planning options, each case that settles is another opportunity to defer your fee. There is no long term commitment as is required in other retirement planning options.
- Lifetime payments – most solo practitioners don’t have the time nor manpower necessary to establish and manage a pension plan. Structuring attorney fees allows the attorney to establish a personal pension plan that will pay for the rest of the attorney’s life without the headache and administration of typical pension plans.
- Source of capital for firm -- Attorneys fees can be structured to pay in future years to help smooth out the hills and valleys associated with a contingency fee law practice.
- Incentive plan – Structuring fees to a future time can be a way of applying “golden handcuffs” to junior associates and be used as an employee retention and incentive plan.
While there are many compelling and distinct advantages to structuring attorney fees, it is important to understand that there are also some disadvantages.
While these annuities are flexible in their design, once attorney fee structures are created, they become extremely inflexible and illiquid. In order for you to receive the tax deferral desired from attorney fee structures, you cannot have unfettered access to the cash. Also,
the guaranteed nature of a fixed annuity lends itself to lower rates of return than other equity based investment vehicles. This is to be expected. While most attorneys will view the guarantees associated with fixed annuities to be an advantage rather than a disadvantage, it is nonetheless a fact that guaranteed rates of return are generally lower than can be found in stocks, mutual funds, and other equities. Of course, with any guaranteed investment vehicle, the investment is only as strong as the company or entity backing it. Attorney fee structures are written and guaranteed by many of the largest and oldest life insurance companies in the world.
Attorneys also need to understand the legal framework behind structured attorney fees. In 1996, the 11th Circuit affirmed without opinion the 1994 Tax Court’s ruling in Childs v. Commissioner,[1] which laid an approved framework for attorney fee structures. Bear in mind, however, that though the Childs case outlines the requirements and acceptable procedures to successfully create a periodic payment stream for an attorney, and the Service has not made a concerted challenge to structured fee payouts since Childs, the Service has not officially acquiesced[2] to the 11th Circuit’s decision.
Attorneys that would like to take advantage of this unique opportunity need to contact a settlement planner with experience handling structured attorneys fees to ensure the process is handled correctly.[3] Please contact us to discuss your particular situation.
[1] Childs v. Commissioner, 103 T.C. 634, (1994), aff’d, 89 F.3d 856 (11th Cir. 1996).
[2] The Service issued a Field Service Advisory (200151003) on December 21, 2001 concerning constructive receipt and attorney fee structuring arrangements. The Service on page 9 of the FSA states, “where attorneys entered into a structured settlement which called for deferred payments of their fee, and the settlement was entered into prior to obtaining an unconditional right to compensation for their legal services, the court held that they had not constructively received income upon the purchase of the annuity contracts meant to provide payment for the legal services fee” (citing Childs v. Commissioner).
[3] Kevin Moriarty, Feature: Structured Payouts of Attorney Fees: A Golden