As the 2022 tax deadline draws nearer, now is the time to get your firm’s financials in order and ready to file. While doing so, it’s useful to also consider strategic initiatives your firm plans to undertake, such as advertising for new cases, jumping into new practice areas or bolstering your legal staff.
Here are 5 tips to help start the process.
- Accomplish year-round organization
Maintain a solid understanding of your firm’s operations, financial position, payables and receivables throughout the year, to avoid a bottleneck at tax time. By always having a clear picture of your cash flow, you can effectively anticipate and get ahead of expenses such as tax payments. Using an accounting software can help expedite this process and make the data accessible and user-friendly for anyone at your firm that may need it. In addition, it can assist you in projecting if or when your firm may run into cash deficiencies, allowing you to plan for peaks and valleys in liquidity.
- Diligently track your case expenses
For contingent fee firms, up-front costs for case workup can be substantial. It’s critical you identify how much capital you’ll need to dedicate to each case and to project when invoices will need to be paid.
Contingent-fee case expenses are generally not considered “tax-friendly” so having a solid handle on them will help avoid any problems that may come up during tax time. You may want to institute case management software to make staying on top of your case expenses a more manageable task.
It’s also good practice to record your case expenses as receivables when paid, rather than expenses as they will be repaid when you earn your fee at the conclusion of the litigation. If categorized as expenses, you run the risk drawing attention from the IRS—which you want to avoid whenever possible by employing best practices. Consulting a tax or accounting professional in instances such as these will help to ensure you’re keeping the books in the correct manner.
- Take deductions where they apply
Contingent fee law firms have a very unique structure. Having to make significant capital outlays up-front while simultaneously managing normal firm operations can pose major challenges to your business. Working capital from a third-party lender can give you the stability and flexibility necessary to keep propelling your firm forward, whether through growing your staff, sourcing the best experts for your clients’ cases or advertising to expand your case portfolio. Using a law firm lender can also help your firm to avoid fee-splitting due to co-counsel agreements.
Interest on law firm loans, and specifically credit lines, is deductible as a business expense and may therefore reduce your tax burden as well. Provided borrowed capital is used for qualified law firm expenses, the interest is deductible.
- Categorize payments based on legal structure
The classification of your firm’s payments to its partners can be dependent on your firm’s legal structure.
Limited Liability Companies (LLCs) usually require that all pay-outs are taken as distributions. These payments typically stay separate from the profit and loss allocations made among members of the LLC.
Conversely, shareholders of S Corporations are generally required to be paid based upon the work performed by each person and are subject to standard state and federal tax withholdings. After a reduction for the aforementioned wages, income or losses are then allocated among shareholders.
There are many other business structures a law practice may employ—sole proprietorship, professional corporations, limited liability partnerships, and so on—each with unique tax treatments. It’s prudent to work closely with a tax professional to keep compliant with IRS rules and regulations and ensure you are correctly following the most current tax code, while also obtaining the most favorable tax treatment.
- Reduce taxable income
Looking ahead and planning for your future is a win-win, as it also may help to decrease your taxable income. Contributions to a 401K, IRA or Supplemental Retirement Plan can all work toward reducing the amount you pay taxes on. Your financial advisor and accountant can help you to strategically manage these savings plans throughout the year, so when tax season approaches, you’re already one step ahead.
Another option may be to structure your attorney’s fees over a certain period of time in order to defer taxation on your earnings. Or, if you engage in pro bono work for charity, there may be additional deductions that apply to your firm. Keep in mind that the expenses must be directly correlated with a non-profit and not be personal expenses of any kind.
All of the strategies and tips above can be subject to limitations and exceptions, so it is best to consult with an accountant or tax professional for additional insight.
Counsel Financial can provide working capital to your firm during tax season and beyond. To learn more about the financial programs available to your firm, visit CounselFinancial.com or call us at 800-820-4430.