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Whether you’re newly licensed or are looking to start your own law firm, the IRS will want its cut. And unfortunately, the fee sharing rules don’t apply to taxes. This tax guide for attorneys tells you how to get started.
What’s Your Employment Status?
How you pay taxes, and what you can deduct, depends on how you’re classified.
If you’re an associate in a law firm or working for the government or in-house, you’ll likely be classified as an employee. This means that your employer will withhold taxes for you and send you a W-2 at the end of the year.
Unfortunately, employees can’t deduct things like bar dues. The Tax Cuts and Jobs Act ended deducting unreimbursed employment expenses as itemized deductions in 2018 and beyond.
If you’ve signed on as an independent contractor, you’ll receive a 1099 at the end of the year. You must pay all taxes directly to the IRS including income tax and self-employment taxes.
Independent contractors count as sole proprietors and file a Schedule C with their tax return. You can deduct all ordinary and necessary business expenses on your schedule C.
Note: Contractor in this context refers to tax status. Some temporary or fixed-term positions may be called a contract but classify you as a W-2 employee for tax purposes.
If you start a solo firm, your tax treatment is generally the same as independent contractors. If you organize your firm as an LLC, you may be able to elect to be taxed as a corporation. Some states allow law firms to incorporate as a professional corporation.
Being taxed as a corporation allows you to pay yourself as an employee. A common tax strategy is to elect S-corporation status. This passes the corporation’s income to your own tax return instead of paying corporate income taxes. When you do this, you can potentially split your income into wages subject to FICA taxes and dividends that are only subject to ordinary income taxes. So you can potentially save on Social Security and Medicare taxes.
If you’re using an S-corporation, pay close attention to the IRS reasonable compensation rules. You can’t just pay yourself a low salary and shift all of your income to dividends to avoid taxes. You have to take a reasonable salary. It’s easier to claim more money as dividends if you have employees doing some of your work (attorneys or support staff). This is a move you really want to talk to an accountant about to get it right.
In a partnership, each attorney divides up their share of the earnings and expenses in accordance with the partnership agreement. Their share is then taxed on an individual basis similar to a solo firm or independent contractor.
This only applies to the partners. Associates and support staff will generally be paid and pay taxes as employees.
Section 199A Qualified Business Income Deduction
Attorneys who are not employees are eligible for the 20% deduction on pass-through qualified business income. The deduction is roughly 20% of your business profits meaning that you pay income tax on about 80% of your profit.
The practice of law is a specified service business, so income limits apply. The income limits cover all of your income including business income, employment income, investment income, and other sources.
|Single Filer||Joint Filer|
|Full deduction for income up to:||$157,500||$315,000|
|Partial deduction for income up to:||$207,500||$415,000|
|No deduction over:||$207,500||$415,000|
Unlike income tax brackets, this deduction is all or nothing. If your income is above $207,500/$415,000, you don’t get a 20% deduction on your first $157,500/$315,000. You get 0%.
To calculate the partial deduction (example for a joint filer earning $365,000 in business income in parentheses):
- Subtract the full-deduction income limit from your income. ($365,000 – $315,000 = $50,000)
- Subtract the full-deduction income from the no-deduction income limit. ($415,000 – $315,000 = $100,000)
- Divide 1 by 2. ($50,000/$100,000 = 50%)
- Multiply by 20%. (50% x 20% = 10% deduction)
General Business Expenses
If you have your own firm, you can deduct general business expenses such as:
- Office rent.
- Office supplies.
- Employee salaries.
- Phone and internet costs but only to the extent you use them for business. If you use them 50/50 for business and persona, you can only deduct half.
Bar Review Courses
Bar review courses are not deductible. You can’t deduct education costs that allow you to enter into a new profession.
Bar Memberships, Continuing Legal Education, Trade Journals, Etc.
These expenses are generally deductible if you have your own firm or are a contractor to the extent that they are ordinary and necessary business expenses that further your practice of law.
Employees cannot deduct these expenses as itemized deductions under the Tax Cuts and Jobs Act.
Talk to Your Tax Accountant
This tax guide for attorneys gives you a basic overview of what you need to know. To maximize your tax savings and make sure you don’t miss anything, talk to an experienced tax accountant.