Why Consider Structuring Your Legal Fees or Attorney Fees?
1. Spreading out legal fees or attorney fees over several years, or even deferring them out further, may help attorney taxpayers avoid a higher marginal tax bracket, allowing the money saved (resulting from deferring current taxes) to be invested at little to no risk with no money management fees.
2. Provide a source of guaranteed income to the attorney or law firm to match up against future expenses.
3. Attorneys or law firms can smooth out future cash flow.
4. Attorneys or law firms can effectively achieve the results of a qualified pension plan without the annual administrative and regulatory burden required of employee benefit plans.
5. Structured Legal Fees or Structured Attorney Fees are not subject to annual qualified pension plan contribution limits. Getting close to retirement and need to catch up? If you have the cases, this is one way of doing it.
6. Provide a source of funds for future buy-sell agreement.
7. Payments may be exempt from creditors. For example, the ruling In re John J. Lynch, Debtor, 321 B.R. 114 (S.D.N.Y., Feb. 10, 2005) found that that the CNA annuity from an attorney fee structure, which attorney.John Lynch accepted in settling a 2003 case, was not available to creditors in bankruptcy. Lynch filed for bankruptcy in 2004. When the Bankruptcy Trustee tried to use the annuity to pay Mr. Lynch’s creditors, Mr. Lynch resisted, arguing that to do so would pose a hardship on him.
Applying New York law, the U.S. Bankruptcy Court sided with Mr. Lynch and ruled that the annuity was exempt from the reach of creditors. A similar conclusion under Louisiana law was reached in Canfield v. Orso, 283 F.3d 686(5th Cir. 2002). In that case, the Court of Appeals for the Fifth Circuit also held that an attorney fee structure was beyond the reach of the attorney ’s creditors.
These rulings are helpful but readers should realize that each state has its own bankruptcy exemptions that might be applied to reach a different result.
8. On cases with certain types of taxable damages you can help mitigate your clients' exposure to the alternative minimum tax (AMT) in the tax year of the settlement.
Example to Fund Retirement: Structured Attorney Fees of $ 175,000*
Structured plan design to fund retirement in 20 years, either a guaranteed lump sum of $545,411.99, or, starting in 20 years, payments of $3,513.69 per month ($42,164.28 annually) for life, with 20 years guaranteed to be paid whether or not the attorney survives the payment schedule.
*example using 45 year old male and rates available during the week of June 20, 2006 for illustrative purposes.
Related Tax Information
The U. S. Court of Appeals for the 11th Circuit affirmed in Richard A. Childs, Et al. v Commissioner of Internal Revenue 103 T.C. No. 36 Docket No. 15639-92 (1)(2) that attorneys may structure their fees, holding that taxes are payable on structured attorney fees when the amounts are received. (3)
The Court held that the fair market values of the taxpayers rights to receive payments under the settlement agreements in the case were not includable in income under Sec. 83, in the year settlement agreements were effected, since the promises to pay under the structured settlements were neither funded or secured and thus did not meet the definition of property for purposes of Sec. 83 The Court further held that the doctrine of constructive receipt is inapplicable because the taxpayer had no right to receive the attorney’s fees prior to the time the agreement fixing a structured settlement was entered into.
Section 409A of the Internal Revenue Code (included in the American Jobs Creation Act of 2004) initially brought concerns of changes to the tax treatment of structured attorneys’ fees. However, on December 20, 2004 the Department of Treasury ("Treasury") and Internal Revenue Service issued comprehensive guidance interpreting new Section 409A. The guidance in Notice 2005-1 excludes most service provider arrangements from the scope of Section 409A. The Notice states:
A-8…Section 409A…DOES NOT APPLY to arrangements between a service provider and a service recipient if (a) the service provider is actively engaged in the trade or business of providing substantial services, other than (I) as an employee or (II) as a director of a corporation; and (b) the service provider provides such services to two or more service recipients to which the service provider is not related and that are not related to one another.
The guidance cautions that other tax principles may apply. Therefore careful planning must be done in advance should you wish to structure your attorney fees! There's no reason to feel intimidated by this, but don't wait until the last minute! We can help you. Call us!
Generally an attorney or law firm can structure a portion (or all) of their fees when:
1. The attorney's or law firm's contingency fee agreement permits the structuring of all or a part of attorney's fees.
2. The attorney or law firm does not have constructive receipt of the funds
3. The guidelines set forth in the Childs case are followed
4. The requirements and/or guidelines of the issuer of the structured attorney fee annuity contract are followed.
Other critical issues to be addressed, arise out of the form of business under which the law firm operates and such issues (and their impact on the law firm or is partners or shareholder ability to structure legal fees) will vary from law firm to law firm.
It is also recommended that attorneys contemplating structuring attorney fees or structuring legal fees consult with competent tax counsel prior to entering into a structured attorney fee transaction.
Footnotes
(1) Copy of Childs decision
(2) Copy of Childs appeal
(3) Although the Tax Court upheld the deferral of attorney fees in Childs, attorneys should be careful not to rely too heavily on it. The facts in that case are quite specific and the result reached in Childs should not be relied upon in cases that are materially dissimilar.
(4) FAQ
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