Any law firm owner will tell you that winning cases and maintaining an inventory are how you keep the lights on. But optimizing a firm’s financial strategy requires even more of a lift – namely, planning out revenue before year-end while also supporting future firm growth. How can managing partners achieve that level of financial zen, when it’s impossible to predict exactly when settlement revenue will arrive?
The answer: Timing income from contingency fees
It’s true that trial lawyers cannot predict the day – or even the month – when cases will settle. However, they can plan for incoming revenue from contingency fees. To do so, they need to rely on two key financial management vehicles: the firmwide qualified settlement fund and attorney fee deferral.
A qualified settlement fund (QSF) is a trust that holds settlement proceeds from the conclusion of a lawsuit. While the money from a settlement is held in the QSF, there is no constructive receipt of those funds. This system allows the plaintiff(s) and attorney(s) to independently plan how they receive their portion of a settlement – making the firmwide QSF a gamechanger for managing firm cash flow.
Why qualified settlement funds exist
Although the qualified settlement fund is especially advantageous to plaintiffs and their attorneys, its inception was originally meant to benefit defendants. Congress enacted 26 US Code § 468B to help defendants receive their tax deduction immediately after a case settles, instead of waiting on the plaintiff’s side to plan for the incoming settlement funds. Today, QSFs have become the standard of care on the plaintiff’s side – both as a wealth planning tool for the attorney and law firm and a means of receiving adequate settlement planning time for the plaintiff – while remaining beneficial to the defendant.
A qualified settlement fund does not need to be established for each individual case. A law firm can open its own firmwide QSF under a single court order, after which it stays open to use with any and all of its cases.
Deferring contingency fees for personal and law firm financial planning
A QSF gives contingency-fee attorneys and law firms the time and space to utilize an important investment tool called fee deferral, which allows them to spread contingency fees into a schedule of payments over time. This strategy can be helpful in several ways.
Fee deferral can benefit the attorney’s own wealth planning. When a contingency fee is deferred, it can be invested pretax, like an IRA or a 401(k). Investing a pretax fee provides a higher investment starting point than a post-tax fee would. The larger the fee, the more this starting point matters in terms of growth over time. The pretax and post-tax investment of a $1 million fee is a difference between hundreds of thousands of dollars.
The attorney’s payment arrangement is also totally customizable, within certain necessary limits. By spreading their fees into periodic payments over time, they can better plan for their personal financial goals and life’s important milestones – retirement, their kids’ college education, family vacations, etc. – than they would if they had received their fee in a lump sum. There is no maximum or minimum to how much an attorney can defer.
Payments from a fee deferral can be payable to the law firm, enabling its financial team to address both the short- and long-term financial plan. The managing partners or the firm’s CFO can develop a payment schedule from their big cases that can cover operating costs, future firm growth, and other company-wide initiatives. Firms can also think of what cases they have settling in the near and long term, and plan to structure receipt of their fees accordingly. Using this method, they can plan for the short term – controlling revenue in a calendar year – while deciding how their attorneys’ fees can most effectively be used over time.
Attorneys have had the ability to structure contingency fees since 1994. In Richard A. Childs, et al. v Commissioner of Internal Revenue, the 11th Circuit U.S. Court of Appeals ruled that any attorney involved in tort cases under contingency fee agreements may receive a fee in the form of periodic payments instead of in one lump sum. The IRS followed up with comprehensive tax guidance on attorney fee deferral.
Bringing it all together
So, how do these two invaluable financial strategies connect? The best way to start deferring contingency fees is to have them paid into a QSF. The attorney can then come up with the most advantageous schedule for the incoming contingency fee. Once the defendant and their insurers issue the fee payable to the QSF, it is then issued to the selected assignment company. After that, the firm will know exactly when to expect revenue – down to the last dollar.
For contingency-fee law firms of all sizes, “the secret sauce” to efficient growth is controlling cash flow with firmwide qualified settlement funds and fee deferral.
