Essential Tax Information for Newly Minted Lawyers
Law ranks among the most publicly well-regarded professions in our society. Though they may be gently teased throughout our media, lawyers are still generally viewed as civic leaders and hold considerable social prestige. However, law is also a business, and because of this fact, it is very important for lawyers to possess the financial tools that can help them maximize their industry.
Surprising though it may be, a high percentage of lawyers operate their practices without adequate knowledge of the tax concepts that can potentially save them large sums of money.
So, let’s discuss a few of the more important bits of tax information that tax professionals should make new lawyers aware of as they begin to develop their businesses.
Perhaps the most important concept new lawyers need to be familiar with is entity selection. This is true despite the fact that many – if not most – newly minted lawyers do not establish their own practices right away.
There are six distinct corporate arrangements from which lawyers can choose:
- Sole proprietorship
- Single-member PLLC
- Multimember PLLC
- S corporation
- C corporation
Each of these arrangements has their pros and cons. Before new lawyers make a selection, it is important they take into account all of the facts of their particular situation and then determine which entity will yield the best financial outcome.
Unfortunately, a large number of lawyers lose out on earnings because they do not understand the ups and downs of these various corporate structures. New law graduates entering the profession will need to carefully study the merits of these structures or else risk forfeiting a good amount of their income.
It is also very important to make new lawyers aware of the various deductions available to them throughout the course of their business. Utilizing deductions will help them offset some of the costs that are an inescapable part of the business of practicing law.
For instance, lawyers are eligible to deduct the expenses associated with meals and entertainment provided that there is a sufficient nexus between such expenses and running their business. Lawyers routinely engage in discussions with prospective clients (as well as other professionals) in order to create business opportunities and generate income. Sometimes these discussions occur during a meal or some form of entertainment (i.e., comedy show, sporting event, etc.).
Lawyers can deduct the costs of the meal and entertainment as long as they meet the substantiation requirements of Section 274 of the Internal Revenue Code. To satisfy the requirements of Section 274, lawyers must be able to thoroughly substantiate the expenses (i.e., identify the meal or the entertainment, who ate or was entertained, when they ate or were entertained, etc.) and demonstrate a clear connection between the business discussion and the expenses.
The deduction for travel expenses likewise has the potential to save lawyers substantial sums of money. Not all lawyers travel for business, but those who do tend to travel quite frequently and the expenses incurred through such travel are usually high. As with the deduction for meals and entertainment, lawyers must be able to fully substantiate their travel expenses in order to take the deduction.
Lawyers also have the ability to deduct the expenses associated with research. Lawyers conduct a great deal of research throughout the course of their practice in order to handle individual cases and also to stay well-informed about developments within their profession. Research expenses are deductible, but the manner in which they are deducted differs in some respects when compared with other expenses.
When lawyers buy books and subscription services that have a “useful life” of greater than one year, the cost of these things may be depreciated over a five-year period. Software is amortized over a three-year straight-line period. And if lawyers buy any type of material (books, periodicals, software, or others) on an annual subscription basis, the costs would be deductible in the usual manner.
Yet another deduction that lawyers may utilize relates to client-driven expenses. Very often, lawyers advance money to clients or incur expenses on behalf of clients. Unfortunately, if money is directly advanced to a client, this advance is treated as a typical loan, so it cannot be deducted. However, there is an important exception: If lawyers do not recover client-driven expenses that are classified as being part of “normal operating procedure,” they become deductible.
As an example, postage and photocopies are expenses that are typically paid by lawyers up front for their clients. These expenses are then passed to the client, and the lawyer is reimbursed for them. If a lawyer is unable to collect payment for these expenses that are very much part of ordinary business procedure, then they may be deducted as “bad debts.”
Other Key Tax Information
Along with entity selection and the deductions referenced above, lawyers need to be aware of lots of other tax information. They need to learn about the tax implications surrounding client trust funds, accounting methods, bonus depreciation, constructive receipt of income, and others as well.
The information provided here should be a good start for fresh law graduates as they begin to navigate the legal profession.
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John Huddleston, CPA, is the founder and principal of Huddleston Tax CPAs, a firm based in the greater Seattle area that specializes in helping small businesses. In addition to being a CPA, John also holds a JD degree and a master’s degree in tax law from the...