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Focus on Law Firms: Tax Implications for New Partners

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The end of the calendar year usually coincides with an important time in many law firms – partner promotions. In law firms structured as partnerships, newly promoted partners can expect their tax situation to change for the 2015 filing year. This is primarily due to the way partnerships report income and how the income “flows through” to partners of the firm.
January 9, 2015

The end of the calendar year usually coincides with an important time in many law firms – partner promotions. In law firms structured as partnerships, newly promoted partners can expect their tax situation to change for the 2015 filing year. This is primarily due to the way partnerships report income and how the income “flows through” to partners of the firm.

It’s important to note that, as a partner, you’re no longer an employee of the firm and will instead receive a Form K-1. The Form K-1 reports your earnings for the year whether it is in the form of guaranteed payments and/or your portion of firm income. One major difference is that taxes are no longer being withheld and remitted to the IRS for these earnings. That responsibility now falls to you personally. This is a different method than simply using Form W-2 in preparing your Form 1040 (U.S. Individual Income Tax Return), which is more common in reporting an employee’s gross wages.

As an employee, federal and state income taxes were not the only items previously withheld from your compensation. Social Security and Medicare (commonly known as FICA taxes) were also withheld from your compensation and matched by your employer. As a partner, you’re now considered to be self-employed which means your earnings, both guaranteed payments and firm income, are subject to self-employment tax. This tax replaces the FICA taxes previously withheld from your payroll and matched by your employer. Self-employment tax will be added to your estimated federal income tax to determine your quarterly federal tax estimate requirements.

If you were promoted to partner effective in 2015, in addition to your year-end income reporting forms being different, you may need to consider making quarterly estimated payments.

If your federal 2015 tax liability is expected to be $1,000 or more, you should be making quarterly estimated payments. These amounts are due April 15, June 15, September 15 and January 15 of the succeeding year. Your total quarterly estimates plus any withholding should equal at least 90% of your tax for the current year (including the self-employment tax) or 100% of your tax from the prior year. However, if your prior year adjusted gross income was over $150,000, this amount increases to 110%.

In order to figure out the amount due each quarter, you’ll need to calculate your projected taxable income, deductions and credits to then determine your tax liability. Internal Revenue Service (IRS) Form 1040-ES and the form’s related instructions can help with this determination.

Form 1040-ES is also the voucher used to remit your taxes if you’re paying by check. Taxes can also be paid electronically by enrolling in EFTPS (Electronic Federal Tax Payment System). If you plan to pay electronically, you’ll need to enroll several weeks prior to the payment due date to allow time for the IRS to mail you a personal identification number to activate and access your account.

Should you have questions or need assistance with these calculations, please contact your RubinBrown advisor.

 

Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.

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