Personal wealth management can be a big headache for mass tort attorneys, given the peaks-and-valleys nature of their fee income. When a multidistrict litigation settles after years of work, the fee for a large case inventory is certainly welcome. But a huge amount of that money is already spoken for, as the IRS and state governments will take a major cut of those hard-earned fees at tax time.
It’s staggering when you do the math. Plaintiffs’ attorneys earn an average of 33 to 40 percent in contingency fees. And since 99 percent of their equity ownerships are pass-through tax entities like PPCs and partnerships, a portion of the revenue from an MDL will hit each attorney’s personal tax return. In 2022, individuals with the top marginal federal income tax rate will owe $162,718 in taxes, plus 37 percent of any amount earned over $539,900. When you also consider state taxes, mass tort attorneys could pay well over 40 percent in taxes on one recovery. In high-dollar MDL settlements, taxes owed could reach billions from all contingency fees combined. Even as payments to associates, staff, and referring attorneys dilute these numbers slightly, the nature of mass tort practice is that big chunks of revenue come in every few years and trigger substantial taxes owed.
Of course, taxes are part of life. But if there’s a simple and legal strategy to reduce the taxes owed, doesn’t it make sense to utilize it?
Attorney fee deferral is a tool exclusively available to trial lawyers that helps relieve the substantial tax burden associated with earning contingency fees. Mass tort attorneys who haven’t yet considered this strategy are well advised to explore their deferral options before the next MDL settles. Leveraging pre-tax investing and income spreading can significantly reduce taxation of the next fees earned.
Fee deferral as a tax planning method has been around for decades. In 1996, the 11th Circuit affirmed the 1994 Tax Court’s ruling in Childs v. Commissioner, which stated that attorneys involved in tort cases under contingency fee agreements may receive their fees in the form of periodic payments. Instead of paying income tax on one large lump sum of fee income, attorneys only pay taxes on the payments they receive within the year. Meanwhile, the rest of the fee grows tax-deferred in an investment account.
Contributions to a 401k and IRA can max out quickly. Deferring fees does not replace these retirement accounts; rather, it’s an additional investment strategy with its own benefits.
If you’re a mass tort attorney looking ahead to the next settlement, we welcome you to contact Milestone to discuss the fee and tax planning benefits of attorney fee deferral.