Retainers

[Gretel]

I am confused. When is a payment to a lawyer deemed to be paid for a cash basis taxpayer? When retainer is paid? Or in increments as services are provided?

Am I correct that the lawyer has to report income as money received? Could it be different for client, who paid?

I have a trust who was defending the title to a farm and I will file the final tax return now. Some fees have been paid before the last tax year, so they are lost, but some are paid/incurred for the last tax year.

It's just amazing how a little thing can throw me off totally.

[BOB W]

Refunds..

... I've never heard of a lawyer giving back retainers. I would deduct as paid.

[Unregistered]

Here is an interesting thought:

Legal fees for defending the property title of real property is capitalized and recovered through depreciation. Wouldn't that apply to farm land as well?

[KJ Judd]

Generally a legal retainer is required to be kept in a completely separate bank account by State Bar rules. The money only becomes the attorneys' after invoice is generated (and in WI a certain amount of time is allowed to pass) then the funds can be moved from the separate retainer account to the law firm's checking account.

(I used to be the tax accounting manager for a large nationwide law firm.) So a legal retainer would not be taxable until the services are rendered.

[Snaggletoof]

Cash Basis

Gabriele, I'm going to stretch my expertise to the extent of its limited boundary and say that this would fall as most Schedule A deductions - cash basis only. The IRS makes money by allowing only amounts actually paid on schedule A stuff, especially if the total expense is paid for over 2 years or more.

It gets even worse in the matter of legal fees, as they are subject to the 2% floor. This way the IRS gets to apply the 2% floor TWICE instead of only once.

This of course applies only to an individual 1040. If the payments are made by a business, it is probably going to work by not expensing the prepaid retainer if the business is on an accrual basis. Almost all business are allowed the accrual basis - Partnerships, Proprietorships, Corporations, LLCs, etc.

How the lawyer treats the income is irrelevant to your client and to the IRS, unless of course the lawyer IS your client. But just to answer the question, the lawyer has the same capability to defer the income through accrual accounting as the abovementioned businesses have to prepay it (only in mirror-image fashion).