A Case for Structuring an Attorney’s Fee
Last year, I worked with an attorney and his CPA to defer his seven-figure fee from a personal injury case. The attorney called recently to thank me. Why? In these uncertain times, he had the cash flow necessary to keep his firm running, pay his employees and continue to build his retirement nest egg. All attorneys who litigate on behalf of physically and, in some cases, mentally injured clients can structure their fee using a structured settlement.
What is a Structured Settlement?
A structured settlement defined under IRC § 5891(C)(1) is an arrangement established by a suit or agreement for the periodic payment of damages excludable from the gross income of the recipient under section 104(a)(2). Simply stated, it is akin to an annuity with the ability to adjust the nature and timing of periodic payments at the initiation of the contract only. The inability to alter the guaranteed payments later requires precise planning and coordination between all interested parties. All payments are guaranteed by the credit of the nation’s largest life insurance companies.
Structuring attorney fees represents such an important economic right, and it is recommended that attorneys protect this right by including language in their compensation agreement (firm), retainer agreements (client) and any mediation or settlement agreements they negotiate for their clients ensuring their ability to utilize and the willingness of the counter-party to support the use of a structured settlement. This essential inclusion avoids difficulty and eliminates questions about consideration later.
Benefits of a Structured Settlement
Cases often take years to complete while they generate costs daily. A structured settlement provides a guaranteed income stream matching revenue with expenses and gives the firm the flexibility to meet future funding needs. The firm’s ability to fund cases using payments from a structured settlement increases the economic viability of the firm.
How does the attorney smooth and derive increased cash flow? Structured settlements created under IRC § 130 use “Constructive Receipt” as the defining line for revenue recognition. If you avoid constructive receipt then income recognition only occurs when future distributions occur. This helped the previously mentioned attorney achieve long-term guaranteed retirement income while saving $270,000 in cashflow by minimizing his short-term tax exposure, which kept his firm solvent.
Cash flow management generated additional dollars by avoiding tax thresholds. The federal tax schedule incorporates large increases in tax rates at certain income levels. For example, the federal rate for a married couple filing jointly with income above $326,000 increases from 24 percent to 32 percent. In this example, deferring income above the 24-percent threshold increases cash flow by $8,000 per $100,00 of income.
The additional cash flow and peace of mind in knowing guaranteed revenue exists for the following year is one clear benefit of structuring attorney fees. Another benefit is the creation of a solid retirement foundation. The guaranteed income of a structured settlement solidifies the base of the retirement pyramid. Other asset classes, retirement vehicles and compensation plans cannot guarantee returns and hold significant levels of financial and regulator complexity that a structured settlement just does not encounter. Defined benefit programs, 401(k)s, deferred compensation or structured insurance plans should be utilized in concert with a systematic use of structuring attorney fees. Through proper planning and implementation, the security of clients’ retirement years increases with the addition of a structured settlement to their retirement portfolio.
Whether a client requires a stream of income, needs to catch up on retirement contributions or some combination of both, a structured settlement accomplishes these goals effectively, at a lower cost and with the added benefit of providing guaranteed results.
This article appeared in the November/December 2020 issue of New Jersey CPA magazine. Read the full issue.