According to the American Bar Association, in 2019, over 1.3 million attorneys actively practiced in the United States, with approximately 63 percent practicing in a solo 1099 lawyer or small firms (2-9 attorneys). However, no matter if a lawyer practices in a larger firm or hung out her own shingle, all attorneys need to be keenly aware of the tax rules that apply to them and their practices.
Putting a tax plan in place is part of good overall business management. From understanding tax deductions to filing quarterly taxes to understanding the new 1099 rules, attorneys should incorporate these tax rules into their overall financial strategy, making sure they don’t fall into non-compliance or end up with a larger than the expected tax bill. Further, reliable accounting and tax practices are critical indicators of whether the firm (whether solo, small, or large) performs well.
When planning for taxes, it’s essential to know that your firm's size impacts taxes paid. For example, if you are a solo practitioner or in a small firm, you may file your law practice taxes on Schedule C of your individual taxes. Or, as a small firm operating as a partnership, you may report your earnings on a Form K-1. Although it is becoming more common practice for law firms to issue Forms 1099 to clients even where they are not strictly necessary.
In this article, we’re going to explore some fundamental tax rules applying to attorneys and their practices, de-mystifying some dreaded reportable tax requirements.
Common deductions for lawyers
First, let’s look at some standard tax deductions available to attorneys. After all, you don’t want to pay more tax than required, and deductions reduce your taxable income, thus lowering your tax bill.
Tax deductions must include “ordinary and necessary” business expenses. Here are some common deductions recognized by the Internal Revenue Service (IRS):
You can deduct rent paid for office space that you do not own used for your law practice.
Continuing education costs
For any professional education requirements needed to maintain your license, such as CLE, you may deduct those costs on your taxes.
Generally, you can deduct your employees’ pay if they are service providers for you in your law practice.
Books, periodicals, or online research tools
Since these educational tools are ordinary and necessary to your practice, you may deduct any costs related to maintaining a legal library.
Any insurance you maintain for your business or your license, such as professional liability insurance, is deductible.
If you borrowed money to support your law practice, then you can deduct any interest on that money owed.
If you offer a retirement plan, such as a 401(k) plan, to your law firm employees, then you can deduct any contributions you have made to that plan as the employer.
Some additional deductions you may take include a home office deduction, use of your car for business, and use of your smartphone for business. To take an appropriate deduction, you should keep track of the percentage of time you use your car or smartphone for business or the dedicated square footage for your home office to take an appropriate pro-rata deduction.
By strategically planning your law firm's taxes, you can maximize your deductions by keeping careful paperwork and records of your business expenses throughout the year.
Understanding estimated taxes
Unlike W-2 employees who have federal and state taxes withheld from each paycheck, potentially covering any tax liability owed to the IRS or applicable state, many attorneys have unique tax filing requirements, including estimated taxes. Estimated taxes are tax payments made over four periods annually based on income received that is not subject to withholding, such as legal fees received in a limited liability company.
For example, sole proprietors, partners, and shareholders in S-corporations generally must make estimated tax payments if they expect to owe more than $1,000 taxes for the current tax year. Corporations that expect to owe more than $500 for the current tax year must also file estimated taxes.
More specifically, for individuals such as solo practitioners in a limited liability company, you’ll need to pay estimated taxes if the following statements are true:
- You expect to owe at least $1,000 in taxes for the current tax year, after you subtract any applicable withholding or refundable credits; and
- You expect that for the course of your trade the withholding or refundable credits to be:
- at least 90 percent of your owed taxes throughout the current tax year; or
- 100 percent of your owed tax on your tax return from the previous tax year.
Different rules apply if you are in a partnership or an s-corporation. However, estimated tax payments are due for all on the same dates as follows:
- April 15th: For January 1st – March 31st
- June 15th: For April 1st – June 15th
- September 15th: For June 1st – August 31st
- January 15th of the following year: For September 1st – December 31st
You may file your estimated taxes filing Form 1040-ES for individuals, Form 1120-W for corporations, or online. Use our free estimated quarterly tax calculator to determine your payments.
Understanding the new 1099 rules
Form 1099 reporting is not a new reporting requirement. However, beginning with the 2020 tax year, the 1099 reporting rules have changed, specifically as to attorney fees and legal settlements.
As a review, Form 1099 is an informational return, typically reporting certain types of income. Currently, over 20 different types of Form 1099 exist, including 1099-MISC (for miscellaneous income such as that earned by self-employed individuals), 1099-INT (for interest income, such as that received from a savings bank account), and 1099-DIV (for dividend payments received from investments).
Form 1099s are based on income received during the calendar year, with the reporting entity generally the due date for sending a copy of the 1099 to the recipient of the payments by January 31st of the following year and a copy to the IRS by the last day in February or March 31st if electronic filing, also in the following year. However, with the 1099-NEC, as discussed further below, you must send a copy to recipients and to the IRS by the same date – January 31st.
In this article, we’re going to examine further the newly re-released Form 1099-NEC and the Form 1099-MISC, as they relate to attorney fees and reportable legal settlement requirements.
The new Form 1099-NEC has not been used for informational reporting since the 1981 tax year. In late 2019, however, the IRS re-introduced this form for the specific purpose of reporting non-employee compensation, effective for the 2020 tax year. Non-employee compensation explicitly includes fees paid to attorneys and law firms, if the following criteria are met:
- You pay at least $600 in a taxable year for:
- Services performed by a non-employee; or
- Payments to an attorney or law firm
- And such services were made in the ordinary course of your business.
Generally, payments made to corporations, limited liability companies, or other corporate structures are exempt from having payments reported on the Form 1099-NEC. However, and importantly, payments made to attorneys or law firms for professional services are not exempt from being reported on the 1099-NEC; thus such amounts are reported in Box 1 on Form 1099-NEC. This reporting requirement applies no matter if the attorney’s professional services are provided through a sole proprietorship, a limited liability company, or a corporation.
A lawyer or law firm paying fees to co-counsel (or referral fee) to a lawyer must issue a Form 1099.
For more information on the Form-NEC as it relates to 1099 legal fees, see our previous post.
Unlike the 1099-NEC, the Form 1099-MISC is used to report other forms of payments, unrelated to non-employee compensation. However, certain attorney and law firm payments are reported in Box 10 of the Form 1099-MISC, and not on the Form 1099-NEC, if the following are true:
- Legal types of payments are made to an attorney or law firm in the course of the business or trade, excluding personal services provided by an attorney. Examples of these payments include those related to a settlement agreement with another person or business;
- The legal payments amount to $600 or more; and
- The legal payments have not been reported in Box 1 of Form 1099-NEC.
- The IRS says payments of medical and healthcare payments must are exempt to be reported
In the instruction to the IRS form 1099-MISC, the Internal Revenue Service gives the following example:
An insurance company pays a claimant's attorney $100,000 to settle a claim. The insurance company reports the payment as gross proceeds of $100,000 in box 10. However, the insurance company does not have a reporting requirement for the claimant's attorney's fees subsequently paid from these funds in the full amount.
Further, the IRS emphasizes that these rules apply, no matter if:
- “The legal services are provided to the payer;
- The attorney is the exclusive payee (for example, the attorney's and claimant's names are on one check); or
- Other information returns are required for some or all to report payments under another section of the Code, such as section 6041.”
Depending on your law practice, you need to understand which tax rules are applicable to you. Failure to understand these rules can result in not only a higher tax bill but penalties and interest if not completed or not completed correctly. As an attorney, you already must keep up with a number of rules. However, these tax rules are not ones to be ignored. If you’d like to reach out to get some professional advice, be sure to hire an accountant or download an app like Keeper Tax, helping you stay on the straight and narrow while giving you the tax confidence needed as a business owner or independent contractor.
Sign up for Tax University
Get the tax info they should have taught us in school
At Keeper, we’re on a mission to help people overcome the complexity of taxes. That sometimes leads us to generalize in our educational content. Please email email@example.com if you have questions.