8 Financial Planning Tax Considerations for Attorneys in Law Firm Partnerships

Income taxes can be especially tricky for partners in a law firm. Partners are considered self-employed for tax purposes and are required to report their share of the Partnership’s income and expense items on their personal tax returns. As a result, law firm partners tend to face a unique set of issues including numerous state and local reporting requirements, various state tax deductions and credits, and proper utilization of foreign tax credits, just to name a few.

As income and employment tax rates have risen in recent years, poor tax compliance and/or planning can be quite costly to a practicing attorney.  Therefore, proper tax return preparation and thoughtful, proactive tax planning are critical components of an attorney’s overall wealth management strategy. Below are some items that every partner should consider:

1. Align your estimated tax payments with your cash flow. Law firms may experience significant variability in income from one year to the next. In addition, many firms have uneven partner distribution schedules, many of which are heavily weighted towards the end of the year.  Working with your tax advisor, set up smaller estimated tax payments in years of lower income and/or make smaller estimated payments at the beginning of the year and larger payments later in the year to better mirror your cash flow.  This advice comes with a cautionary note:  be sure to work with a tax professional to avoid substantial under/late payment penalties.
2. Make sure you are filing in all relevant tax jurisdictions. Attorneys are often required to file in multiple states and localities. This can quickly get complex, confusing and possibly trigger audits and penalties if not handled correctly.  Work with your tax advisor to ensure you satisfy these filing requirements, capture all available deductions, and properly document your filings as a safeguard against audit risk.  Note: if you need to file foreign tax returns, make sure your accountant has experience in that area.
3. Consider the pros and cons of filing individual versus composite state returns. Partners should work closely with their tax advisor to properly determine which filing method would minimize their tax liability.
4. Consider the potential benefits of a foreign tax deduction versus a foreign tax credit. Partners of law firms with international operations can pay significant taxes to foreign countries. There are various strategies available to optimize the benefit of these foreign taxes on your U.S. return. Discuss with your tax advisor whether a credit or deduction would be more beneficial and whether any prior year returns should be amended to optimize your taxes (there is a special 10-year look-back period that may apply).
5. Don’t save all your tax preparation for the weeks or days before filing deadlines. Set up meetings with your accountant for non-tax-crunch times and spread tax paperwork and decisions throughout the year to ensure accuracy and thoughtful planning.
6. Leverage your retirement plan. Take advantage of the savings opportunities provided by your firm’s retirement plan.  Deferring income until later years may translate into tens of thousands of dollars in tax savings.  You also may be able to supplement your retirement savings in a tax-efficient manner.
7. Don’t forget about taxes when achieving firm milestones or changing law firms. Key firm events such as mergers, sales, and bankruptcies as well as changing law firms, can have a significant impact on your tax bill.  Be sure to discuss these events with your tax advisor in advance to ensure you fully understand the tax implications and have time to plan appropriately.
8. Make sure your investment portfolios are managed with tax considerations in mind. 

The important item to remember is that tax consequences should be considered in all aspects of your wealth management.  Remember: It’s not what you earn, but what you keep.