Retainers


H

Howard Kaikow

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?
 
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J

John H. Fisher

Howard Kaikow said:
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 - (e-mail address removed)
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!=:)
 
B

BRaskinCPA

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
(e-mail address removed)
Small Business and Individual Tax and Accouting Services
 
H

Howard Kaikow

Is a retainer fully taxable in the year in which the
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.
 
S

Stuart Bronstein

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
 
T

TaxSrv

Howard Kaikow said:
...
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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M

MTW

Howard said:
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
 
H

Howard Kaikow

TaxSrv said:
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.
 
S

Stuart Bronstein

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
 
H

Howard Kaikow

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.
 
H

Howard Kaikow

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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S

Stuart Bronstein

Howard said:
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
 
H

Hamlet the Prince

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.
 
M

MTW

Howard said:
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
 
S

Stuart Bronstein

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
 
M

MTW

Stuart said:
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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S

Stuart Bronstein

MTW said:
Stuart Bronstein wrote:
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
 
H

Howard Kaikow

MTW said:
Stuart Bronstein wrote:
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?
 
E

Ed Zollars, CPA

Stuart said:
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.
 
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S

Stuart Bronstein

Howard said:
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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