The dreaded t-word: Taxes. It’s notorious for inflicting panic. We get it. You went to law school, not business school, so why should you have to deal with numbers? Quite simply, your law firm won’t run itself. The only way to be successful is to run your law firm like the business it is.
Law firm accounting and taxes are necessary parts of compliance and are financial indicators of just how well your small firm is doing. If you’re looking for tax help, that simply means you made money in your firm—and that’s a good thing.
You’re not alone in your disdain and confusion towards accounting and taxes. We’ve all been there. The good news is that over the years we’ve gathered some accounting and tax hacks and guidelines that will help. All you need is the right mindset, the right tips, and the right technology.
Law Firm Accounting & Taxes: Choose a Positive Mindset
“My system for tax and finance is too ridiculously hard and unmanageable…”
Regardless of the system we choose to use, we often find law firm accounting and taxes to be ridiculously hard and unmanageable. Yet, with a simple mindset change, we can start to see accounting and taxes as critical to our firm’s success instead of a “waste of time.”
“…I think that with some tweaks, streamlining my accounting is what I need and will allow me to stop entering data elsewhere and start running meaningful reports.” – Robert B.
Accounting is one of the primary functions of your firm, just like client intake, billing and collections, and marketing. Without a clear picture of your finances, you can’t make the critical business decisions required to grow. Stop thinking of accounting as something you have to do. Think of it as something meaningful, just like Labster Robert.
After all, proper accounting:
- Helps you evaluate your firm’s overall performance when compared to long-term goals
- Ensures you stay compliant with both state and federal regulations
- Aids in the setting of budgets and financial key performance indicators (KPIs)
Understanding Your Tax Responsibilities & Common Deductions
There’s nothing worse than being surprised and completely caught off guard by your tax bill.
Erica was dedicated to running everything through Quickbooks, completely convinced that everything was going great. All it took was a trip to the mailbox where she found a tax bill for thousands to show her otherwise.
Immediate cold sweat, right? This is the type of stuff that keeps attorneys like us up at night. Don’t face a cash crisis when your law firm taxes are due. Put a plan in place for taking care of your tax responsibilities, so you can sleep much better at night. We’ll show you how.
Your Tax Responsibilities
Your law firm’s taxes and tax planning will depend on many factors including:
- Entity type
- Number of owners
- Location of practice
And other variables. At tax time, you’ll find there are consequences for how you hire employees, how you pay yourself and your partners, the equipment you buy, and how you save your cash. For example, you’ll need to pay employment taxes and taxes on the interest you collect from your savings account. This is why we say it’s critical to understand your finances.
You have unique tax responsibilities depending on whether you’re a solo attorney or have a small firm. For example, if you’re a solo attorney:
- You must file your law firm taxes using a Schedule C on your individual tax return
- You must pay estimated taxes throughout the year
The first step is to know when you must report and pay based on your entity type and jurisdiction. If you own a small firm in the form of a partnership, a limited liability company (LLC), an S-corporation, or an E-corporation, you have unique tax filing requirements you must comply with, depending on your formation.
Common Deductions for Your Firm
We believe in taking advantage of deductions. A tax deduction reduces your amount of taxable income, resulting in you owing less. The deductions you choose must be business-related and must also follow some basic rules. For example, an expense must be necessary for maintaining your business and also reasonable.
Here are some of the most common expenses you can deduct:
- Meals. When you decide to take that client to dinner before that Justin Bieber show, there’s a deduction for that. In fact, you can deduct 50% of your meals and expenses you accrue during meetings to network with clients. We keep detailed notes including who the meal or outing was with and what we discussed as well as receipts for each of these occasions, just in case the IRS wants to complete an audit.
- Home office. Corner office located in the swanky corner of your kitchen? Regardless of where, if you run your firm from your home, a percentage of your home expenses can be deducted including mortgage interest, rent, utilities, etc. Of course, this part of your home should be used regularly and exclusively for business.
- Professional fees. After hiring an accountant or tax preparer, you can deduct those expenses on your law firm taxes.
- Furniture, computers, and other equipment. That new office chair with the built-in back massager is totally tax-deductible. If you’ll benefit from these purchases within the taxable year, you can deduct them. Or, you can capitalize on them instead.
Other potential deductions may include travel, continuing education, health insurance, internet, and email services, professional association dues, and more. Be sure to check with your tax professional to make sure what you think is a deduction is indeed a deduction.
Should You Spend More to Reduce Tax Liability?
Businesses often receive this advice from tax professionals: spend more money at the end of the year to get tax deductions. Yet, we disagree. If it means spending your profit, it’s unwise to spend money on things you don’t need simply to avoid taxes. Yet, if it makes sense to spend money to receive the benefit in that year, such as for equipment upgrades you know you need for your firm, go for it.
Tax Planning for the Future
Now that you understand when to report and pay, and have a basic understanding of what deductions you might receive, it’s time to do a bit of tax planning. After all, some cash saved now will help you avoid receiving a tax bill that makes you want to skip town later.
You should work with a tax professional to come up with a general amount to save throughout the year for your taxes. We recommend saving at least 15% of your revenue each month in a separate bank account. Yes, each month.
Remember Erica’s tax bill from earlier? If she would have saved each month, she could have paid her bill and moved on to better (and less expensive) things.
Take Advantage of Accounting Software & Tools
Let’s face it: accounting is tedious work that makes our heads spin. Yet, there are plenty of tools available that can help get you started. You can’t simply use an Excel spreadsheet to maintain all of your financial books and records for an entire year. When used for that much data, it’s clunky and lacks features you could be using to improve your reporting.
Before you purchase software or a tool, make sure it fits your needs. Over the years of trial and error, we know a solid law firm accounting software should include features such as:
- Billing and invoicing
- Reporting and analytics
- Expense tracking
- Tax prep
The software you choose might also include a mileage tracker, the ability to offer online payments to your clients, timekeeping tools for tracking your time, bill payment, and the ability for multiple users to access the tools.
How to Choose an Accounting Software for Your Firm
With all the options available, we know it’s difficult to choose which software is the best choice for your firm. After all, you have to sift through the options alone, convince your partners to buy-in, and pray that it works as it should. Talk about overwhelming.
To find the best fit:
- Decide what you need moving forward. If you don’t have any accounting tools in place, you’ll need a great, basic software that can do it all. If you only need a few features such as bookkeeping, a simpler tool or two may suffice.
- Find tools to try. We have a list of accounting software you can choose from. You can also conduct a quick online search to find the tools you want to try. Do some additional research to narrow your list down to only your two 2-3 choices.
- Test. Most tools give you a free trial so you can see if the software fits your needs. Try the tools out and see which one meets your needs in the best way.
To make the most of your finances, tax prep, and bookkeeping, we recommend hiring a professional tax preparer. Nothing, not even the best software or tool, beats the eyes of a professional when it comes to your finances.
You Can’t Do It Alone: It’s Time to Hire Professional Tax & Accounting Help
“For the first few years of my practice, I did my own taxes because with online software, how hard could it be?”
As an attorney with a law firm, everything falls on your shoulders. Not only are you responsible for advocating for your clients, but you must also manage your team, make critical business decisions, and take care of your finances. All of this can make you feel like crawling into a hole, totally waving the white flag, and giving up.
Before you start digging, we have good news. Although you can’t do it alone, you don’t have to. There are professionals for that. Although having some basic financial statements, understanding your tax liability, and taking advantage of accounting and tax software gives you a great foundation, you need to hire professional help to make the most of your finances.
Stephanie discovered that even software can’t replace the benefits of hiring a professional:
“When things got complicated and I hired a CPA, they offered to look at the last few years of filings as a courtesy. Wow! They found some things I didn’t know about and ultimately filed amended returns that resulted in a nice refund check. Lawyers should take their own advice about representing ourselves, and hire a tax professional to handle their returns.”
Start by Hiring a Bookkeeper
As a solo attorney, managing your books via accounting software may get you started. Yet, if you own a small firm with multiple attorneys, employees, or contractors, hiring a bookkeeper is more than worth it. Bookkeepers offer many benefits:
- Saves you time. We know all too well how some necessary tasks get pushed to the wayside while we juggle everything else. Yet, your bookkeeping shouldn’t be one of these tasks. A bookkeeper can take it off your hands.
- Assists you with keeping your books updated. If you fall behind on bookkeeping, you won’t have an accurate overview of your finances. This can cause you to make decisions that result in serious consequences for your business. A bookkeeper keeps your books updated and even sends you reports periodically so you’re always in the know.
- Uncovers useful business expenses. Just like in Stephanie’s experience, bookkeepers take the time to carefully categorize your expenses, finding useful ones you can use at tax time to lower your liability.
Next Up: A Certified Public Accountant
It’s a common misconception that Certified Public Accounts (CPAs) and bookkeepers do the exact same things. That’s not true. A CPA provides an in-depth analysis of your books, helping you to:
- Obtain credit the right way. CPAs use their expertise and an analysis of your finances to guide you in the right direction when you’re looking to obtain a loan. For example, they can help you choose a loan type and size that’ll fit your bottom line in the best way.
- Plan for the future. If you’re considering closing your firm or want to sell in the future, a CPA can educate you on your tax responsibility, your firm’s market value, and more to help guide your decision.
- Invest with confidence. CPAs can also guide you towards investments that make the most sense for the future of your firm.
A CPA can also help you prepare your business taxes, a feat that no one should ever attempt to do alone.
You also have the option to hire a permanent accounting, bookkeeper, or tax preparer as an employee of your firm as you grow. For now, an independent contractor relationship is a great start and a great way to help you avoid that dreaded audit.
Don’t Sacrifice Your Sanity for the Sake of Your Taxes & Accounting
We all have our nightmare stories such as attempting to file our taxes on the same day as a plumbing emergency that floods the office. Yet, it doesn’t have to be this way. By taking control of your finances and outsourcing your tax prep and accounting to a professional, you can save your sanity.
To Take Control of Your Finances, Become a Lawyerist Insider
As a solo attorney or first-time business owner, understanding and managing your accounting and taxes can be overwhelming. The good news is, you don’t have to go it alone. Instead, learn more from our Labsters and attorneys just like you by becoming a Lawyerist Insider today.