10 Top Tax Tips for Law Firms
With all the tax changes in recent years, it’s more important than ever for law firms to be careful with accounting and filing taxes. In my business preparing corporate returns, I often see attorneys make costly errors and miss opportunities because they’re not as vigilant with their finances as they are with their core business. In order to minimize tax liability and audit risk and maximize deductions, law firms of all sizes can benefit from these 10 tips.
No. 1 Set up the best business structure.
Most attorneys start their business as a professional limited liability company (PLLC), this means they’re filing their schedule C on their personal return. This may not be the best structure, as the risk of an audit is much higher and the tax burden can get out of control quickly. Changing your business structure to a C-corp or S-corp can benefit you tax-wise and allow you to grow.
For those who do operate as a PLLC, I always urge attorneys to put away 30% on every dollar to help cut the cost of their tax liability and their quarterly payments. Even in the first year of business, many firms are surprised how high their income is compared to expenses, and they end up with more profits than expected and a high tax bill.
No. 2 Be sure your bookkeeping is perfect.
Whenever I talk to attorneys, I emphasize how important books are. They used to be able to take shortcuts with accounting, but the IRS isn’t putting up with that anymore. With all the online software and affordable accounting firms out there, it’s not as easy to skirt this responsibility.
You need to keep impeccable books, especially in terms of your trust accounts. When funds are placed in an IOLTA account, lawyers must pay close attention to ensure all entries are accurate. Additionally, lawyers should follow up to make sure the appropriate statements go out to clients at the end of the year. Legal software is available to help firms handle a lot of this.
Because attorneys often don’t take the same time with bookkeeping as they do with their billing come tax time, they expect their preparer to log receipts, balance books and rectify discrepancies. Expecting a tax professional to do all of the accounting for an entire year in a week, gets expensive.
No. 3 Track equity, distributions and loans.
I often see issues in tracking equity, distributions and loans to partners of a firm. If firms get sloppy and their balance sheet is incorrect, it makes the firm look less financially sound than it really is. This can come back to bite the firm when they apply for loans or when a partner transitions in or out of the firm.
No. 4 Keep accurate records of expenses.
Attorneys are generally good with paperwork, but for some reason they’re not as good with keeping receipts. No matter how small, keep accurate records of everything that can be deducted. Many attorneys fail to keep receipts for parking, court costs, meals and so on. Remember that business meals are now 100% deductible, versus 50%.
Attorneys also forget about deductions for a dedicated home office, travel, professional dues and continuing education. I also urge firms to buy any big-ticket items like computers at the end of the year if they haven’t already in order to increase deductions.
No. 5 Don’t overlook tax credits and donations.
Tax credits are available for employee retention and student loan debt assistance. Firms that have paid employees throughout the pandemic may qualify for a fully refundable tax credit equal to 50% of the qualified wages, but this can be complex, so talk to your tax professional. Sick leave and family leave credits also are available. And, did you know businesses can pay $5,250 annually toward employees’ student loan debt and take a deduction for it?
Also, rules regarding charitable donations have changed. You may be able to take a deduction without itemizing. In addition, your state may have a state tax credit, and companies can qualify for higher donations than individuals. Service businesses like law firms with high profits should consider doing some serious giving.
No. 6 Digitize all receipts.
The best way to keep track of expenses and donations is to keep them digitally. Scan all receipts (even if it’s just a photo taken on a phone) and put them in a dedicated file. Many businesses now send receipts via email or text, which makes it even easier.
There’s another reason this is crucial. Everybody always asks me how long do I keep my records? IRS law says seven years, but there’s a caveat: If there’s an audit and they’re looking at any of those years, they can go back as far as they want. And the state can go back forever. It all depends on the type of audit.
I always urge my clients to digitize everything and keep everything forever. A hard drive is cheap; a secure drive is cheap. It’s worth the investment. I promise the $100 you spent now will be for less than the costs associated with the audit.
No. 7 Tread carefully with 1099s.
The number one thing I see attorneys fail to do is file their 1099s. If they operate as a sole proprietor, LLC or PLLC, they should be receiving 1099s. If they’re hiring contractors, they should be issuing 1099s and keeping W-9s on file for each.
Non-employee compensation has been removed from the 1099-MISC and has been replaced with the 1099-NEC, which stands for “non-employee compensation.” This is a tricky area, so it’s essential to tread carefully and work with a professional.
No. 8 Properly record depreciation.
It is important to have clean profit and loss statements and balance sheets where all assets are accounted for and being depreciated correctly. Depreciation applies to office equipment, vehicles, and primarily real property. Buildings allow for a ton of depreciation, but also catches the attention of the IRS, so you want to make sure you’re doing that correctly.
One common issue I’ve seen is where a tax professional prepares the taxes and does the depreciation correctly, but the law firm mistakenly doesn’t track the the depreciation in the books, so it doesn’t match the tax return. When firms go to sell the asset, they need to know how much depreciation they have.
No. 9 Outsource human resources.
Many businesses still aren’t aware of the boom in small, reasonably priced human resources services. Whether firms are paying employees or contractors, they can make sure all the appropriate paperwork is done—and save time and effort—by outsourcing it.
This is no longer justifiable to big firms or companies. These helpful HR people know the laws and can easily provide payroll and other reports to tax preparers.
No. 10 Meet with a tax adviser.
Tax laws can be complex and confusing, and doing your own returns can eat up an inordinate amount of time. Using a tax professional can save money in the long run—from the hours saved to the deductions and credits gained. Firms need to start early in the year doing tax planning, and if any major changes come up, make sure to see their tax professional by October. Now’s the time to start thinking about 2022 taxes!
This article was featured in Attorney at Law Magazine.
