Taxes are frustrating in general but they can be even more frustrating for your law firm. It can be overwhelming to figure out which tax benefits and deductions are applicable for each individual situation. There are also differences among both partners and associates. Below are some specific tax tips specific to partners, associates and then general tips. Tax Benefits for Partners The following deductions and benefits pertain to partners in a law firm:
Home office deduction: The home office deduction may be available to practitioners who run their business out of their home. The space must be dedicated to your work. Additionally, the deduction is based on the square footage of that dedicated work space, not the total square footage. Once the square footage is calculated, a proportional share of expenses, including mortgage interest, real estate taxes and utilities, may be deducted. This deduction has a cap limit.
Unreimbursed partnership expenses: Law firm partners may be able to use Schedule E to deduct business expenses that were not reimbursed by the firm. This is a valuable deduction because it reduces both taxable income and the self-employment tax.
Capital account loans: Interest paid on capital account loans also are deducible on Schedule E.
Retirement savings: Take advantage of the tax saving offered by your firm’s retirement plan. Deferring income can result in substantial tax savings.
Tax Considerations for Associates
Associates are salaried employees at their firms who have federal and state income tax withholding taken out of their paychecks and whose income is reported on Form W-2. Consequently, they have fewer options for deductions. They cannot take itemized deductions unless they exceed the standard deduction amounts. They may, however, benefit from the following:
Unreimbursed employee business expenses: These expenses are no longer a federal deduction (still deductible on state level), but associates can ask their firms to implement an accountable reimbursement plan. Such a plan would allow associates to be reimbursed without having to report the reimbursements as income, and the partners would be able to deduct the amounts on their Schedule E.
Income deferral: Deferring income by maximizing use of the firm’s retirement plan may reduce taxable income.
Student loans: If your firm has a student loan payment program, the amount they pay may not be taxable if certain parameters are met.
General Tax Considerations for Attorneys • Backdoor Roth IRA
If your income is below $116,000 ($183,000 if married filing jointly), you can contribute to a Roth IRA without any restrictions.
For higher income individuals, you can achieve the same effect by contributing to a Backdoor Roth IRA. A Backdoor Roth IRA is the same as a Roth IRA, except that you’ve made your contribution through the “backdoor” – a loophole Congress made available in 2010 and has not addressed since then.
The loophole is that anyone, regardless of income, is permitted to convert a Traditional IRA to a Roth IRA by paying income tax on any account balance being converted that has not already been taxed.
Because you can make a non-deductible contribution to a Traditional IRA (i.e. an after-tax contribution) regardless of your income, you can make this contribution and immediately convert it to a Roth IRA. It sounds more complicated than it actually is and can be taken care of with a few clicks. Because you paid income taxes on the original non-deductible Traditional IRA contribution, no additional taxes are due when you convert it to a Roth IRA. From there, the money grows tax free and you won’t have to pay taxes on qualified withdrawals.
One thing worth pointing out is that this process doesn’t leave you with multiple Roth IRA accounts. You only have a single Roth IRA account. Each year you effectively roll the $5,500 in contribution to your non-deductible Traditional IRA to your Roth IRA.
Why a Roth IRA? Because you pay taxes on the money today but it grows forever tax-free and all withdrawals will be tax-free.
• Stealth IRA (Health Savings Account)
If you have access to a High-Deductible Health Plan, you likely will also have access to a Health Savings Account. Individuals can contribute up to $3,350 ($6,750 if married filing jointly). HSA’s are triple tax advantaged: you don’t pay taxes on the contributions, growth or withdrawal (if such withdrawal is for a qualified health expense).
HSA money also rolls over from year to year, so there’s no concern with losing your money at the end of the year (like a Flexible Spending Account). Even better, after age 59 1/2 you can withdraw money from the account as if it were a Traditional IRA (you’ll need to pay income taxes on the amount withdrawn, but that’s okay since it will be the first time the account is taxed).
• Charitable Deductions
As a group, lawyers donate hours and hours to pro bono projects. If they aren’t giving time, lawyers donate money and other resources to charity. All charitable donations to a tax-exempt organization are tax-deductible (assuming you itemize your deductions, which is true for many lawyers).
TurboTax’s ItsDeductible program can help you keep track of charitable giving. You can deduct expenses associated with driving to and from a charity using the IRS federal mileage reimbursement rate and any other expenses associated with donating your time (although you can’t deduct the value for your time.)
Since charity donations reduce your income dollar for dollar, a highly taxed lawyer could save around $0.45 for each $1 donated to a charity or each 2 miles driven. Charitable donations are even a good way to flush out capital gain taxes.