Retainers

Discussion in 'Tax' started by Howard Kaikow, Aug 4, 2004.

  1. Is a retainer fully taxable in the year in which the
    retainer is received?

    Or, is the taxable part of the retainer only that part of
    the retainer against which there have been fees/expenses
    charged?

    Does it matter whether any unused part of the retainer will
    be returned at the end of a project if all fees and expenses
    have been paid?

    --
    http://www.standards.com/; See Howard Kaikow's web site.

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    Howard Kaikow, Aug 4, 2004
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  2. "Howard Kaikow" <> writes:

    > Is a retainer fully taxable in the year in which the
    > retainer is received?
    >
    > Or, is the taxable part of the retainer only that part of
    > the retainer against which there have been fees/expenses
    > charged?
    >
    > Does it matter whether any unused part of the retainer will
    > be returned at the end of a project if all fees and expenses
    > have been paid?


    If you receive advance commissions or other amounts for
    services to be performed in the future and you are a cash
    method taxpayer, you must include these amounts in your
    income in the year you receive them.

    If you repay unearned commissions or other amounts in the
    same year you receive them, reduce the amount included in
    your income by the repayment. If you repay them in a later
    tax year, you can deduct the repayment as an itemized
    deduction on your Schedule A (Form 1040), or you may be able
    to take a credit for that year.

    "Jack" - John H. Fisher -
    Philadelphia, Pa - Atlantic City, NJ - West Wildwood, NJ
    My Newsgroups & Boards at: http://members.aol.com/TaxService/index.html

    Where Ignorance is bliss, 'tis folly to be wise!=:)

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    John H. Fisher, Aug 5, 2004
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  3. Howard Kaikow

    BRaskinCPA Guest

    > Is a retainer fully taxable in the year in which the
    > retainer is received?
    >
    > Or, is the taxable part of the retainer only that part of
    > the retainer against which there have been fees/expenses
    > charged?
    >
    > Does it matter whether any unused part of the retainer will
    > be returned at the end of a project if all fees and expenses
    > have been paid?


    Generally, a retainer is fully taxable in the year it is
    received. Expenses incurred are deducted as ordinary
    business expenses.

    You should contact a professional in your area so that
    he/she can do the research necessary to answer the second
    part of the question.

    Bruce Raskin, CPA

    Small Business and Individual Tax and Accouting Services

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    BRaskinCPA, Aug 5, 2004
    #3
  4. >> Is a retainer fully taxable in the year in which the
    >> retainer is received?
    >>
    >> Or, is the taxable part of the retainer only that part of
    >> the retainer against which there have been fees/expenses
    >> charged?
    >>
    >> Does it matter whether any unused part of the retainer will
    >> be returned at the end of a project if all fees and expenses
    >> have been paid?


    > If you receive advance commissions or other amounts for
    > services to be performed in the future and you are a cash
    > method taxpayer, you must include these amounts in your
    > income in the year you receive them.
    >
    > If you repay unearned commissions or other amounts in the
    > same year you receive them, reduce the amount included in
    > your income by the repayment. If you repay them in a later
    > tax year, you can deduct the repayment as an itemized
    > deduction on your Schedule A (Form 1040), or you may be able
    > to take a credit for that year.


    The retainer is just to cover my rear for certain types of
    work.

    For example, depositions/testimony/etc. in a court case in
    which I would be consulting. It's really hard to collect
    after the deed is done, so advance payment is needed.

    --
    http://www.standards.com/; See Howard Kaikow's web site.
    "John H. Fisher" <> wrote:

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    Howard Kaikow, Aug 7, 2004
    #4
  5. Howard Kaikow wrote:

    >>> Is a retainer fully taxable in the year in which the
    >>> retainer is received?
    >>>
    >>> Or, is the taxable part of the retainer only that part of
    >>> the retainer against which there have been fees/expenses
    >>> charged?
    >>>
    >>> Does it matter whether any unused part of the retainer will
    >>> be returned at the end of a project if all fees and expenses
    >>> have been paid?


    >> If you receive advance commissions or other amounts for
    >> services to be performed in the future and you are a cash
    >> method taxpayer, you must include these amounts in your
    >> income in the year you receive them.


    I don't necessarily agree. If the money is not actually
    earned when paid, and might be returned to the extent it is
    unearned, I think of it more as a loan.

    > The retainer is just to cover my rear for certain types of
    > work.
    >
    > For example, depositions/testimony/etc. in a court case in
    > which I would be consulting. It's really hard to collect
    > after the deed is done, so advance payment is needed.


    I put advance payments in my trust account. When I withdraw
    that money to pay for my time, that's when I acknowledge it
    for tax purposes. Up to that point it is still the client's
    money and I don't have any more than custody of it.

    Stu

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    Stuart Bronstein, Aug 10, 2004
    #5
  6. Howard Kaikow

    TaxSrv Guest

    "Howard Kaikow" wrote:

    > ...
    > The retainer is just to cover my rear for certain types of
    > work.
    >
    > For example, depositions/testimony/etc. in a court case in
    > which I would be consulting. It's really hard to collect
    > after the deed is done, so advance payment is needed.


    See this ABA link, regarding client trust accounts:

    www.abanet.org/genpractice/compleat/su96boot.html

    Another potential downside not mentioned in the article is
    deductibility to the client, so this may be more commonly
    done in personal injury cases and the like, where the fees
    are unlikely to be deducted. Where it is a deductible legal
    fee, then both parties end up dealing with paperwork so the
    proper year of deduction and amount can be documented. And
    that further presumes that the contractual arrangement is
    worded such that it deductible by the client as you expend
    the funds, else the client's deduction could be deferred too
    and in greater amount than the "net" income is deferred for
    you.

    It also seems there should be enough money involved to
    warrant any bank fees on an additional checking account(s),
    which reduce the economic benefit of deferring tax on some
    of the advance to maybe no more than the following year,
    depending upon the probable length of the litigation.

    Fred F.

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    TaxSrv, Aug 10, 2004
    #6
  7. Howard Kaikow

    MTW Guest

    Howard Kaikow wrote:

    > For example, depositions/testimony/etc. in a court case in
    > which I would be consulting. It's really hard to collect
    > after the deed is done, so advance payment is needed.


    Assuming you are a "cash basis" taxpayer, it would be
    taxable when received. Labeling it "refundable" will likely
    not change that unless at the time of payment there is a
    substantial likelihood (not simply a remote contingency)
    that a refund will occur (and, even then, I'm not so
    sure...).

    MTW

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    MTW, Aug 10, 2004
    #7
  8. "TaxSrv" <> wrote:

    > See this ABA link, regarding client trust accounts:
    >
    > www.abanet.org/genpractice/compleat/su96boot.html
    >
    > Another potential downside not mentioned in the article is
    > deductibility to the client, so this may be more commonly
    > done in personal injury cases and the like, where the fees
    > are unlikely to be deducted. Where it is a deductible legal
    > fee, then both parties end up dealing with paperwork so the
    > proper year of deduction and amount can be documented. And
    > that further presumes that the contractual arrangement is
    > worded such that it deductible by the client as you expend
    > the funds, else the client's deduction could be deferred too
    > and in greater amount than the "net" income is deferred for
    > you.
    >
    > It also seems there should be enough money involved to
    > warrant any bank fees on an additional checking account(s),
    > which reduce the economic benefit of deferring tax on some
    > of the advance to maybe no more than the following year,
    > depending upon the probable length of the litigation.


    The bottom line is there are no guarantees on what the IRS
    would rule.

    IMHO, the tax laws should distinguish between refundable and
    non-refundable advances. A refundable advance is clearly a
    liability, not income.

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    Howard Kaikow, Aug 15, 2004
    #8
  9. Howard Kaikow wrote:
    > "TaxSrv" <> wrote:


    >> Another potential downside not mentioned in the article is
    >> deductibility to the client, so this may be more commonly
    >> done in personal injury cases and the like, where the fees
    >> are unlikely to be deducted.


    > The bottom line is there are no guarantees on what the IRS
    > would rule.
    >
    > IMHO, the tax laws should distinguish between refundable and
    > non-refundable advances. A refundable advance is clearly a
    > liability, not income.


    The IRS has gotten the courts to go along with treating
    payments by lawyers before they get paid, as loans to the
    client, so not deductible, even if repayment doesn't happen
    for several years.

    It seems to me reasonable to claim that in the inverse case,
    when the client makes advance (and refundable) payments to
    the lawyer, it should also be treated as a loan, with no tax
    effect until it is either earned or spent by the lawyer.

    Stu

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    Stuart Bronstein, Aug 17, 2004
    #9
  10. "Stuart Bronstein" <> wrote:
    > Howard Kaikow wrote:
    >> "TaxSrv" <> wrote:


    >>> Another potential downside not mentioned in the article is
    >>> deductibility to the client, so this may be more commonly
    >>> done in personal injury cases and the like, where the fees
    >>> are unlikely to be deducted.


    >> The bottom line is there are no guarantees on what the IRS
    >> would rule.
    >>
    >> IMHO, the tax laws should distinguish between refundable and
    >> non-refundable advances. A refundable advance is clearly a
    >> liability, not income.


    > The IRS has gotten the courts to go along with treating
    > payments by lawyers before they get paid, as loans to the
    > client, so not deductible, even if repayment doesn't happen
    > for several years.
    >
    > It seems to me reasonable to claim that in the inverse case,
    > when the client makes advance (and refundable) payments to
    > the lawyer, it should also be treated as a loan, with no tax
    > effect until it is either earned or spent by the lawyer.


    Yes, that's my position.
    But "reasonable", heck we are talking about our Uncle Sam.

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    Howard Kaikow, Aug 19, 2004
    #10
  11. > "Stuart Bronstein" <> wrote:
    >> Howard Kaikow wrote:
    >>> "TaxSrv" <> wrote:


    >>>> Another potential downside not mentioned in the article is
    >>>> deductibility to the client, so this may be more commonly
    >>>> done in personal injury cases and the like, where the fees
    >>>> are unlikely to be deducted.


    >>> The bottom line is there are no guarantees on what the IRS
    >>> would rule.
    >>>
    >>> IMHO, the tax laws should distinguish between refundable and
    >>> non-refundable advances. A refundable advance is clearly a
    >>> liability, not income.


    >> The IRS has gotten the courts to go along with treating
    >> payments by lawyers before they get paid, as loans to the
    >> client, so not deductible, even if repayment doesn't happen
    >> for several years.
    >>
    >> It seems to me reasonable to claim that in the inverse case,
    >> when the client makes advance (and refundable) payments to
    >> the lawyer, it should also be treated as a loan, with no tax
    >> effect until it is either earned or spent by the lawyer.


    > Yes, that's my position.
    > But "reasonable", heck we are talking about our Uncle Sam.


    I found the following on page 14 of the 2003 edition of Pub 334:

    "Constructive receipt. You have constructive receipt of
    income when an amount is credited to your account or made
    available to you without restriction, You do not need to
    have possession of it. If you authorize someone to be your
    agent and receive income for you, you are treated as having
    received it when your agent received it."

    So the question appears to be what "restriction" is
    necessary to cause the amount to not be treated as
    constructive receipt,

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    Howard Kaikow, Sep 2, 2004
    #11
  12. Howard Kaikow wrote:

    > I found the following on page 14 of the 2003 edition of Pub 334:
    >
    > "Constructive receipt. You have constructive receipt of
    > income when an amount is credited to your account or made
    > available to you without restriction, You do not need to
    > have possession of it. If you authorize someone to be your
    > agent and receive income for you, you are treated as having
    > received it when your agent received it."
    >
    > So the question appears to be what "restriction" is
    > necessary to cause the amount to not be treated as
    > constructive receipt,


    Law generally provide that a lawyer is not allowed to
    withdraw money from his trust account to pay himself until
    the money is "earned." So to me it is fairly clear that
    money in that situation is restricted.

    Stu

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    Stuart Bronstein, Sep 6, 2004
    #12
  13. "Howard Kaikow" <> wrote:

    >>>> The bottom line is there are no guarantees on what the IRS
    >>>> would rule.


    I think that about sums it up.

    > I found the following on page 14 of the 2003 edition of Pub 334:
    >
    > "Constructive receipt. You have constructive receipt of
    > income when an amount is credited to your account or made
    > available to you without restriction, You do not need to
    > have possession of it. If you authorize someone to be your
    > agent and receive income for you, you are treated as having
    > received it when your agent received it."
    >
    > So the question appears to be what "restriction" is
    > necessary to cause the amount to not be treated as
    > constructive receipt,


    Of course, the IRS may argue that a retainer has "actually" been
    received by the lawyer and therefore it wouldn't need to meet any
    constructive receipt tests for the full amount to be taxable.

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    Hamlet the Prince, Sep 6, 2004
    #13
  14. Howard Kaikow

    MTW Guest

    Howard Kaikow wrote:

    > So the question appears to be what "restriction" is
    > necessary to cause the amount to not be treated as
    > constructive receipt,


    Welcome to the world of cash-basis tax accounting!

    Restrictions that would likely negate constructive receipt might
    include:

    1) Deposit of the money with a third-party escrow agent who must
    receive the permission of ALL involved parties before disbursing
    funds.

    2) Deposit the money to a "joint" account that requires the
    signatures of BOTH you and your client to make disbursements.

    3) Create a bona fide "trust" or "agency agreement" under
    applicable state law whereunder you are the trustee or agent, but
    do NOT under any circumstances commingle the funds with your own.
    (However, I won't guarantee this will work. There would probably
    need to be some very definitive standards regarding the
    circumstances under which you can distribute the funds to
    yourself. The fact that attorneys [always a "special case" under
    the law, it seems] get away with this approach should not be
    viewed as permitting NON attorneys to do so, in my opinion.)

    4) Etc.

    MTW

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    MTW, Sep 6, 2004
    #14
  15. Hamlet the Prince wrote:
    > "Howard Kaikow" <> wrote:


    >> I found the following on page 14 of the 2003 edition of Pub 334:
    >>
    >> "Constructive receipt. You have constructive receipt of
    >> income when an amount is credited to your account or made
    >> available to you without restriction, You do not need to
    >> have possession of it. If you authorize someone to be your
    >> agent and receive income for you, you are treated as having
    >> received it when your agent received it."
    >>
    >> So the question appears to be what "restriction" is
    >> necessary to cause the amount to not be treated as
    >> constructive receipt,


    > Of course, the IRS may argue that a retainer has "actually" been
    > received by the lawyer and therefore it wouldn't need to meet any
    > constructive receipt tests for the full amount to be taxable.


    But since legal restrictions prohibit a lawyer from
    withdrawing money from his trust account until it is
    actually earned (and requires him to withdraw it once it is
    earned), I seriously doubt any court would support an IRS
    position like that.

    Stu

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    Stuart Bronstein, Sep 8, 2004
    #15
  16. Howard Kaikow

    MTW Guest

    Stuart Bronstein wrote:

    > But since legal restrictions prohibit a lawyer from
    > withdrawing money from his trust account until it is
    > actually earned (and requires him to withdraw it once it is
    > earned), I seriously doubt any court would support an IRS
    > position like that.


    Note, FWIW, the last sentence of the following quote from
    Chapter 4 of the IRS MSSP "Attorneys":

    "Specific Retainer

    This is an agreed fee for a particular case, part of which
    may be payable in advance. The attorney typically sets a fee
    in writing with the client for a prescribed dollar amount
    per hour plus costs. There is a predetermined amount of
    money due before the case is accepted. This advance payment
    is commonly deposited into a trust account. The attorney
    then transfers part or all of the money from the trust
    account to the general account as it is earned. If the
    attorney is on a cash basis of accounting and has free
    access to the funds, the retainer is taxable when received."

    MTW

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    MTW, Sep 9, 2004
    #16
  17. MTW wrote:
    > Stuart Bronstein wrote:


    >> But since legal restrictions prohibit a lawyer from
    >> withdrawing money from his trust account until it is
    >> actually earned (and requires him to withdraw it once it is
    >> earned), I seriously doubt any court would support an IRS
    >> position like that.


    > Note, FWIW, the last sentence of the following quote from
    > Chapter 4 of the IRS MSSP "Attorneys":
    >
    > "Specific Retainer
    >
    > This is an agreed fee for a particular case, part of which
    > may be payable in advance. The attorney typically sets a fee
    > in writing with the client for a prescribed dollar amount
    > per hour plus costs. There is a predetermined amount of
    > money due before the case is accepted. This advance payment
    > is commonly deposited into a trust account. The attorney
    > then transfers part or all of the money from the trust
    > account to the general account as it is earned. If the
    > attorney is on a cash basis of accounting and has free
    > access to the funds, the retainer is taxable when received."


    The key phrase is, "has free access to the funds." Until it
    is earned, an attorney, by law, does not have free access to
    the funds.

    Stu

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    Stuart Bronstein, Sep 11, 2004
    #17
  18. "MTW" <> wrote:
    > Stuart Bronstein wrote:


    >> But since legal restrictions prohibit a lawyer from
    >> withdrawing money from his trust account until it is
    >> actually earned (and requires him to withdraw it once it is
    >> earned), I seriously doubt any court would support an IRS
    >> position like that.


    > Note, FWIW, the last sentence of the following quote from
    > Chapter 4 of the IRS MSSP "Attorneys":
    >
    > "Specific Retainer
    >
    > This is an agreed fee for a particular case, part of which
    > may be payable in advance. The attorney typically sets a fee
    > in writing with the client for a prescribed dollar amount
    > per hour plus costs. There is a predetermined amount of
    > money due before the case is accepted. This advance payment
    > is commonly deposited into a trust account. The attorney
    > then transfers part or all of the money from the trust
    > account to the general account as it is earned. If the
    > attorney is on a cash basis of accounting and has free
    > access to the funds, the retainer is taxable when received."


    How does one set up such a trust account? Can the trust
    account commingle funds from more than one client?

    --
    http://www.standards.com/; See Howard Kaikow's web site.

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    Howard Kaikow, Sep 11, 2004
    #18
  19. Stuart Bronstein wrote:

    > The key phrase is, "has free access to the funds." Until it
    > is earned, an attorney, by law, does not have free access to
    > the funds.


    I think the IRS's concern was that some attorneys would be
    somewhat "slow" to transfer funds from the trust account
    around the end of the year <grin>. So their interest has
    concentrated on if there are funds in the account where the
    attorney does have the right to draw but has not yet done
    so.

    --
    Ed Zollars, CPA
    Phoenix, Arizona

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    Ed Zollars, CPA, Sep 13, 2004
    #19
  20. Howard Kaikow wrote:

    > How does one set up such a trust account? Can the trust
    > account commingle funds from more than one client?


    Check with the state bar in your state.

    In California there are two types:

    The most common is a specific type of account that must be
    arranged by by the bank. The State Bar pays all bank
    charges, but receives any interest that may be given on
    deposits. Funds from different clients may be deposited
    there, but records must be kept to determine how much was
    deposited and how much is being held for each client at any
    given time.

    Financially this makes sense because for smaller accounts
    any bank charges would exceed any interest (if any) payable.
    So this scheme allows the State Bar to aggregate these
    funds for purposes of calculation of fees and interest, with
    interest going to pay for legal services for the poor.

    For deposits large enough to make earning interest worth
    while, a specific account can be opened for money held for
    individual clients. For this I believe you can only deposit
    one client's funds in any given account. You use their tax
    id number on the account, but the attorney has signature
    authority.

    Stu

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    Stuart Bronstein, Sep 13, 2004
    #20
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