Are your employees getting the tax relief they deserve? Are you? Should you process your own payroll? A CPA tells lawyers a thing or two about the financial side of running a practice.
For solo and small firm lawyers, there's more to a successful practice than pounding out the perfect brief or delivering a winning closing statement.
For many attorneys who are starting and running their own law practices as sole practitioners or owners of a small firm, managing the nitty-gritty, dollars-and-cents aspects of being a small-business owner lies well outside the comfortable realm of rendering legal services. But staying on top of the accounting and finance function of the practice can be just as important as knowing the law.
"If you don't get paid, you're going out of business. If you don't pay your bills, your vendors are going to cut you off. If you don't pay your employees, you're not going to have any people," accountant Matthew J. Costello of Costello CPA Group, Ltd. said. (Costello, a Chicago-based business and tax consultant, spoke on the financial aspects of running a law practice at the 2012 ISBA Solo and Small Firm Conference in Itasca - see sidebar for more.)
"When you're a small business owner you are responsible for every facet of a business enterprise, which includes the financial aspect," Costello said. "It doesn't only include rendering legal services; it involves making sure the company is financially healthy."
In the transition from employee to employer - from practicing at a big firm or other organization, where all of the administrative functions of the operation are handled by others - the challenges for the sole practitioner or small firm operator in managing a law practice can be particularly acute, Costello said.
"[Small firms] don't have the layer of administrative support to help them out with a lot of things. With one- to three-owner shops, how much administrative support do they have? The resources to assist are greatly reduced," Costello said in an interview.
"You still have to bill your clients, collect your money, and perform the other administrative functions of the firm," Costello said. And, he stressed, "Every hour that the owner allocates to an administrative function is one less hour of billable time, or one less hour of 'me' time."
Outsource what you can
Often, the best way for lawyers to take care of collecting and paying bills and compensating employees is to turn it over to someone else, Costello said. He recommends outsourcing financial administration to the fullest extent possible.
"The benefits of outsourcing are two-fold," Costello said. "Number One: It frees up the time of the owner or support staff to do something that will either generate more revenue or is the highest best use. Number Two: When you outsource the function, you're probably going to get a higher quality product."
"If the small-firm operator were to outsource its bookkeeping or accounting function, the quality of financial information that results will most likely be higher. The timing will be better and you'll get the information necessary to make business decisions," Costello said. "Ultimately, the most important thing is the timing of cash flows. What bills do I have to pay? Who owes me money? You can't make well-informed decisions based on your cash flow if you're using stale financial information."
The processing of payroll for practitioners who have employees should be outsourced 100 percent, Costello said, because, "it's rather labor intensive and it's a highly competitive industry - you can really do it in a cost-effective manner." And, Costello said, "The penalties are steep when you goof up. The IRS doesn't mess around with payroll tax liabilities."
Or use the latest accounting technology
Maybe you have some experience with accounting or are otherwise a do-it-yourselfer when it comes to finance. If so, the many software packages available today to automate the finance and bookkeeping function of a small firm can also free up time for revenue-generating attorneys, Costello said. (See sidebar on page 79 for specific products.)
"In all of your accounting processes you have to take a critical look at what you're doing and ask yourself, 'Where can we clip some time off of this and how can we improve the nature of the information generated from the process?' Take a look at everything you do."
Take, for example, your law practice's accounts payable cycle. "Someone opens the mail and a bill comes into the office. What happens to the bill at that point? Does it get entered into the accounting system? [If so,] then it's approved for payment. Then you have to cut a check, sign the check, mail the check. It's a long, tedious process," Costello said. "With some of today's technology tools, this whole accounts payable cycle can be greatly reduced with very little cost."
The news is also good on the accounts receivable side. "For the whole process of billing your clients - recording time, billing time, and collecting from clients - the tools out there are just amazing," Costello said.
With these sorts of technology tools, the attorney can have easy access to all unpaid invoices and send reminders, or resend a bill or statement - all with a few computer keystrokes and a few clicks of a mouse.
"With these tools you don't have to see a piece of paper in the whole process," Costello said. "You press a couple of buttons, you create the bill, you email it to the client, he sees the bill or documentation behind it, and he has the ability to pay electronically and it goes right into the attorney's bank account."
"You can have up-to-date financial information: How much money you have in the bank, who you owe money to, who owes you money. You can have that on any device at any time, from anywhere," he said. "There has been an absolute explosion in the accounting and finance technology space over the last five years."
Paying the IRS as you go: switching from withholding to estimated tax
You don't need to be an accountant or tax lawyer to know that minimizing tax liability is a great way to boost the bottom line. Alternatively, failing to pay taxes in full or on time can lead to serious trouble.
Beyond that, it's important - especially for attorneys starting their own practices - to understand the impact of the business entity on the owner's personal tax liability, whether the practice is set up as a sole proprietorship, a limited liability company (LLC), or a corporation.
"Many of the small firms are so-called "flow-through" entities, whereby the company itself doesn't have any federal tax liabilities. The income flows through to the owner and all the tax burdens are assessed there," Costello said. "It's important they're aware of this and assess how it impacts their personal tax situation in light of other sources of income and deductions.
"If they're coming from a large firm and they weren't a partner there, the switch from employee to self-employed is a big change," Costello said. "They're going to have to make estimated tax payments instead of paying their taxes via withholding. If you don't plan for these tax liabilities they can really add up.
"You can't avoid the payment of tax, but you can put yourself in a good position to assess your obligations," Costello said. "The only way to do that is to have good financial information - a good accounting system, up-to-date information."
As such, Costello said, maintaining a good working relationship with your accountant throughout the year, not just at the end, can go a long way. "When your accountant is relegated to the mop-up role there's very little he or she can do," Costello said. "When the accountant is engaged throughout the year to help monitor and stay on top and plan for the income tax, that's when you get the best bang for your accounting buck."
Estimated tax basics. Questions about personal estimated income tax payments - how much and when to pay -are among the most common Costello hears from small-firm owners. "There seems to be a lot of mystery with these estimated tax payments and, really, there is just one general rule to follow," Costello said.
"The general rule states that…to be free from penalties and interest resulting from the underpayment of tax, taxpayers are required to pay in amounts equal to the lesser of: 1) 90 percent of the tax to be shown on your current year tax return, or 2) 100 percent of the tax shown on your prior year tax return," Costello noted in a handout accompanying his Solo and Small Firm conference seminar last fall. "[I]f your adjusted gross income (AGI) for the prior year exceeded $150,000, then you must use 110 percent of your prior year tax instead of 100 percent when following the general rule. While your eventual tax liability in total is pegged, you do have a couple of options and planning opportunities in terms of the amounts of the individual payments."
Quarterly estimated tax payments are due on April 15, June 30, September 15, and January 15 of the subsequent year.
Going gangbusters? Use the Safe Harbor. Estimating income for the current year can be tricky for small-firm operators. But you can protect yourself by using a relatively simple, commonly used approach to estimating quarterly tax payments - a method referred to as the Safe Harbor because "no matter what your current year tax amount eventually is, you will be safe from interest and penalties as long as you pay in the required minimum amounts based on your tax from the prior year."
Consider, for instance, that your tax bill for 2011 was $4,000. Quarterly payments for 2012 would be $1,000, Costello said.
"But what happens if in 2012 you start your own firm and things are just gangbusters? You're going to have a million dollars of income this year. Can you still pay $1,000 per quarter?"
Under that scenario, Costello said, even if your tax bill amounts to $400,000 at the end of the year and you paid only $1,000 per quarter, the Safe Harbor method allows you to make up the difference without penalties or interest.
"You're going to have one whopper of a balance due with your return on April 15, and a super huge whopper because April 15 is a double whammy time. Not only is tax due for the tax year, your first quarter estimate is due also on that day for the next year. That's a big, mega payment. That's the pain day," Costello said. But if you wanted to do that you could."
Expecting a pay cut? Use the projected current year. That method works, Costello said, when income is going up. But what if when you were an employee, you were earning a significantly high income and you start your own practice and "things aren't going too well in the early stage and your income this year is pretty low?
"Let's say that your prior year tax equaled $85,000 and your current year tax ends up being $4,000," Costello said. "If you were to pay in based on the 'Safe Harbor Method' of your prior year tax, you would [have] the government sitting on a pile of your money for a lengthy period of time. Undoubtedly, you could find a better use for those funds."
Instead, Costello said, you can use your projected current year tax as the basis for making quarterly tax payments. Under that scenario, the rule is to pay in 90 percent of the amount you're estimating to generate for the current year to be free from interest and penalties.
Tax breaks for you and your employees
Costello pointed out some of the ways lawyer-employers can structure benefits to lower their employees' tax bills. One option, he said, is to convert compensation from wages to benefits, like paying for health care, that aren't subject to income tax.
"Compensation that is excludable from gross income is, by definition, not subject to income tax. Employees get a good deal," Costello noted. "Because it is not considered taxable wage income, this excluded compensation also escapes payroll taxation. Not only does the deal become sweeter for the employee, but the employer realizes a benefit in the form of reduced payroll taxes as well.
"There is some serious low-hanging fruit that you could convert to something that's not taxable to the employee," Costello said. "Very easily, you can reduce some of your tax burden."
Cafeteria plans. For instance, Costello said, by setting up a cafeteria plan that offers health benefits, a lawyer-employer can reclassify a specified amount of compensation paid to the employee, who uses it to pay his or her health insurance premium.
"When you do that it's not considered compensation anymore. You're paying with pre-tax dollars," Costello said during the CLE seminar. "[P]re-tax dollars [are] not subject to income taxes or payroll taxes."
Costello offered this scenario: A small-firm owner hires an employee at a salary of $100,000. In addition, the firm sponsors a health insurance plan in which the employer pays $100 of the employee's $600 premium each month.
"Of that $100,000 of the compensation, we're going to run her portion of her medical premiums [$500 per month] through a §125 Cafeteria Plan," Costello said. "That $6,000 then [the annual cost of the employee's premiums] is not considered taxable wage income to her. When she gets her W-2 only $94,000 is considered wages because $6,000 is pre-taxed."
A cafeteria plan isn't limited to health insurance premiums, Costello said. It can include accident benefits, financial help with adoption and dependent care, group term life insurance premiums, and health savings accounts - so called "flex" accounts - that enable workers to buy everything from aspirin to hearing aids with pre-tax dollars.
Qualified Transportation Plan. Or how about letting employees pay for parking or mass-transit commuting expenses with pre-tax dollars? According to Costello, small firm employers often overlook this option.
It's called a Qualified Transportation Plan, and it's governed by IRS code section 132, Costello said. It's available to owners with employees who incur qualified mass transit commuting costs via a train or bus or who pay to park. Under the plan, those transportation and parking expenses of an employee are paid for with pre-tax dollars, effectively reducing taxable wage income of the employee and resulting in a reduction of the associated income and payroll taxes, Costello explained.
"I'm surprised it's not more widely used," he said. "You get the pre-tax treatment like in the cafeteria plan, but you get it for very little administrative costs. You can shave off some payroll tax dollars you would otherwise pay and give a really good benefit to your employees."
Retirement plans. Retirement plans are another way small-firm owners can reduce employees' tax bills - and their own, Costello said. He said the plans allow participants to defer up to $50,000 in personal income that would otherwise be taxable in that year. Annual contributions to retirement plans are typically voluntary from year to year, he said, and certain plans permit contributions up to nine and one-half months after the end of the tax year.
"The small-firm owner should have some sort of retirement plan," Costello said. "At least get it set up [so] you can use it when you need it, and you don't have to do anything if you don't need it.
"In a year where you have healthy income and find yourself with a little bit of cash lying around, you can put away a pretty decent amount of money in these plans," Costello said. "Number One: You save for retirement - great. Number Two: You knock down your current tax liability - very good."
Administration of these plans can be fairly straightforward, with many small firms finding they can administer them in-house or with the help of their payroll processor, Costello said.
Maria Kantzavelos <email@example.com> is a Chicago-based freelance writer focusing on legal topics.
Matthew J. Costello, CPA, a Chicago-based business and tax consultant, and South Elgin attorney and ISBA Board of Governors member Lisa M. Nyuli presented a seminar last fall during the ISBA Solo and Small Firm Conference entitled "The Practice of Practicing Law - Part Two: The Business Side of Starting a Law Practice." Costello focused on financial basics for small firms, and Nyuli discussed lawyers as employers. The seminar was one of three programs during the conference that focused on various aspects of starting and running a law practice. It is online and available at http://isba.fastcle.com (search under 8th Annual Solo and Small Firm Conference).
An important accounting challenge unique to lawyers is maintaining client trust accounts in accordance with the dictates of the Illinois Rules of Professional Conduct (specifically, Rule 1.5 (f)-(h)). And for lawyers who accept payment by credit card, the IRS has upped the ante by imposing new verification requirements, complete with harsh penalties for those who fail to comply. For more information, visit the Lawyers Trust Fund of Illinois (www.ltf.org) or ARDC (http://www.iardc.org/IRSCreditCardWarning.pdf) websites. The LTF site is a great source of info about IOLTA requirements generally.
If your accounting program is either Quickbooks 2012 Professional or GnuCash 2.x, ISBA member Bryan Sims has made managing IOLTA accounts much easier for you. His free-to-ISBA-members guides for maintaining IOLTA accounts using these programs are available at http://www.isba.org/practiceresourcecenter/ioltacalculators.
Planning to Succeed
By Helen W. Gunnarsson, November 2011
How many lawyers really know where they want to take their practices? How many have a strategic plan, complete with a mission, goals and an action plan flowing from that mission, and a system for measuring success? This article explains why you should be one who does.
The Five Biggest Business Mistakes Lawyers Make
By Helen W. Gunnarsson, September 2011
In an effort to make themselves attractive to clients, too many lawyers - especially new ones - undervalue their services. It's a short-sighted approach that can lead to big trouble, as this article explains.
By Helen W. Gunnarsson, February 2012
More clients - and lawyers for that matter - are looking for value-based alternatives to the billable hour. The good news? They can be a win-win for attorney and client.
From Sheepskin to Shingle
By Helen Gunnarsson, September 2009
Can you really go straight from law school into solo practice? Do you know enough? What are the surest ways to succeed - or stumble? This article explains.
Selling a practice
By Maria Kantzavelos, October 2012
How much is your practice worth? How can you maximize its value? How do you find buyers? Even if you aren't ready to sell, experts say the time to ask yourself these questions is now.
Taking Down Your Shingle
By Helen W. Gunnarsson, January 2009
Selling or otherwise closing your private practice? Don't forget to take care of important business before you do.
Lawyer as employer
Hiring How-Tos, Firing Fundamentals
By Helen W. Gunnarsson, March 2011
Businesses are only as good as their people, but recruiting employees and letting them go are both fraught with legal pitfalls. This article shows you how to help your clients and your own firm avoid HR missteps.
You're the Boss - Now What?
By Helen W. Gunnarsson, March 2010
Supervising employees, meeting a payroll - more things
they didn't teach you in law school. This article tells you some of what you need to know to be an effective, legally compliant, ethically aware employer or supervisor.
By Helen W. Gunnarsson, December 2011
The Rules of Professional Conduct make managing
nonlawyer staff a high-stakes business. This article explains which rules are most directly implicated and learn how to be a better boss.
In managing the dollars-and-cents aspect of running a law practice, attorneys can get a helping hand from a wide variety of small-business accounting software products on the market, including cloud-based offerings that allow access to financial data anytime and anywhere.
Accounting software programs like QuickBooks Premier Professional Services (desktop version), QuickBooks Online, Xero, and Sage 50 Accounting are just a few of the technology tools out there that can make for a good fit for sole practitioners and operators of small law firms, according to Chicago-based accountant Matthew J. Costello. (See sidebar on page 78 for help with mission-critical IOLTA client trust fund accounting.)
Quickbooks Online, Intuit's cloud-based offering, "has really come a long way and most likely would be a good fit for almost all small firms," Costello said.
The accounting package streamlines and automates time-consuming accounting tasks like creating and managing invoices and business reports, and creating, printing, and tracking checks. Users can keep track of such financial matters as client payments, bills paid and invoiced, checks written and received, credit card payments, incoming and outgoing expenses, and outstanding invoices.
Xero, also a cloud-based accounting package, is a fairly new product that is "very forward-thinking" and accepts live bank feeds whereby company cash and credit cards balances are updated in real time, Costello said.
With cloud-based accounting tech tools, data is stored online so that attorney users can reach it from a mobile phone or tablet anywhere an Internet connection is available, providing the flexibility to manage the financial side of the practice wherever they are.
"Paying your vendors or sending an invoice to your client while standing in line at Starbucks or in the back of a cab is not science fiction, it is a reality," Costello said.
"It might be typical for attorneys to come in over the weekend to the office to take care of some of the administrative tasks. But a lot of times they do that because they have to, because everything is on the premises. They're tethered, more or less, to the office," Costello said. "[With cloud-based accounting packages] that tether has been cut."
Additionally, Costello said, these cloud-based technologies allow for an unprecedented level of collaboration between the firm and its outside accountant.
"There is only one set of data. Gone are the days of transferring financial records back and forth," he said. "These technologies have completely transformed the way I can service my clients - I am but a few mouse clicks away from my clients' live financial information."
Among the host of accounts payable and accounts receivable applications geared for small firms, Costello recommends Bill.com. The cloud-based product allows users to pay vendors electronically and to create bills and receive payments from clients electronically.
"It completely streamlines the whole [accounts payable/receivable] operation," Costello said. "For someone who has a full-time bookkeeper you can probably cut half a person out of your whole accounting function. You can take five to 10 hours off of it a week."
Before selecting an accounting tech tool, Costello said, look first to your existing practice management and time and billing applications to assess potential integration.
"Get your accountant involved in the process, the earlier the better," Costello said. "Your accountant can assist you greatly in the selection, implementation and ongoing utilization of your technology."
And, Costello stressed, "Time spent on set-up and training on the basics of the application is time well spent."
Many of the cloud-based products offer free trials that allow users to test-drive the software for a specified period.
"They all have fairly robust resources on their websites and online user communities and knowledge bases. Most likely you can even find a YouTube channel with detailed videos. Generally, I have also found technical support to be more than adequate," Costello said. "You can really self-teach yourself."
- Maria Kantzavelos