With the holidays and year-end approaching quickly, it’s a great time to lay out your firm’s strategic plan for 2019. This includes preparing for the upcoming tax season.
Planning now will go a long way in easing your stress when it comes time to file your returns, and it can be especially important for firms experiencing growth or looking to restructure.
Here are 5 tips to help you plan ahead and tackle your taxes:
- Keep everything in order
The old “shoebox” filing system has no place here! It’s imperative that you have a clear picture of your firm’s operations and performance, so staying organized is the way to go. This way, you know where you stand and can properly manage your cash flow when anticipating upcoming expenses, such as taxes. It may be beneficial to employ an inexpensive, user-friendly accounting system if you don’t already have one in place. A good system will allow you to better track your revenues and expenses, as well as more easily set goals for your firm.
- Track your Case Expenses
Depending on the type of practice you have, case expenses can be significant. You’ll want to have a solid handle on how much you’re spending and when you expect those outstanding invoices to be paid.
The reason? Case expenses are generally not “tax-friendly.” Thus, properly managing, tracking and reporting your case costs cases is essential to avoiding potential issues during tax season. A wide variety of case management software is available to help you keep everything organized and easily accessible.
Generally, when case expenses are paid they should be classified as a receivable rather than an expense. These receivables are repaid when the fee is collected. Booking the case cost as an expense when paid may raise red flags with the IRS. While you may qualify for an exception, it’s best to consult a tax professional prior to doing so.
- Take deductions where it’s prudent
Many contingent-fee law firms gain working capital through a line of credit, helping them to gain a competitive advantage by having funds to advertise, add staff and foster growth. Along the same lines, having capital to pay for the best experts and case work-up is better for your firm, rather than having to turn to a co-counsel agreement and in turn, share a portion of your fee. Generally speaking, interest on a credit line is deductible as a business expense, which many firms don’t realize can reduce their tax burden. Provided that the borrowed funds are used for qualified law firm expenses, the interest will be deductible.
- Be mindful of your firm’s legal structure
It’s important to remember, depending on the structure of your firm there may be differing requirements on how partners’ payments are classified for tax purposes. For example, S Corporations typically require partners (known as shareholders) to be paid wages that directly relate to the work they perform. These wages are subject to standard state and federal tax withholdings. Then, the remaining income or losses of the S Corp are typically allocated among the shareholders, after deducting for those wages.
Conversely, partners (known as members) of Limited Liability Companies are typically required to receive all payments as distributions. The profits and losses of the LLC are usually then allocated among the members without regard to the distributions made.
These are examples of just two types of legal structures law firms adopt, with two different tax treatments. It’s critical that you work with your tax professional to be sure you’re able to gain the most favorable tax treatment applicable to your firm’s structure, while ensuring you’re properly following the most current tax code to mitigate the risk of having to undergo an IRS audit.
- Reduce your income the right way
There are some ways that your firm and its partners can reduce taxable income. Contributing to a 401(k), Supplemental Retirement Plan or IRA provides a dual-benefit: reducing taxable income and wisely saving for the future. Talk with your accountants and financial advisors to explore what options are available for you, so that you can make these contributions throughout the year as you plan ahead.
There are also methods of deferring taxation on earned fees by structuring them over a certain period of time. For firms that engage in charitable activities, it’s good to keep in mind that pro bono work also qualifies you for additional deductions, as long as the expense is directly related to a non-profit and is not a personal expense.
As with most things in life, any 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.
By taking the time out of your busy schedule to sit down and evaluate “where can I take my firm this year?” you’ll stay one step ahead of the competition and poster your firm in the best position for growth and success.