Tax Reduction and Deferral Strategies for Trial Attorneys – Part 1

Overview

Trial attorneys are extremely vulnerable to changing tax landscape which is quickly becoming hostile territory. As the Bush tax cuts are due to expire at the end of December 2012, the tax increases will further erode trial attorney income. The top federal bracket increases to 39.6 percent. Wealthy lawyers will face an additional 3.8 percent on investment income. Additionally, they will face 1-2 percent in additional taxation due to the phase out of itemized deductions.

State taxation in most states easily adds another 4-5 percent. Dividend income will be taxed as ordinary income. The long term capital gains rate increases to 20 percent and most states tax capital gains as regular income. On the estate tax front, the exemption equivalent decreases from $5.12 million to $1 million.

Qualified retirement plans are minimally beneficial to high income trial attorneys. The limit on contributions to defined contribution plans is $50,000 which is not much for an attorney with $10 million of income due to a settlement. The deferral into a 401(k) plan is $17,000 in 2012 with an additional available contribution for a taxpayer over age 50 or older. Again, these limits are pretty meaningless to the high income trial attorney. Similarly, the controlled group and affiliated service group rules that apply to qualified retirement plans limits the ability of the trial attorney to work around “rank and file” employees in the firm in order to increase contributions.

What is a wealthy trial attorney to do? Part I of this series will focus on the use of private placement variable annuities (PPVA) as a structured settlement option in order to defer contingency fee income. The combination of low cost and unlimited investment flexibility makes PPVA an excellent vehicle to use. The ability to defer contingency fee income is like a Super IRA for the trial attorney.

The use of private placement variable deferred annuities (PPVA) as an SSA is something completely new to the SSA marketplace. What is arguably the best solution in terms of costs and investment flexibility is not being offered by SSA brokers. What is arguably the best solution in terms of costs and investment flexibility is not being offered by SSA brokers.

Background

Structured Settlement annuities (“SSA”) have been recognized by federal law since 1983. The original use of these arrangements was for physical injury cases. The typical arrangement for cases involving physical injury and sickness as defined under IRC Sec 104 provides for the defendant to make a “qualified assignment” of the periodic payment obligation as prescribed under the settlement agreement between the plaintiff and defendant to a qualified assignment company.

The qualified assignment company is the applicant, owner, and beneficiary of the annuity contract which it uses to make payments to the plaintiff. The plaintiff receives tax-free annuity payments and the defendant or its casualty insurance company receives a tax deduction in the year the payment it made. The defendant is released from further liability or obligation in the year it is made.

The marketplace for these annuities has evolved to handle a wider range of cases workers’ compensation claims, employment claims, non-bodily injury property and casualty claims and other negotiated settlements. SSA arrangements have been used in commercial business transactions as well.