Your law firm may not specialize in tax law, but it still must plan for tax season like any other business. Part of the tax planning process is coming up with effective tax strategies to maximize savings and minimize liabilities. Tax laws are changing all the time, and your law firm needs to stay updated on these changes to ensure its finances are not adversely affected.
Top 4 Tips to Optimize Your Tax Strategies
The success of your law firm depends on several factors. Besides winning cases and getting clients to pay invoices, the other part of the success is tax planning. If you sit down with a specialized law firm accountant, they can help you optimize your tax strategies to improve profitability and reduce liability for your law firm.
Below are the top 4 tips that your accountant can help you do to optimize your law firm’s tax strategies and reduce its tax liability.
1) Review Financial Statements
Ensure all your law firm’s income and expenses are accurately recorded in the appropriate accounting software, such as Clio’s legal accounting management software. Clio automatically inserts the information into the proper financial statements and makes the necessary calculations for you.
You need to review all the financial statements associated with your law firm, such as its balance sheets, cash flow statements, and income & expense statements. To ensure the income and expenses have been accurately recorded, you will need to reconcile your law firm’s debit and credit accounts with these three financial statements.
Verifying the accuracy of your financial statements through reconciliation will ensure your law firm’s income taxes are completed accurately and successfully. Then, you don’t have to worry about an IRS audit discovering unpaid taxes or ineligible deductions in the future.
2) Plan for Deductions and Tax Credits
Law firms have a wide range of deductions and tax credits they can use to lower their income tax liability. Deductions can reduce your law firm’s total taxable income, while tax credits reduce the total taxes owed. Let’s review each of these below in more detail.
Deductions
Like any business, when your law firm makes business-related purchases, they can be used as deductible expenses on its income tax return. Some examples of such deductibles may include:
Office equipment
Furniture
Computers
Software (e.g., accounting tools)
Travel expenses (e.g., attending trials, meeting with clients, interviewing witnesses)
Restaurants and meals
Legal books
Legal education courses (e.g., continuing education)
Association dues
State and local taxes
As you can see, law firms make all kinds of purchases that can be used as deductions on their tax returns. Your specialized law firm accountant can help keep track of these expenses and apply them to your tax returns for maximum deductions and lower tax liability.
Tax Credits
Your law firm should always look for all eligible tax credits to reduce the owed tax amount directly. Some of the tax credits are like what other types of businesses can claim. The credits your firm will be eligible for will depend on its specific actions and operations. Some examples of typical tax credits for law firms are as follows:
Work opportunity tax credit for employing people from specific targeted groups
Employer social security credit
Investment credit
Biodiesel fuel credit
Employer-provided childcare credit
Employer differential wage payments credit
Small employer pension plan credit
Ask your specialized law firm accountant for advice on which tax credits your law firm is eligible to receive. Your accountant will help your firm look for ways to maximize its tax credit eligibility in as many areas as possible.
3) Implement Tax Strategies
Develop plans to minimize tax liabilities for the rest of the year. Proactive tax planning is the key to lowering your law firm’s long-term tax liability. It involves exploring all the possible ways to move your law firm into a more suitable income tax bracket without losing too much income in the process.
Here are some helpful tax strategies for law firms:
Choose a Suitable Federal Tax Classification
Law firms, like all registered businesses, must select a federal tax classification for tax purposes, such as sole proprietorship, S corporation, C corporation, partnership, and limited liability company. Each classification has its tax advantages and disadvantages depending on the size and structure of your law firm.
Small law firms can save more money on their income taxes by classifying themselves as a limited liability company, sole proprietorship, S corporation, or partnership. The main advantage of these classifications is that your law firm’s taxable income passes to the individual owner’s tax return.
That way, the owner doesn’t have to pay corporate income taxes and personal income taxes separately. On the other hand, the C corporation classification requires two separate income tax returns. Talk to your law firm accountant for their recommendation on which classification can maximize savings for your law firm.
Send Out Invoices at the End of the Year
Many law firms utilize an “income timing” strategy to have their clients pay their invoices the following year rather than the current year. They do this by sending the invoices to their clients at the end of the year, so they will likely be paid the following year.
Remember that you don’t have to pay income taxes on invoices until those invoices are paid. So, if you send out an invoice this year but the client pays it next year, you don’t pay taxes on it for this year’s income tax return. Of course, you will have to pay taxes on it for the following year’s income tax return, but it is a way to delay incurring that tax liability.
4) Provide Accurate Financial Data to Your Accountant
Your specialized law firm accountant can help you with much of the development and implementation of your law firm’s tax planning strategies. However, you will have to provide your accountant with precise and comprehensive financial data to aid them in effective tax planning and strategy formulation for your law firm.
Clio’s legal accounting management software can help keep your information accurate for your accountants. It can streamline the recordkeeping process while eliminating human error. Counsel CPAs and Advisors can set up and manage your law firm with Clio to maximize profitability and reduce tax liability. Contact us for more information.
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