Introduction to Capitalizing Advanced Client Costs
Case costs related to contingency fee matters are capitalized on the firm's balance sheet, even for cash basis taxpayers. The advanced amounts are largely treated as loans that are repaid when the case settles. If a case is lost, the expenses are deducted in the year when the case was lost.
Year 1 - The firm pays $10,000 in expert witness costs. The $10,000 will appear on the firm's balance sheet and is not deducted as an expense.
Year 2 - The case is not resolved and the $10,000 remains on the balance sheet.
Year 3 - The case is won. In the settlement, the firm receives $60,000 in legal fees and a $10,000 reimbursement for the expert witness cost, for a total payment of $70,000. The firm's financial statements will report $60,000 in legal fee income, and the $10,000 advanced client cost balance is removed from the balance sheet.
If the case was lost in year three, the firm would report a $10,000 deductible expense.
The advanced client cost requirement starts on page 37 of the Attorneys Audit Technique Guide.
Paragraph G.5 summarizes the position.
"Therefore, attorneys on the cash method of accounting may not take a current deduction for client expense advancements for which an attorney expects to be reimbursed."