Personal injury attorneys have the ability to control the amount of income tax they pay in any given tax year by deferring their contingent legal fees. This means that attorneys can control their taxes by deferring the receipt of their legal fee to future tax years. This is commonly known as an attorney fee deferral.
While the tax benefits of deferring income tax are the most obvious benefit and most common use case for deferring taxes, there are other creative planning strategies that are made possible through attorney fee deferrals.
Here are some other common use cases and strategies that are available by deferring legal fees to future years:
Smooth and Stable Cash Flows Over the Years
In a contingency fee-based firm, revenues can be unpredictable. In one year the income is more than enough; the next year, the numbers are not so great. It can be hard to juggle the ups and downs in a firm’s cash flows.
Deferring legal fees to future years allow you to forecast and plan for future needs. When you defer fees to future years, you level out the cash flow rollercoaster and can rest at ease knowing that your overhead costs, salaries, and other expenses are taken care of.
Another common use case with attorney fee deferrals is planning for an attorney’s retirement. Attorney fee deferrals can either provide a fixed, guaranteed rate of return at dates you set (using an annuity), or a fee deferral can provide market-based rates of return and flexibility on when payments will be made (using an investment account).
Some attorneys like to set up an annuity that will pay for their entire lifetime (and if desired, for the entire lifetime of their spouse). Other attorney prefer the flexibility of an investment account.
Either way, funding your retirement needs and goals through the use of an attorney fee deferral is a great option.
Golden Handcuffs For Young Associates
An increasingly popular use of attorney fee deferrals is to incentivize associates to stay with the firm by using “golden handcuffs.” If you’re an attorney with young associates or employees that don’t want to lose, you can create a “vesting schedule” for them through an attorney fee deferral.
To use this strategy, you will enter into a deferred payment agreement with your key employees or associates. When you defer a legal fee to future years, the key employees’ receipt of those deferred payments is contingent on whether they are still with your firm.
If the key employees are still with the firm when those deferred payments come into your firm, then the employees receive whatever amount was negotiated in the vesting schedule. In other words, if the key employees stay with your firm, they receive the deferred payments per the terms of the deferred payment agreement.
On the other hand, if a key employee decides to leave, then those payments will come to your firm — and they can be used however you choose.
This strategy is a great way to put golden handcuffs on your key employees — and if they choose to leave your firm, then you haven’t funded a retirement plan that they can take with them. You’ve only funded a future payment schedule. Thus, if they are no longer work with you, then those payments come to your firm, and you can use those funds however you’d like.
Attorney fee deferrals are a great way to reduce your taxable income — but tax savings is only one benefit. Attorney fee deferrals open doors to many other creative planning strategies, including stabilizing firm cash flows, funding your retirement, and placing golden handcuffs on key employees and associates.
We work with hundreds of personal injury attorneys across the country, and the failure to take advantage of attorney fee deferrals is one of the biggest mistakes we see in our practice. Don’t miss out on the tax and other planning strategies made possible by deferring a portion of your legal fees to future tax years.
If you’d like to discuss some of these creative planning strategies or have other questions about deferring your contingent legal fees, please give us a call — we’d be happy to chat with you about your options.