The Internal Revenue Service and the Treasury Department are extending a number of tax deadlines for individuals, trusts, estates, corporations and others due to the impact of the novel coronavirus. In Notice 2020-23, they extended key tax deadlines for both individuals and businesses. In March 2020, the IRS said that taxpayers would generally have until July 15, 2020, to file and pay federal income taxes originally due on April 15. No late-filing penalty, late-payment penalty or interest will be due. As a result, your firm can take advantage of this extra time for strategic planning purposes. With emergency, short-term financial relief available through the CARES Act and long-term consequences to the legal industry likely to come, planning now for the best tax-advantaged filing is imperative.
Here are 5 ways you stay on top of the process:1. Plan ahead and stay organized
If you don’t have a strong grasp on your firm’s operations, income and expenses throughout the year, it can prove difficult to employ a strategic plan during tax season and beyond. By constructing a clear roadmap of your cash flow, you’ll be better able to anticipate and prepare for upcoming expenses, such as tax payments. Consider tracking your revenues and expenses with some form of accounting software—there are many available and most are very user-friendly—if you don’t already. Having such a system in place will also allow you to set goals for the future and track your results. Also, hire the right individual to manage that software. Too often, law firms may rely on under-qualified personnel to maintain important accounting records.2. Track your case expenses
For contingent fee firms, up-front case expenses can be significant. It’s imperative to know exactly how much capital a case ultimately requires and when outstanding invoices can be paid.
Cases expenses are typically not considered “tax-friendly” so having a solid grip on the amount of these costs will help avoid any problems that may arise during tax time. Case management software is widely available via many different vendors that will assist in this challenge.
When case expenses are paid they generally should be classified as a receivable rather than an expense, because they are set to be repaid when your fee is collected at the close of the case. Recording case costs as firm expenses may be flagged by the IRS—something you’re sure to want to avoid. In the event the case is lost, the attendant expenses can be written off at that time. Consulting a tax professional in instances such as these is a prudent way to ensure you’re keeping the books in the correct manner.3. Take deductions where they solidly apply
Contingent fee law firms have a very unique structure wherein they bear a multitude of up-front costs while concurrently managing firm operations. Sourcing working capital from an outside party can give your firm added flexibility for advertising, hiring additional attorneys and staff, expanding your practice or hiring the best experts for your clients’ cases—without giving up a portion of your fees to a co-counsel agreement.
Interest on law firm loans, specifically in the form of a line of credit, is deductible as an ordinary and necessary business expense. Many firms may not realize that doing so can reduce their tax burden. As long as borrowed capital is used for qualified law firm expenses, the interest is deductible.4. Legal structure matters
Be cognizant that the classification of payments to partners can be dependent on your firm’s structure.
With Limited Liability Companies (or LLCs), partners are usually required to take all firm compensation as distributions. These payments typically remain separate from the profit and loss allocations made among members of the LLC.
Conversely, S Corporations normally require shareholders 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 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. To be certain you are correctly following the most current tax code while also obtaining the most favorable tax treatment, your firm should work closely with a tax professional to mitigate any potential IRS issues.5. Taxable income can be reduced, if done correctly
Good news: planning for your future is also a great way to help reduce your taxable income. By making contributions to your 401K, IRA or Supplement Retirement Plan, you can reduce taxable income—the right way—and also help ensure that you’re taking steps to prepare for retirement. Your financial advisor and accountant can help you to strategically manage these savings plans throughout the year, so when tax season rolls around, you’re already one step ahead.
Another popular alternative is to “structure” your fees, similar to the structured settlement offered to your clients. Under this option, you can elect to be paid your attorney’s fees over a period of time in order to defer taxation on your earnings. Some structured fee programs even permit you to borrow against the deferred payments, accomplishing two important goals: securing working capital for your firm and lowering taxes over time.
In addition, if you engage in any 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 constitute personal expenses of any kind. Again, consulting with a tax professional is a smart way to be sure you’re staying within the tax code guidelines.
Remember, all of the strategies and tips above can be subject to limitations and exceptions, so it is best to consult with a professional for additional insight.
Counsel Financial can provide working capital to your firm during tax season and for your long-term initiatives. To learn more about the financial solutions available to you, visit CounselFinancial.com or call us at 800-820-4430.