Structuring Attorney Fees
In Personal Injury Cases: The Pros And Cons by Dan Tannen
Dan Tannen has been a plaintiff advocate for structured settlements for 14 years and works exclusively with plaintiff attorneys. He is also an experienced financial planner originally specializing in helping families with developmentally disabled children. He has conducted estate-planning seminars for a number of organizations including the United Cerebral Palsy and the Association for Retarded Citizens. A member of the National Association of Insurance and Financial Advisors, Dan is a registered representative of a member firm of the National Association of Securities Dealers.
Structured settlements provide for a se- ries of periodic payments as opposed to an immediate lump sum. The use of struc- tured settlements for claimants in personal injury cases is quite common, especially when minors are involved, because of the considerable advantages. Claimants are protected from rapid dissipation of large sums of money as well as from well-mean- ing friends, relatives and financial advisors. All payments are tax-free, regard- less of when they are received. In most instances, future payments are guaranteed by highly rated life insurance companies. In cases involving minors, the alternative in most states is that they receive huge sums of money when they reach the age of majority, which is seldom a desirable outcome. Many attorneys would like to struc-
ture their fees in a similar fashion. Just like professional athletes and others who enjoy deferred compensation plans, they would prefer not to receive the entire sum immediately and pay close to 50 percent of it in taxes. Instead, they would rather let the money remain for a time with a life insurance company, where it grows at a rate of around 6 to 7 percent, and re- ceive it later. They might want it in a lump sum at retirement, since they don’t have a business to sell in the traditional sense. Or they may want monthly payments to start at a certain age that will last for the rest of their life, with payments guaran- teed for a number of years, so that in the event of their death, their spouse will en- joy guaranteed income. Or they might need it for tuition when their children reach college age. Or they might simply want to protect themselves from their own proclivity to spend. There are many pos- sible reasons to defer payment, and an infinite number of future payment streams available, but the bottom line is that attorneys in personal injury cases have the same flexibility in structuring their fees to meet their particular financial circum-
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stances as do the claimants they represent. Obviously, only those who don’t need the income immediately find this alternative attractive.
Any deferral of attorney fees assumes, of course, that the government will tax the money as the attorney receives it, rather than taxing the entire amount im- mediately. But ten years ago the Internal Revenue Service targeted this type of de- ferred compensation in an IRS National Office Technical Advice Memorandum (Letter 9134004, May 7, 1991). As a re- sult, the practice of structuring attorney fees, which had been widespread, went into “hibernation.” Then came an important case, Richard A. Childs, et al. v. Commissioner, No. 15639- 92 (Tax Court, November 14, 1994), which changed the picture. The IRS claimed that attorneys should be taxed currently rather than when they received the money, not only because their right to receive future payments was funded or secured, but be- cause they were in constructive receipt of their fees. But the Tax Court found that the right to receive future payments was not funded or secured, and that the attorneys were not in constructive receipt. This rul- ing was affirmed by the U.S. Court of Appeals for the Eleventh Circuit (95-8762, June 11, 1996). In response to this development, a
growing number of life insurance com- panies that issue structured settlements for claimants are now willing to structure at- torney fees as well.
Since the attorney
cannot own the structured settlement annuity and still have deferred taxation, these life insurance companies now accept qualified assignments on structured attor- ney fees. A qualified assignment is a legal mechanism used to transfer the obligation to make payments to a third party in con- formance with the tax code (IRC Section 130). Since structured attorney fees are initially purchased by defendants, quali- fied assignments are required to assign
Trial Reporter
such obligations to third parties who are equipped to execute them. These third parties, called assignees, are usually affili- ates of the companies who issue the structured settlement annuities. Some an- nuity companies will even accept qualified assignments for “stand-alone” structures – that is, in cases when the claimant does not use a structured settlement but the attorney wishes to structure his fee. Of course, one court case is no guar- antee that the IRS won’t continue to litigate attorney fee structures – even though many don’t think this likely in light of the fact that the appellate court affirmed the decision of the Tax Court with no further comment. For this rea- son, structuring your fee still entails some amount of risk, and will continue to do so until more test cases reinforce the re- sults of Childs v. Commissioner. Yet these risks should be weighed against a number of compelling reasons in favor of structuring your fee, in cases where there is no pressing need for im- mediate cash: Instead of paying income tax on a large fee immediately, you can pay the tax in the future, perhaps in a year when you are in a lower marginal bracket. The money you defer earns around 6
to 7 percent annually, with little or no risk and no money management fees. The money you defer is not available
to creditors. You are able to design a deferred com- pensation plan, similar to those of professional athletes, that is specific to your financial goals and is very flexible, as each case gives you a new opportunity to decide between current income or de- ferred compensation. Selecting the manner in which fees are
received is an important decision for at- torneys in personal injury cases. To make the right choice, they must be well in- formed about all of the options, including deferred compensation.
Fall 2001
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