Trial Lawyers’ Unique Access to Uncapped Tax Deferral

Trial lawyers can defer taxation on their fees because of the tax-favored status of their plaintiff clients and the contingent nature of their fees. They can “contribute” an uncapped amount of fees into a vehicle similar to a 401(k).

Trial lawyers have increasingly used this option since the 1990s when the U.S. Tax Court ruled that a contingent fee deferral arrangement successfully deferred taxation. The Eleventh Circuit Court of Appeals affirmed, and since then, the IRS has repeatedly referenced those rulings without question.

Also, since the 1990s, some facilitators of fee deferrals have offered increasingly aggressive deferral programs. In late 2022, the IRS released a non-binding memo that criticized many aspects of a particularly aggressive hypothetical fee deferral. The memo provides context — and reminders — on what trial lawyers should consider in choosing between programs.

I. The Basics of Plaintiff Tax Underlying Fee Deferral

Two lines of authority governing plaintiff taxation protect most fee deferrals.

First, plaintiff clients can “control” when they receive lawsuit proceeds for tax purposes. As IRS rulings have held, plaintiffs can agree to a “structured settlement” instead of receiving their recovery in a lump sum. If the recovery is tax-free, plaintiffs benefit by avoiding tax on the structured settlement’s investment earnings. If the recovery is taxable, plaintiffs pay tax on all proceeds, but benefit by deferring the year in which they do so.

Second, tax law treats the payments plaintiff firms receive from the defense as received “on behalf of” their clients. Even if the defense pays only the “fee portion” to the firm, that fee portion is treated as (1) paid to the client and then (2) paid by the client to the firm. This has been true since the U.S. Supreme Court’s 2005 decision in Commissioner v. Banks.

Until 2018, the Banks rule usually didn’t harm plaintiffs. Typically, plaintiffs could still deduct their legal fees. However, legislation in 2017 disallowed such deductions in most contexts, leaving many facing the “plaintiff double tax.” That concern can be addressed by certain trust arrangements, like the Plaintiff Recovery Trust.

Fortunately, the combination of Banks and structured settlement tax rules allows lawyers to defer taxation of fees. If plaintiffs aren’t taxed on the right to future payments, and lawyers aren’t taxed until plaintiffs are, lawyers can contract to defer payments of fees “on behalf of” their clients. Of course, contracting correctly is critical.

II. All Quiet on Fee Deferral Since the 1990s

Even before Banks, trial lawyers could rely on the benefit of contingent fee deferrals. The basics of the arrangement were considered at length in the 1990s and respected by the U.S. Tax Court and the Eleventh Circuit Court of Appeals. Childs v. Commissioner, 103 T.C. 634 (1994), aff’d 89 F. 3d 856 (11th Cir. 1996).

In Childs, several trial lawyers represented plaintiffs after a home gas explosion. The claims were resolved in two settlements, both providing for deferred payments of the lawyers’ fees. In one, the defense promised such payments, and then paid an insurance company to assume the future payment obligation. In the other, the defense promised such payments and remained the primary payor.

In both settlements, the lawyers remained “general creditors.” Before both settlements, the clients and lawyers agreed that the fees would be paid on a deferred basis. In fact, the clients insisted on this since they would also be receiving proceeds over time.

The Tax Court considered IRS arguments that the lawyers’ taxation on their fees was immediately taxable, even if they would only receive their fees on a deferred basis. The Tax Court disagreed, and the Eleventh Circuit Court of Appeals affirmed.

Since then, the IRS has repeatedly and positively referenced Childs, including when analyzing plaintiff tax treatment of structured settlements. In its 2022 memo, the IRS concluded that Childs “does not apply” to the hypothetical considered. As noted below, the hypothetical assumed particularly aggressive facts.

III. The IRS’ 2022 Non-Binding Memo

In December 2022, the IRS released an internal and non-binding memo that considered a particularly aggressive hypothetical fee deferral by plaintiff counsel. The memo concluded that the deferral failed – i.e., that the fee portion of the hypothetical settlement was immediately taxable to plaintiff counsel.

Under the hypothetical facts, counsel was entitled to a 30% contingent fee upon the plaintiff client’s recovery. In negotiating the settlement agreement, the defense agreed to make payment on the recovery “according to payment instructions.” Thus, counsel failed to remove their right to immediate fees.

On the day before the settlement agreement was executed, counsel contracted with a deferred fee provider. That contract required that any fees counsel earns “be transferred directly” to the provider. Again, counsel failed to remove their legal right or ownership of immediate fees, merely agreeing to transfer them upon receipt.

In connection with the fee deferral program, the provider loaned the deferring counsel $200,000. The note allowed the provider to reduce future fee deferral payments to the extent that counsel failed to repay the loan principal or interest.

The IRS analyzed several tax doctrines and statutes, concluding that counsel was immediately taxable. These included the economic benefit doctrine, constructive receipt doctrine, assignment-of-income doctrine, and Section 409A of the Internal Revenue Code. In truth, the particularly aggressive nature of the hypothetical made such a conclusion fairly simple. Fortunately, such steps are not typically found in modern fee deferral arrangements.

IV.  Important Steps for Any Fee Deferral

Based on Childs, Banks, and the IRS’ 2022 memo, trial lawyers continue to have access to this unique, and uniquely valuable, tax planning option. However, particular care should be taken to follow the five steps below.

First, amend your lawyer-client fee agreement before effecting a settlement. In general, you’re entitled to a percentage of the recovery immediately after execution. Thus, to defer taxation, it’s critical to defer that right. Ideally, you should include such language in all your client fee agreements. In the meantime, you should amend agreements with clients whose fees you plan to defer. In doing so, remember to obtain informed waiver of your conflict-of-interest. In general, a fee deferral won’t negatively affect your client – in taxable cases, you’ll need further disclosures.

Second, establish that your provider is entitled to the defense’s payment to the extent you wish to defer your fees. The amendment to your lawyer-client agreement arguably prevents you from any entitlement to such funds. But memorializing that they belong to the provider further distances you from being treated “as if” you received them for tax purposes. This is particularly important in light of tax common law that allows the recharacterization of transactions to better reflect transactional “substance.”

Third, when possible, include deferral language in the settlement agreement in the same manner as you do for structured settlements. The language obligates the defense to make future payments, then arranges for the defense to pay a third party (e.g., a deferral provider) to assume the payment obligation. Doing so best approximates the facts in Childs. This isn’t necessarily a requirement after Banks. In fact, some providers skip this step, which can prove far more practical because it allows defendants to completely avoid participating in the arrangement. But, if you’re skipping this step, pay extra attention to everything else.

Fourth, consider any added risk in having the right to borrow from the provider. The concern is that the amounts held by the provider might be treated as owned by you or held for your exclusive benefit. Notably, the IRS didn’t make this argument in its recent memo, which bodes well for deferral programs allowing this option.

Fifth, and last, memorialize that deferred payments to you, or other lawyers at your firm, will be made for the benefit of the law firm. Ideally, payments are made directly to the law firm, and the firm doesn’t make a fixed promise of future payments to its lawyers. If that’s not possible, take care to avoid premature taxation under Section 409A and tax rules for partnerships, S corporations, and C corporations. There are options for each.

V.     Conclusion

Since the 1990s, trial lawyers have deferred fees with greater confidence. In that time, insurance companies and other financial service providers have offered varying programs to take advantage of this unique tax planning option.

In using them, and securing significant tax benefits, lawyers can and should take care to avoid “premature taxation.” The IRS’ 2022 memo serves as an excellent reminder to do so.

About the Authors

Jeremy Babener consults for plaintiff firms and their service providers. He served in the U.S. Treasury’s Office of Tax Policy, now serves on the legal committees of the three national settlement planning associations, and can be reached at


Greg Maxwell advises plaintiff firms across the country on settlement planning, special needs planning, and income tax planning. He served as president of the Society of Settlement Planners and can be reached at


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