Contingency Fee Accounting: Tax Treatment of Legal Fees Received on Settlements — CPA Firm Near You, Montreal

Introduction

Contingency-fee lawyers in Quebec — especially litigators, personal-injury firms, class-action counsel, and employment lawyers — face unique tax and accounting challenges. Revenue often arrives irregularly, years after work begins, and only if the client wins or settles. CRA and Revenu Québec apply strict rules for recognizing contingency-fee income, deducting case expenses, and reporting Work in Progress (WIP). This guide explains how contingency-fee revenue is taxed, how to properly record disbursements, and how a CPA firm near you in Montreal can help ensure fully compliant financial reporting.

Legal and Regulatory Framework

Under the Income Tax Act and the Taxation Act of Quebec:

Income Recognition

• Contingency-fee revenue is generally taxable when received, not when work is performed.
• Fees must be included in income in the fiscal year the settlement or judgment is collected.
• Holdbacks, trust-account deposits, and partial settlements must all be reported when they become the lawyer’s property.

Disbursements (Case Expenses)

• Client-chargeable disbursements (filing fees, experts, photocopying, medical records, etc.) are not deductible — they are reimbursed through the settlement.
• Law firms must treat disbursements as receivables, not expenses.
• Expenses that are not recoverable from the client are deductible as business expenses.

GST/QST

• GST/QST applies to the legal fee portion of a settlement.
• Disbursements passed through at cost are typically not subject to GST/QST.

Trust Accounting Requirements

• Funds must remain in trust until distributed according to the settlement agreement and the Barreau du Québec trust rules.

Key Court Decisions

Courts have ruled that:
• Contingency-fee lawyers must recognize income in the year it becomes unrestricted, even if the underlying case took years.
• Disbursements recovered from the client cannot be deducted as expenses.
• Firms must maintain accurate trust-account ledgers; discrepancies lead to tax adjustments.
• CRA may adjust income if the contingency arrangement percentages are unclear or undocumented.
• WIP rules generally do not apply to contingency practices (income is recognized upon settlement).

Judges emphasize documentation — settlement agreements, trust ledgers, fee agreements, and disbursement logs.

Why CRA and Revenu Québec Target Contingency-Fee Lawyers

Audit risk is extremely high because:
• Revenue recognition can be inconsistent
• Trust-account records may not match income reporting
• Disbursement accounting is often incorrect
• GST/QST is sometimes not applied correctly on legal fees
• Case expenses are frequently mixed with office overhead
• Multi-year files complicate year-to-year income reconciliation

Auditors compare trust statements, case ledgers, settlement agreements, T4A slips, and disbursement records.

Mackisen Strategy

At Mackisen CPA Montreal, we help contingency-fee firms build systems that correctly track revenue and expenses. We:
• Reconcile trust accounts with income statements
• Categorize disbursements as receivables, not expenses
• Time revenue recognition to match settlement dates
• Calculate GST/QST on the fee portion only
• Build clear documentation for audit defense
• Prepare year-end statements that reflect multi-year case pipelines
• Implement systems for client-cost tracking and contingency-fee calculations

Real Client Experience

A Montreal personal-injury firm was reassessed after CRA found mismatches between trust-account ledgers and reported income. We reconstructed case files, corrected disbursement treatment, and reinstated proper income recognition. Another firm incorrectly expensed recoverable disbursements; we restructured accounting and prevented a major audit adjustment.

Common Questions

When is contingency-fee revenue taxable?

When received and unrestricted — usually at settlement or judgment.

Are case disbursements deductible?

Only when they are not recoverable from clients.

Do WIP rules apply to contingency cases?

No. Income is recognized only when payment is received.

Is GST/QST charged on settlements?

Only on the legal-fee portion, not on disbursements passed through at cost.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps contingency-fee legal practices maintain compliant and optimized accounting. Whether handling large personal-injury cases or multi-year litigation pipelines, our expert team ensures precision, transparency, and full audit protection.