While case costs are often considered the life blood in the litigation space, a firm’s approach to managing client case costs can impact, good or bad, cash flow, operations and growth — and it can result in tax implications.

For many contingency fee law firms, especially those that are self-financed, case disbursements often tie-up a law firm’s revenue. The result is limitations on access to capital that can hinder operations and growth.

Avoiding the Pitfalls of Phantom Income

Since case expenses are not considered current tax deductions, they can create phantom income at tax time.

Phantom income occurs when a business owner pays taxes on income that has not been distributed to the business owner. Most often, the business uses this income to pay for operating costs. For trial lawyers, the income is often used to pay for case costs. For more information about avoiding phantom income, read our blog, “How Attorneys Can Avoid the Phantom Income Trap: 3 Key Considerations”.

Viewing Case Costs As An Investment

According to Tim McKey, CEO of Vista Consulting, a consulting firm that works with hundreds of attorneys throughout the United States and Canada, law firms should view case costs as “an investment, not an expense”  and “something better managed through financing.” By financing case costs, the firm can free-up capital to invest in law firm staff, operations, case acquisition, and growth.

Financing Case Costs to Improve Cash Flow

By utilizing case cost financing, law firms can run the firm’s operations while leveraging a credit facility to finance case disbursements. Creating cash and credit reserves not only helps alleviate current and future cash flow concerns, but it can also provide a minimal-cost, high-benefit way of building up the firm’s operations.

Additionally, the firm can deduct the interest expense or potentially pass it along as a case cost to the client if included in the retainer agreement and permitted by that state’s ethics opinion**.

Click above to watch the 4-minute video featuring Tim McKey, CEO of Vista Consulting, on how your firm’s approach to managing client case costs can improve cash flow or create tax woes.

Meet with Esquire Bank

Now that you understand the best practices for managing client case costs and how attorneys can avoid the phantom income trap, a good next step would be to contact an Esquire Bank relationship manager to discuss your law firm’s case inventory, growth trajectory, and capital needs.

Schedule a no-obligation consultation with an Esquire Bank Business Development Officer today at a time convenient to your schedule.

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For more on Esquire Bank’s expertise in providing tailored solutions for law firms, please visit Esquire Bank’s resources portal, Lawyer IQ, where you can learn about growing your business, financing for law firms, marketing strategy best practices, and more.

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*The information provided on (or accessed through) this email is provided for general informational purposes only and is not intended as, and should not be relied on for, law firm operations, tax, legal or accounting advice. Some of the information may not be applicable or appropriate for all law firms. Please consult your own tax, legal and accounting advisors as appropriate.

**As per the ethics opinion of the state you operate in.