Before any tax planning can be properly performed, attorneys must have a good understanding of the anticipated net income for both their law practice and their personal taxes. This requires having timely financial statements for the law practice and knowing the estimated taxable income and projected tax liability for their personal situation.
Having stated that, let’s look at some tax planning moves to consider:
Move No. 1
Many law practices have a 401(k) company retirement plan. This is a good start but tends to fall very short of providing a decent retirement funding for the key employees. The 401(k) plan can be modified with provisions that increase the company funding for key employees without increasing proportionately company funding for the rank and file employees. That implementation can be as simple as signing new retirement plan documents. The provisions I refer to also do not require mandatory funding of the retirement plan each year. Each year stands on its own, as to whether the attorneys want to discretionarily fund the retirement plan for the current year.
Move No. 2
Quite often there are business expenses that end up being paid by the attorney personally with no reimbursement by the law practice. One of the major tax cut changes was to disallow individuals from taking deductions related to unreimbursed business expenses. These expenses should be captured and paid by the law practice, which creates deductions for the practice.The attorney would then be reimbursed on a nontaxable basis, as the attorney is simply reimbursed for business expenses by providing required written documentation. Examples of these types of expenses could include:
- An office in the home of the attorney, especially if substantial office administrative procedures/functions are done at the home. The reimbursement would consider expenses incurred to maintain the house and household.
- Mileage by the attorney to meet with his/her advisors such as the CPA or other professionals. Any travel that benefits the law practice should be reimbursed including business entertainment miles.
- Reimbursement of items like continuing education and association dues.
Move No. 3
If the children of the attorney have done some work that benefited the law practice then those children should be paid a salary for their work. If the work of the children is justified, the salary could be several thousand dollars without there being any income tax to the children while still being a deduction for the law practice. With those salaries, ROTH IRA accounts up to $6,000 (if salaries are $6,000 or more) could be funded for the children.
Move No. 4
Often times the law practice has an expensive car on its books that is being written off over a much-extended period of time. This makes for the car having a high tax basis but a much lower market value. If the attorney is so inclined to dispose of this car in favor of another car, then the attorney should carefully think about selling the current car.
Move No. 5
If the attorney does not currently have a large regular IRA account balance, then the attorney should consider funding a nondeductible IRA account and then immediately rolling over that nondeductible IRA account into a Roth IRA account. This process allows the Roth IRA account to grow on a tax free basis with the future withdrawals not being taxable at all. This funding of the nondeductible IRA account does not create a tax deduction, so it is not necessarily a tax planning move.
Move No. 6
With stock market investments, there may be capital losses available to trigger so as to eliminate already incurred capital gains and capital gains distributions from stock holdings.
Move No. 7
Acquisitions of business depreciable assets and software, if needed, should always be considered. It’s worth pointing out that fixed asset purchases financed with loans will also qualify. In tandem with this idea is accelerating payment of fixed expenses (rent, supplies, insurances, utilities) into the current year. An example of this is paying the January rent in December to get the deduction in the current year. Expenses paid with a credit card also represent a deduction in the current year, even if the credit card is not paid off until the following year. The issue of whether to accelerate deductions into this year or push them into next year is based on an understanding of your current taxable income situation.
Move No. 8
Finally, it is just as important to review the current tax reporting structure for your law practice. If the practice is reporting to the IRS other than as an “S” corporation, there should be an analysis of the merits of converting the tax status to an “S” corporation.
Bottom line: be sure to meet with your CPA soon. Jim Rice