THE PAPER CHASE

Using the Loan Method of Split Dollar as an Alternative to Attorney Fee Deferrals

One of my favorite movies that inspired me to go to law school was The Paper Chase. The movie follows the trials and tribulations of a first-year law student James Hart at Harvard Law School. During the same period that I was an Army officer stationed at Fort Hood, the Showtime series of the story was mandatory watching. The series followed Hart, the law student in his second and third years of law school. Nevertheless, it never occurred to me to apply to Harvard. I was not a maven when it came to standardized tests. Coincidentally, my friend and West Point classmate who tutored in all the math and science classes, Jim Bowen, did graduate from Harvard Law School. I have always joked that he is the only West Point graduate who has his name on two West Point diplomas, his own and mine.


I took the LSAT at Baylor University on the way to my next duty station, Fort Eustis. I did not apply to law school until three years later while living in South Florida. At that time, the University of Miami (UM) had the only evening law program in South Florida. Since that time, UM dropped its program apparently because prestigious law school programs (like Harvard!) don’t have evening programs.


I have written previously about the deferral of attorney contingency fees and have been on a several week rant about the planning power of the Loan Regime Method of Split Dollar. This article focuses on how deferred contingency fees can be strategically repositioned through the Loan Method of Split Dollar to produce more tax efficient benefits during lifetime and at death.


Attorney Fee Deferrals


Attorneys can defer contingency fees in either qualified assignment or non-qualified assignment cases. The seminal case recognizing an attorney ability to defer contingency fees before there is constructive receipt is Childs v. Commissioner, 103 T.C. 634 (1994), aff’d without opinion, 89 F.3d 856 (11th Cir. 1996). Fee deferrals in qualified assignments are usually structured in structured settlement annuities or in qualified settlement funds. Non-qualified assignments are usually structured through foreign assignment companies in jurisdictions that have favorable tax treaties with the United States.

In my view, trial attorneys have under-utilized fee deferrals of any sort. Nevertheless, any deferred compensation ultimately has several problems. First, the deferred fee compensation is subject to federal and state income taxation. Second, the deferred fee income is included in the attorney’s taxable estate. Third, some attorneys are so wealthy that they enough income for one hundred lifetimes and don’t need anymore. The combination of taxes can result in a 70-80 percent erosion in the amount of the deferred fee income. The situation is “Pay now, or pay letter but in all cases, the taxpayer pays.

The Use of Loan Regime Split Dollar as an Alternative to Fee Deferrals

QSFs are trusts that are designed to resolve litigation and satisfy claims of the litigation even if they are not the subject of litigation. The QSF is authorized and governed by the provisions of IRC Sec 468B. A QSF has no statutory time limit within IRC Sec 468B or the treasury regulations regarding how long a QSF may be kept in place.


The QSF has benefits for both plaintiffs and defendants. From a defendant’s perspective, the ability to transfer assets to a QSF can resolve the claim and release the defendant from further liability while achieving an immediate tax deduction regardless of when claimants receive distributions. This is a significant tax planning point for the defendant particularly for non-physical injury tort cases.


The plaintiff can achieve numerous benefits. Claimants can use the QSF to time the receipt of their income. Plaintiffs are not taxed until they receive distributions from the QSF. The QSF provides the plaintiff and their attorney with the ability to work out the details of their distribution.


The QSF can hold deferred contingency fees. The trustee of the QSF can purchase an annuity or invest the deferred fees for future payment subject to a payout schedule. Alternatively, the deferred fees can be used to enter into a split dollar arrangement with the trial lawyer or his family trust.


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