Finances for a Solo Attorney: Paying Taxes and Managing Income (Part 3 of 4)
In many ways, the toughest transition for solo attorneys is learning how to run a small business. First you need to set up bank accounts. Next, you need to figure out how to manage cash flow and lines of credit.
The next step is what I consider a good problem: what to do when you make money. Make sure you withhold for taxes and stuff some cash under a mattress for the inevitable bad month.
Yes, you have to pay taxes—start saving yesterday
In case you didn’t already know this, I’ve got some bad news: small business owners have to withhold and pay their own taxes. Solo attorneys are considered self-employed, which means you need to pay estimated taxes throughout the year, or take a penalty and write a big check at the end of the year (disclaimer: I am not an accountant or a tax attorney).
I know lots of solo attorneys and exactly 0.0% of them use a payroll service to pay themselves, which means they are responsible for withholding and paying their own taxes. Some of them, however are better at it than others. For many attorneys, settling a big case means it’s time to go buy a new car, a new computer, or a new suit. In other words: spend everything, assume you can withhold enough for taxes later. Last time I checked, some of those attorneys made installment payments to the IRS. I’d suggest avoiding that scenario.
Here’s an easy way to avoid that issue: open a distinct and separate bank account that only contains money saved for taxes. When the firm receives income, set aside 30%-33% for taxes. In all likelihood, that is an excessive amount. When you do your taxes (or hopefully an accountant/tax attorney does), you can pay yourself a nice bonus because you have an excess.The alternative is to guess low, and end up having to cough some extra cash to pay your taxes. I’d rather err on the side of caution, but depending on your financial situation, that may not be possible (see the previous installment on cash flow).
The reason to keep the money in a separate account is to ensure it doesn’t get spent and it is easier to track. If you simply put everything into your business checking, how do you know how much money is set aside for taxes? You probably don’t. Many banks charge a small fee for savings accounts, but you can usually get that waived by depositing a certain amount each month. Which means if you are withholding 30-33%, you should get any fee waived.
After another five years in practice, maybe I’ll figure out a better way. For now, however, stashing away the money in a separate account has been brilliant.
Open another account for a excess income
Cash flow for a solo attorney is like a roller coaster, but less predictable, and not as safe. Depending on your practice area, you might go months without a significant amount of income. One month you can make $15,000, but the next two might result in $2,500. I’m not pulling those numbers out of thin air—that is based on some real-life experience.
During a “bonzo” month, I don’t buy a new car, a new computer, or a new suit. I pay myself the same salary that I make when the income for the month is $50. The only reason I can do that is because I stick all the excess into my fourth account, my excess account. I call it the “rainy day” account. Or, practically speaking the “I can pay myself out of this account when I have a month that sucks” account.
You will have bad months. If you want to still pay yourself, then create an excess account. Even if you just need to float some cash to pay part of your salary, an excess account is perfect for that. I guarantee that psychologically speaking, having an account with a few extra months worth of salary is worth ten times the actual money in there. Even if you can’t afford to put much in an excess account, make contributions when you can.
Until you get used to the ups and downs of cash flow, just knowing you have a safety net is useful, even if you never touch it. Unfortunately, chances are you will probably need to use it at least once, or twice, but hopefully not to the point of draining it.
Maintaining financial sanity
Some attorneys spend inordinate amounts of time doing their works and paralyzed by the constant fear of not making money. The fear never goes away, but it does get better.
Next up: forecasting income, analyzing your balance sheet, and maintaining financial sanity.
(photo: http://www.flickr.com/photos/68751915@N05/6355816649)
Randall Ryder is a Minnesota consumer rights attorney whosues abusive debt collectors and is a publisher of Elder Parent Help. Follow him on Twitter @randallryder.
