On September 16, 2014, Attorney and CPA, Kira N. Brucker, presented “Tax Advice for Your Law Firm.” The discussion focused on tax planning strategies for self-employed attorneys, as well as reviewing some IRS “red flags” that are specific to attorneys.
Trust Accounts (IOLTA) must be properly maintained so that the Attorney’s balance sheet reflects an asset and a corresponding liability for the funds held in trust. Furthermore, the client must have supporting schedules to tie into the exact dollar amount of funds in the trust account. For example, an attorney should be able to justify that the $10,000 in the trust account consists of $5,000 from Client A and $5,000 from Client B. From an IRS perspective, the Service will presume that all deposits into an attorney’s account is taxable income unless the attorney may substantiate that the funds belong to clients, which would not be taxable income to the attorney. Without proper reporting, it could be an expensive mistake for the attorney.
Many self-employed attorneys may take advantage of deducting expenses related to their business. Kira reviewed the IRS standard for taking such deductions. An expense may be deductible only if “ordinary” and “necessary” for the business. IRC §§ 162 and 274. Furthermore, the tax payer must substantiate that the expense is “directly related” to the business purpose. Treas. Reg. §§ 1.274-2(a). This means that the attorney needs documentation on all business deductions to show the amount of cost, date, and business purpose. Kira recommends that attorneys review the IRS Audit Technique Guide for Attorneys (http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Attorneys-Audit-Technique-Guide). This is the “instruction” manual for IRS field agents when they are performing an audit. The guide explains in plain English an attorney’s requirements relating to taxable income and deductions.
The most litigated attorney issue by the IRS is the improper deduction of “Client Advances.” Client Advances are most common when an attorney pays litigation expenses on behalf of clients and recovers the costs at settlement of the case in a subsequent year. Most attorney desire to take a tax deduction in the year when paid; however, these costs may not be deducted when incurred, but need to be recorded as a loan receivable until recovered from the attorney. Herrick v. Commissioner, 63 T.C. 562, 569 (1975).
Kira discussed in detail many noteworthy deductions that especially apply to self-employed attorneys. Many of these deductions can provide the taxpayer the opportunity to reduce their taxes, if proper rules, procedures, and elections are followed. Some of the most noteworthy deductions may be: 1) Home Office; 2) Auto Expense; 3) Depreciation on the purchase of new furniture and equipment; 4) Employee and Fringe Benefits; 5) Travel / Meals & Entertainment; and 6) Retirement Accounts.
Lastly, Kira advised the group that self-employed attorneys have several tax filing requirements. In addition to income tax returns, all self-employed attorneys in MD need to file Personal Property Returns and Payroll Tax Returns / 1099 Returns if they have employees or contractors working for them. It is also important for a solo practicing attorney and an attorney who may have been promoted to partner at their firm to understand that they may need to pay quarterly estimated taxes in advance of April 15th.
From a tax perspective, being self-employed provides an attorney with many great opportunities and Kira recommends that an attorney has a good CPA partner to advise on the best way to minimize taxes.