One of our favorite topics to discuss with contingency fee attorneys is attorney fee deferrals. You may have also heard of attorney fee deferrals being referred to as attorney fee structures.
Contingency fee attorneys have the unique opportunity to manage and control the amount of income tax they pay in any given tax year. Few, if any, other professions have the unique kind of flexibility with tax planning as do contingency fee-based attorneys.
What is an Attorney Fee Deferral?
An attorney fee deferral allows contingency fee-based attorneys to defer and put off the receipt of their legal fees to a future year. Deferring fees, as a result, delays the income taxation on that legal fee. The two most common fee deferral vehicles are: (1) a structured settlement annuity or (2) investment-based attorney fee deferral (based on deferred compensation rules).
You can defer your legal fees through the use of a structured settlement annuity. This option allows you to select the payout dates and amounts at the time the deferral is entered into. The rate of return is fixed and guaranteed by some of the largest life insurance companies in the world. The process for setting these up is very similar to the process for your clients.
Investment Account Option
An increasingly popular alternative to the annuity-based approach is through the use of an investment account that follows the deferred compensation plan rules and guidelines. Instead of putting the funds into an annuity and being committed to (and stuck with) a fixed payout date and amount, the investment account option provides additional flexibility for payout dates. Rather than having to decide when payments will be made, under this approach, attorneys can decide at a future date when they would like to receive those future payments.
Why Should Attorneys Defer Their Fees?
Unless you enjoy paying more income tax than need to, why not do some tax planning and reduce your income taxes? What we usually recommend to attorneys is that they figure out how much “take-home” income they need in each year — and then we recommend that they defer the rest of their legal fee income (or some percentage of the income) to future years.
From a tax planning perspective, deferring contingent legal fees allows you to invest or annuitize the pre-tax amount of the fee (rather than getting taxed at a 40%+ tax rate). An attorney fee deferral allows you to invest or annuitize on a pre-tax and tax-deferred basis — which results in a much greater long-term payout.
Beyond the benefits of income tax planning, there are other creative uses for attorney fee deferrals including normalizing firm cash flows, creating golden handcuffs for key employees and associates, planning for retirement or other future needs, and more.
Nearly every attorney we work with who starts deferring fees says the same thing: “I wish I had known about this and started doing this 5 or 10 years ago.”
If you have any questions about attorney fee deferrals, or if you want to discuss some of the more creative use cases, please feel free to send us an email or give us a call. We love chatting with attorneys about fee deferrals, and we’d be happy to explore whether deferring legal fees would be a good fit for you.