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Childs V. Commissioner: The 11th Circuit Court Ruling

Jackie Deelaney

In Childs v. Commissioner1, the 11th circuit ruled that attorneys may use structures to defer their fees and recognize those future payments in the year in which they are received. Attaching the lower court’s opinion to the order, the 11th circuit “affirmed for the reasons expressed in the Tax Court’s opinion.” The Tax Court’s opinion is discussed below . . .

The underlying case involved a suit against Columbus Propane Gas which claimed the company was responsible for a home explosion that killed Willie James Jones and badly injured his step-son, Garrett. Mrs. Jones retained the law firm Swearingen, Childs & Philip, P.C., and, upon settlement, three of her attorneys structured their fees.

The IRS brought suit arguing that the fees should have been included as income in the year the settlement agreement was signed under § 83’s definition of property. The IRS also argued that each attorney constructively received the total fee in the year the annuity was purchased. The fee amount, they reasoned, was the annuity’s purchase amount.

The Tax Court held:
(1) the purchase price of the annuities was not includable in the attorney’s gross income in the year the settlement agreement was executed since the structured settlement was not “property” under § 83 of the IRS code, and
(2) the attorneys did not take constructive receipt of the funds, because they had no right to receive the funds prior to the execution of the agreement that fixed the terms of the structured settlement.

(1) “Property” under IRS Code § 83 must be included in a taxpayer’s gross income in the year received. Property includes “a promise to pay money in the future that is either secured or funded.” The court relied on the precedent of three cases2 to conclude that funding occurs when proceeds from the policy are able to be distributed to the beneficiary (Attorney) with no action required on the part of the obligor (Carrier/Assignee), even if the proceeds are to be distributed in the future3.

Here, the structured settlements were not “funded,” because (1) the attorneys did not own the policies, (2) the attorneys could not accelerate, defer, increase, or decrease the payments, (3) the attorneys’ rights were no greater than those of a general creditor, and (4) the Assignees had the right to change the annuitant or beneficiary without the consent of the attorneys. In other words, the Assignees maintained a requisite level of control over the structured settlement.

The court also considered whether guaranteed payments were “secured.” In determining they were not, the court held that an insurance company maintaining reserves does not equate to property securing the guaranteed funds. As such, the structured settlements were unfunded and unsecured promises and, therefore, not property under the tax code and not includable as income in the year that the annuities were funded.

(2) The court turned to whether the attorneys took constructive receipt of their fees. Income is constructively received in the year it is credited to the taxpayer’s account, is set apart for the taxpayer, or is otherwise made available so that the taxpayer can draw upon it with notice4. A taxpayer does not have constructive receipt if their “control of its receipt is subject to substantial limitations or restrictions.” Alternatively, a tax payer does have constructive receipt upon “an unqualified, vested right to receive immediate payment” or “an unrestricted right to receive [payment] immediately.”

In Childs, the attorneys and plaintiffs entered a contingency fee agreement stating that if the case was won, the attorneys would get a percentage of the settlement or award. The attorneys were not entitled to their fee until that time, and, because the funds were not available at the attorneys “unfettered demand,” the court held the fees were not in constructive receipt.

In conclusion, the Childs court determined that attorney fees don’t meet the definition of property under § 83 (using “funded” and “secured” as guideposts) and are also not constructively received by the attorney. As such, an attorney may request his/her fees be used to purchase a structured settlement. The payments are not includable in an attorney’s income in the year the settlement agreement is signed. Instead, the individual payments are included in gross income in the years they are received.

1 Childs v. Comr. Of I.r.s, 89 F.3d 856 (11th Cir. 1996)
2 Sproull v. Commissioner, 16 T.C. 244 (1951), affd. 194 F.2d 541 (6the Cir. 1952) (where a trust is funded by an employer for past services rendered, but employee owns the beneficial interest, employee will recognize the funding amount in the year it was deposited); Centre v. Commissioner, 55 T.C. 16 (1970) (employee does not recognize insurance premium payment amounts as income where employer is the payor, owner, and beneficiary of the policy); Minor v. United States, 772 F.2d 1472 (9th Cir. 1985) (where employer is the settlor and beneficiary of a trust, and employee determines the percentage of his/her fee to distribute to that trust, employee does not recognize the fee percentage as income in the year it was distributed when employee has no right, title, or interest in the trust; also, when the trust is not secured from employer’s creditors, it is not conferred on the employee and is, therefore, not recognizable income in that year).
3 Caveat – Not important for our discussion here, but it’s worth noting that if the trust or policy is subject to general creditors, it will not be considered funded. The obligor may need to take further action for the proceeds to be released to the beneficiary. For an example, see Minor above.
4 Reg. § 1.451-2(a)
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