Strategic Tax Planning for Law Firm Partners

August 2025

U.S. professional services firms, such as law firms, that are taxed as partnerships present a range of complex tax challenges, both to the firm and, by extension, to its partners. Whether partners are equity or non-equity, active or retired, they often face intricate tax situations due to their partner agreements, unique income structures, profit-sharing arrangements, and layered ownership stakes.

Unlike employees, partners are generally classified as self-employed, which brings a host of tax pitfalls and planning opportunities.

As CPAs, we proactively develop tailored tax strategies to address these issues for our clients. Our approach focuses on navigating these complexities by minimizing tax liability, improving cash flow management, preserving wealth, promoting long-term financial well-being, and ensuring full compliance with continually evolving tax regulations.

Understanding the Tax Landscape

• Partnership Income Tax & K-1 Reporting to Partners: In the U.S., most law firms are structured as partnerships or limited liability companies (LLCs) and taxed as partnerships. This means that they are pass-through entities that do not pay federal income tax. Instead, their income, losses, deductions, and credits are reported on Schedule K-1 and passed directly to the partners who then report their distributive share on their tax returns. Partners may owe taxes on their distributive share of the partnership's income that is reported on Schedule K-1 even if a cash distribution is not actually received during the year. Further, many firms have offices in several states and provide State K1s to partners, which creates additional multi-state tax filing obligations for partners.

• Self-Employment Tax: Since partners are considered self-employed, they must pay both the employer and employee portions of Social Security and Medicare taxes, significantly increasing their tax burden. The self-employment tax rate is 15.3%. Of that, 12.4% is for Social Security but only up to an income cap ($176,100 for 2025), and 2.9% for Medicare, with no income limit.

• Quarterly Estimated Taxes: Partners must timely remit estimated tax payments to the IRS and State(s), on a quarterly basis, thus requiring accurate income forecasting and cash flow management throughout the year. This can present a challenge to law firm partners who receive uneven distributions from the firm either on a monthly, quarterly, or annual basis. As law firm partners frequently earn a large portion of their income in Q4, estimated tax payments during the first three quarters can be smaller amounts with a larger payment made in Q4.

Tax Planning Strategies

• Entity Structuring and Legal Considerations

o Evaluate whether converting the firm to a professional corporation (PC) or limited liability partnership (LLP) with S-corporation election can provide benefits.

o An S-Corp election treats the company as a pass-through, meaning income flows to the owners' returns and is not subject to self-employment taxes.

o Many law firms can meet the IRS' requirements to qualify for S-Corp status, but maintaining that status requires additional steps, including paying owners "reasonable compensation" before distributions can be made; having no more than 100 shareholders; shareholders must be individuals, certain trusts or estates, and U.S. citizens or legal residents. Non-U.S. citizens, partnerships, corporations, and certain other entities are prohibited from owning S corporation stock.

o For law partners, structure your own income channels (e.g., via a personal PC or LLC), to limit liability and explore additional efficiency and tax planning opportunities. Explore S-corporation election. For partners who have other income streams, explore using family trusts or partnerships to lower your tax burden.

• Income Deferral and Timing

o Through the law firm, partners should make use of state pass-through entity tax (PTET) workarounds, which can provide substantial federal tax savings. This can prove especially helpful to law partners who reside in high-tax states.

o If relocating to another state, consider state residency tax planning as part of your compensation arrangement and the timing of bonuses. Beware of states that have a Convenience of Employer rule or Income Accrual rule, which can negate the benefits of changing one's state of residency for tax purposes.

o Time bonuses, discretionary payments, and income distributions to spread tax liabilities across multiple tax years which may be offset by other personal tax deductions and get taxed in a lower tax bracket.

• Deductible Business Expenses, Home Office Deduction

o For law partners, keep meticulous records of expenses incurred for business purposes that aren't reimbursed by the firm to claim on your individual tax return.

o Examples include costs for continuing education, professional dues, marketing, home office costs, legal, and research tools.

o Per the IRS, the home office deduction can be calculated in one of two ways:

1. Actual expense method. Calculate the percentage of your home used for business and apply it to the total expenses for that portion of the home. If you worked from home for only part of the year, adjust your calculation accordingly.

2. Simplified method. Deduct $5 per square foot of your home office, up to 300 square feet. For example, if your office is 300 square feet and you worked from home for nine months, your deduction would be $1,125 (300 * $5 * 9/12).

• Retirement Planning and Charitable Giving

  o Maximize contributions to retirement vehicles, such as SEP IRAs, 401(k) plans, or defined benefit pension plans. A Roth IRA conversion can be very worthwhile. These plans offer substantial tax savings and meaningful retirement benefits.

  o Consider making charitable contributions to qualified charities. Donating via a Donor Advised Fund (DAF) provides immediate tax deductions as well as avoidance of capital gains taxes on appreciation of assets such as stocks, mutual funds, and bonds, and tax-free growth of assets held inside the DAF.

At Perelson Weiner, we understand the complexities of planning for law firms and law firm partners. It's important to plan for tomorrow.

If you have questions, please contact your Perelson Weiner professional.