Contingency Fees and the Benefits of Attorney Fee Deferrals

By Tad Thomas | Aug 25, 2021 | Tad's Trial Practice Tips

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— Tad Thomas

If you’re looking to manage the cash flow of your law firm and haven’t yet considered fee deferrals, it’s time for a crash course. Not only can deferring contingency fees maximize settlement values for your clients, but they also present greater investment opportunities, as well as increased potential returns and more control over your firm’s income.

Plaintiff attorneys have the unique ability to portion some or all of their contingency fees in different types of tax-advantaged investments. If you elect to defer fees, you’ll also be deferring the tax obligation until the year when payments are received. Let’s start by taking a look at two common attorney fee deferral strategies.

Attorney Fee Deferral Strategies

As a contingency-based trial attorney, deferring fees lets you manage and control the amount of income tax you have to pay come tax time. There aren’t many professionals outside of the legal industry, contingency-fee-specific, that have this type of flexibility with tax planning.

The two most common fee deferral structures are a structured settlement annuity and an investment-based attorney fee deferral.

Annuity-Based Deferrals

If you choose to defer attorney fees through a structured settlement annuity, you can select payout dates and amounts when you first enter into the deferral. The return rate is fixed and guaranteed by the insurance company of your choosing.

Facilitating this type of fee structure means the defendant or insurance company has to direct the attorney’s fees to a third-party assignment company. That company uses the money to purchase a fixed annuity that proved the payments on the pre-determined schedule.

There are no ongoing administrative or maintenance fees with structures attorney fees, which means more money will stay in your pocket. Depending on the structure, payments can be arranged monthly, quarterly, semi-annually, or annually.

Investment Account Options

An alternative to the annuity-based deferral is through the use of an investment account. That account follows the deferred compensation plan rules and guidelines. So instead of putting the funds into an annuity and being committed to fixed payout dates and amounts, investments accounts provide more flexibility.

Per the deferred compensation tax rules, there’s no limit to how much money you can put into the account. But it’s important to note that the accounts fall outside the federal laws that control and protect similar accounts like 401 (k)s.

Should Trial Attorneys Defer Their Fees?

While taxes are necessary, there’s no need to pay more in income tax than you need to. However, you can figure out just how much deferring attorney fees will benefit you with some taxing planning.

To start, you need to know how much take-home income you need each year. From there, take what’s left, or whatever percentage you deem reasonable, and defer it to future years

From a financial perspective, deferring those fees lets you invest or annuitize the pre-tax amount instead of getting taxed at a 40% or higher tax rate. Investing or annuitizing on a pre-tax and tax-deferred basis will result in a much higher long-term payout.

Aside from tax planning, attorney fee deferrals can help normalize your firm’s cash flow, plan for retirement or other future needs, and provide key employees and associates with the recognition they deserve.

While deferring attorney fees is beneficial for many law firms, it’s best to speak with an experienced financial advisor or planner before making any big decisions. With their help, however, you’ll have a better understanding of how you can make the most of your law firm’s income.