Attorney Fee Tax Deferral Guidance From The IRS
On December 16, 2022, the IRS issued a non-precedential 25-page Generic Legal Advice Memorandum (“GLAM”) offering guidance on attorney fee tax deferral. The Memorandum opines that where the opposing party’s insurance company sends the portion of the settlement representing the law firm’s fee to the third party, the law firm must include the fee in gross income in the year that the funds representing the fee are transferred to the third party.
GLAMs are issued by the Office of Chief Counsel of the Internal Revenue Service (IRS) to provide guidance on legal issues related to tax administration. The GLAMs are intended to provide general guidance on a specific topic and are not specific to any particular taxpayer or situation. They are intended to provide a legal analysis of the issue at hand and to provide guidance to IRS personnel on how to address the issue. The GLAMs are not binding on taxpayers or the IRS, but they are considered persuasive authority and are often relied upon by the IRS and taxpayers in resolving tax disputes.
Why The Attorney Fee Tax Guidance Matters
Some lawyers working on contingent fee matters elect to place all or a portion of their contingency fees into tax-advantaged investments in the hopes of deferring taxes. In the leading case on the issue, Childs v. Commissioner, 103 T.C. 634 (1994), aff’d, 89 F. 3d 856 (Table)(11th Cir. 1996), the Tax Court held that because the attorney’s fees were transferred directly to certain insurance companies (which, in turn, purchased annuities for the two attorneys in question), the attorneys did not have constructive receipt of the fees. Accordingly, the fees did not yet count as taxable income.
The Issue Before The IRS: Attorney Fee Tax Deferral
Per the GLAM:
A law firm is a cash method taxpayer that represents a client on a contingency fee basis. Before formal settlement of the client’s claim, the law firm enters into an arrangement with a third party that purports to defer receipt of the law firm’s fee, payable out of the settlement amount negotiated by the law firm on behalf of its client. The opposing party’s insurance company sends the portion of the settlement representing the law firm’s fee to the third party, pursuant to the terms of the settlement agreement. When does income inclusion for the law firm occur with respect to the fee sent to the third party?
Summary of Conclusions
The law firm must include the fee in gross income in the year that the funds representing the fee are transferred to the third party. The transaction creates a funded compensation arrangement that results in gross income to the law firm under the anticipatory assignment of income doctrine, the economic benefit doctrine, and section 83. Alternatively, to the extent that the arrangement constitutes unfunded deferred compensation, the arrangement is a nonqualified deferred compensation plan subject to section 409A, and the law firm has gross income in the first year of the arrangement because the plan fails to comply with section 409A.
Full Memorandum
Previously, in 2008, the IRS issued the following guidance:
Please note that the information provided on this website is for general informational purposes only and is not intended as legal or tax advice. The information is subject to change, and it is important to consult a specialist before making any decisions. Law Ledgers provides accounting services to New York lawyers and law firms, including escrow protection, tax advice and bookkeeping administration. Contact us today for personalized support.
