By: Paul G. Barden, Esq. | Settlement Strategist, Paramount Settlement Planning, LLC & Precision Resolution, LLC
Plaintiffs’ attorneys are generally very familiar with the ability to structure their client’s settlement funds. Far fewer, however, are aware that they can structure their attorney’s fees too.
In my travels around New York State talking with plaintiffs’ attorneys about my new role as a Settlement Strategist at Paramount Settlement Planning, I have been surprised by the number of attorneys who have not considered structuring a portion of their attorney fees. Structuring fees is unique to contingent fee attorneys – no other profession enjoys this benefit.
Structuring attorney fees is very similar to structuring a claimant’s case; generally, the same rules and principles apply to both proceedings.
A Simple Process
As a best practice, make sure that your firm’s contingent fee retainer agreement addresses the possibility of the attorney structuring some or all the attorney fee. The language may include the following:
“As you know, our fee arrangement with you is that we will receive _____% of any settlement. We may receive our fee either in an immediate lump sum or solely in future periodic payments, or in a combination of those. If we receive our fee solely in future periodic payments, or in combination with an immediate lump sum, then the present value on the date of settlement of all of the immediate lump sums and future periodic payments that we receive, will not exceed our agreed percentage of ____% of the present value of your recovery.”
As the case works toward resolution, it is important that structuring some or all the client’s proceeds and the attorney’s fees is discussed and negotiated as part of the resolution of the case. If the case is settled through negotiation or mediation, ensure that the settlement statement or the mediation statement includes the following language:
“The parties agree to settle this matter (or, “Plaintiff agrees to release Defendant”) for cash and/or future periodic payments with details of same to follow within 14 days. All of the above will have a cost Defendant or Defendant’s Insurer $_______. Plaintiff reserves the right to structure part or all of this settlement with the structured settlement planner and annuity providers of his/her own selection, specifically Paramount Settlement Planning LLC, and the defense will cooperate with structuring the settlement, including executing the necessary documentation to facilitate a structured settlement.” In most cases, attorneys can structure their fee even if their client does not structure their proceeds.
Once there is an agreement to settle, a general release should never be signed. The language of most general releases acknowledges “receipt” of the settlement funds in consideration for the release. This creates a constructive receipt issue. Even worse, settlement checks often quickly follow the release is signed and are immediately deposited in the firm’s IOLA account. The attorney or client cannot take possession of proceeds that are to be used to purchase an annuity. Constructive or actual receipt of the settlement funds by the plaintiff’s attorney destroys any opportunity to structure either the client or attorney’s proceeds.
Instead of a general release, cases involving structures (for both plaintiff and attorney fee structured settlements) should have a properly prepared settlement agreement and release and qualified assignment which distinctly set forth and preserve the benefits of these periodic payments. It is through these documents that the technical requirements of IRC 104 and 130 are followed, including:
- The defendant directs the attorney fees to a third-party assignment company;
- The assignment company then purchases uses the fees to purchase a fixed annuity that provides the payments to the attorney;
- Must be fixed and determinable;
- No right to accelerate;
- No right to reduce to payout;
- No rights against the structured settlement company greater than that of a general creditor.
The best way to discuss the benefit of attorney fee structures is through examples. So, let’s discuss some hypotheticals.
Jane is a young partner in a plaintiff personal injury firm, organized as a professional corporation (“PC”). She is 47 years old, married, and has two young children, ages 3 and 4. She has consistently earned about $200,000 over the past two years. In 2018 her tax return (filed jointly) placed her in the 24% tax bracket. Jane intends to work at least until her full social security retirement age of 67.
Jane recently settled a medical malpractice case for $1 million dollars. After expenses, she stands to net $300,000 in fees. If she takes the fees in a lump sum, her income will jump to $500,000 for 2019, effectively pushing her and her husband into the 37% tax bracket. With young children and no immediate need to access to the $300,000.00 fee, she is considering an attorney fee structure.
If Jane chooses to structure the entire fee for her planned retirement, at today’s rates she could receive $3,142 per month for life, guaranteed 15 years, commencing at age 67 with the last guaranteed payment at 81. However, as this scenario is guaranteed for life, Jane will continue to receive those benefits beyond her 81st birthday so long as she is living. If she dies before her 81st birthday, her named beneficiary will receive the remainder of the payments guaranteed for 15 years. Therefore, Jane’s guaranteed benefits will be $565,535, but because she is (statistically) expected to live beyond her 81st birthday, the expected benefits are $747,763.
Another attorney fee scenario that she is considering allocates one-third of her fee to fund her children’s college education with the remaining amount used to fund the retirement component of the structure. Under this scenario, (again using today’s rates) we were able to produce semi-annual payments to her two children commencing in the year they turn age 18 for a period of four years. The payments would be made in August and January of each college year in the amount of $10,000 to each child for each payment or $20,000 each year or $80,000 over the child’s four-year college experience. Total benefits to both children would be $160,000 at a cost of just over $113,000.
The advantage of funding her children’s education through an annuity, rather than depositing $100,000.00 into an investment account or a 529 plan is that the annuity is not a countable resource on the FAFSA form. Her children would be able to apply and compete for all available financial aid. The $10,000 payments would hopefully fund any remaining gaps.
With the remaining $187,000 of the fee we were able to generate retirement income for Jane in the amount of $1,961 a month for life, guaranteed for 15 years. Under this scenario, the guaranteed benefit would be $513,029 with an expected benefit of $626,782.
Suppose instead that Jane agreed with her partners to leave the fee in the firm. Following year-end distributions, they always find that the firm’s operating cash flow is tight each January. To alleviate this cash flow issue, they could take that $300,000 fee as periodic payments. If they chose a seven-year payout commencing in January 2020 they would receive $44,509 each year. Only the amount received each year would be reported on a 1099 and is included in the partnership’s income. Given the relatively immediate and short span of the payout, the guaranteed benefit would be a modest $311,567 but would provide the operating account with a substantial first-of-the-fiscal-year deposit, the partners with peace of mind and tax relief.
Whether Jane elects the “retirement only” option, the “retirement with college fund” option, or some split between her and the firm, when Jane structures these fees, she is well on her way to a guaranteed and secure retirement.
The Factors to Consider: Structure Matters
Making the determination of whether or not to structure attorney fees is best evaluated on a case-by-case basis.
Considerations for the individual attorney to structure fees may include age, health, risk tolerance, retirement goals, tax bracket, and current and long-term needs. Some of the benefits for an individual attorney to structure their fee include:
A Professional Corporation (“PC”) is subject to a 21% flat federal tax rate on their corporate earnings (this is down from 2017 and prior where the rate was 35%). With a limited liability company (“LLC”) or partnership, income is passed through to the members and partners who pay personal tax rates on the income, with rates between 10 and 37%.
PCs do have some corporate tax advantages. Their deductions are the same as those that are available to regular corporations; PCs can deduct the cost of salaries and benefits paid to the employee-owners. Many PCs pay out nearly all of their earnings in salaries, benefits, and bonuses at years-end, leaving almost no income to actually tax at the PC level. The downside of this is that most PCs have low operating account balances come January 1st.
Structuring attorneys’ fees to arrive just after the new year is a way a PC firm can quickly replenish its operating account balance.
Firms that structure their fees may enjoy the following benefits:
History and Precedent
Structured settlements for claimants came about in 1982 when Congress passed The Periodic Payment Settlement Act of 1982 (Public Law 97-473). The bill excludes from gross income damage payments made for injuries or sickness whether paid as lumps sums or periodic payments.
For structuring attorney’s fees, the seminal case is Richard A. Childs, et al v. Commissioner of Internal Revenue, 103 T.C. 634 (1994) Docket No. 15639-92; affirmed 898 F3d 856 (1996). In the Childs case, the IRS unsuccessfully challenged a settlement that paid three attorneys on a structured, periodic basis. The Eleventh Circuit ruled that attorneys who defer payment of their fees pursuant to structured settlement are not required to include legal fees generated from a settlement, verdict, or judgment in taxable income until the fees are actually received. They further opined that fees are first property of the claimant until paid to the attorney and that the claimant may elect to pay his/her attorney over time.
Critical to this ruling was the court’s determination that because the fees were payable in the form of an irrevocable, non-assignable annuity contract, the payments could not be accelerated that:
“Petitioners never had the right to receive immediate payment, and no fund or property was set aside for petitioners which they could draw from at a time of their choosing.”
Childs v. Commissioner, 103 T.C. 634, 655, 1994 U.S. Tax Ct. LEXIS 80, *41, 103 T.C. No. 36
(Because, to the best of your author’s knowledge, the annuity structure is the only type of fee structure that has been vetted by the United States Tax Court and, upheld by the Court of Appeals for the 11th Circuit, your author, in his opinion, would caution against other “creative” fee structure program- some of which tout the ability to control the investments and, to even take cash advances.)
There is virtually no limit to the creative possibilities in structuring cases – whether it be the client’s funds or the attorney’s fees. Look into an attorney fee structure on your next case -there is no cost to you to review payout scenarios- and guarantee your retirement plan.