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Establishing a law firm may seem simple at first, but there are quite a few things you need to consider. You will need to know how to set up your law firm accounting, taxes, retirement plans, compensation, etc. Even a few simple mistakes can cost you a lot of money. Working with a team of advisors, such as a financial planner, CPA, corporate attorney, and other professionals, is critical to avoid errors when setting up your law firm.
Law firms often establish partnerships, whether a limited liability partnership, general partnership, or even a professional limited liability company. You can also choose to organize your law firm as a professional association (treated as a corporation), allowing you to be taxed as an S-corporation.
While it's true that an S-corporation and partnership both have "flow-through" taxation, they also differ in many other aspects. Flow-through taxation allows owners to pay income tax personally, based on their share of their law firm profits. In a partnership structure, the owner's share of the profits is based on the partnership agreement.
On the other hand, the profits at an S-corporation are distributed pro-rata, based on ownership of stock. In a partnership, an owner must pay employment and income taxes on their share of firm profits. However, owners in an S-corp will only pay income taxes on the percentage of profit, while not having to pay employment taxes.
A law firm will often organize their company in numerous tiers to gain tax advantages in corporate and partnership forms. However, reaching out to a CPA and a corporate attorney is critical to help you choose the best structure for your law firm.
One of the complicated aspects of accounting in a law firm is the compensation structure. This process is more straightforward in a solo practice, but it can get very complex in a law firm with multiple owners. Profits can be allocated in various ways, such as billable hours, ownership percentage, client billing, and other methods.
Working with a CPA is essential in finding a model that works best for your law firm. Once the method is agreed upon, compensation is paid through wages, distributions, and fringe benefits. A CPA can also help you determine the appropriate amount for each category while ensuring you comply with IRS regulations.
A well-structured retirement plan is another critical part of the compensation package. Law firms can often achieve significant profits, allowing you to put money into tax-deferred and tax-deductible retirement plans for both owners and employees.
Initially, a law firm may select a SEP plan due to its simplicity, but this plan only offers low contribution limits and doesn't provide much flexibility. Adopting a 401(k) plan alongside a defined benefit plan is often a better choice. These plans allow the owners of a law firm to contribute much more than the limits of a SEP, which can provide significant benefits in the long term.
A law firm's ownership change can significantly impact the company. An owner may decide to retire, or a business relationship may not work out. A law firm needs operational documents to handle these different situations.
However, even some well-written agreements can still leave room for interpretation. For example, payments to a retiring owner can be structured as multi-year payments or a lump sum payment, as either option impacts taxes in different ways. Choosing the best option while comparing your choices requires consultation with a CPA and legal counsel.
The day-to-day operation of a law firm may not seem complicated. Still, there are numerous things you need to consider that involve accounting and taxes during the initial setup and life of the firm. It is essential to partner with a team of trusted advisors to guide you in each decision.
Working with a team of accounting professionals can help you make decisions that are in the best interests of your law firm while also reducing the likelihood of making costly mistakes.
If you own or manage a law firm and are looking for a CPA specializing in accounting for law firms in Tampa, contact Brian Leidel at 813-675-8800. For Sarasota-based law firms, contact Beth Ebersole or Ashley Salter at Kerkering Barberio’s Sarasota office at 941-365-4617.