Free Continuing Education for Small Business
Well our topic for today is tax tips for lawyers and we know that the practice of law involves giving legal advice to clients which sometimes includes representation of clients in legal negotiations or in court proceeding or in drafting of legal documents. The right to practice law requires admission to the bar association of a state or territory. To do this, the candidate must sit for the bar examination and meet other requirements such as a background check or a view of their character. Attorneys are held to certain standards for their conduct once they are practicing law. But for most lawyers, the practice of law is a business enterprise and it's a business enterprise that's highly regulated by the states.
How lawyers practice their profession varies considerably. Some lawyers are employed by large organizations such as government agencies or corporations. However, a large number of lawyers are self-employed and operate as sole proprietors or many operate in the form of a shared expense arrangement where they share offices and common expenses with other attorneys. Yet other lawyers are also partners or shareholders of larger law firms or legal organizations. So we see the form of the practice that lawyers are engaged in can vary considerably. Most lawyers do face tax issues, which are comparable to those faced by other business enterprises.
For example, our first topic is choice of entity. We have some lawyers, many, many lawyers, practicing as sole proprietors so they are considered self-employed and they file a Schedule C. Other lawyers you can opt to be taxed as a, to file a corporation entity so they would be taxed as a PLLC. If they're a single member, they could be taxed as a sole proprietorship if no election is made to be taxed as an S corp. or a C corp.
Then if you are a partnership, you would file a form 1065 and that's reported on the individual partners, on their Schedule E and on their Schedule SE because they are paying self-employment tax. With an S corporation, you're filing a form 1120-S and there each shareholder's portion of the corporate profits are reported on a Schedule E of the form 1040 and it's important to note that with an S corporation, there is no tax on the corporate profits in the form of self-employment tax. You don't need a Schedule SE if you're a shareholder of an S corporation.
With a C corporation, you would file the form 1120 and there you're taxed at the corporate rates, which range all the way from 15% up to 39%. The main difference about having a C corporation is that you do have a potential for double taxation of dividends so you would normally pay out all of the distributions in the form of salary or wages because you don't want to pay a double tax on those earnings. Also with a C corporation you have the possibility of it being taxed as a personal services corporation. Basically what they call a qualified personal service corporation means that substantially all of the activities are the performance of services in a professional field such as health, law, engineering, architecture, accounting and you have substantially all of the stock by value is held by individuals performing the services for the corporation and substantially is defined as more than 20%. So if you are held to be a qualified personal service corporation, then you are taxed at a flat rate of 35% instead of at the graduated corporate rates. Those graduated corporate rates are 15% on the first $50,000, 25% from $50,000 to $75,000.
Next, another difference between the different entities is to select how this impacts the home office deduction. The home office deduction is where part of your home is used exclusively and regularly as a principle place of business or as a place to meet or deal with clients. The main difference for a home office deduction, if you elect to be taxed as a sole proprietor, then the home office deduction is a deduction from your Schedule C directly off of your business income. If you're an S corporation or a C corporation, then the corporate home office is deducted on Schedule A as a miscellaneous itemized deduction because it becomes like an employee business expense so it is subject to the 2% threshold so it's not as optimal to have a corporation if you're electing to deduct the home office deduction.
Next we'll look at the selection of the year end. If you are self-employed, then typically you must report on the January 1 to December 31 calendar year. If you're an S corporation, it also generally requires that you opt for a calendar year. With a C corporation, they have a big advantage in that they can select a fiscal year end, which is another year end other than the calendar year end and this can open up the possibility of shifting income between taxable years so it's taxed at a later year. With a partnership, you must use the tax years of the partners owning more than a 50% interest in the profits and the capital of the partnership so this typically results in partnerships also opting for a calendar year. It there is no majority tax interest tax year, then you must use the tax year of all principle partners with a 5% or more interest and then, finally, if there is no majority tax year, then you would be required to use the year end resulting in the least deferral of income. Usually this results in partnerships using a calendar year end.
Next, looking at medical insurance and medical reimbursement plans and how relates to the choice of entity. If you are self-employed, then you would deduct 100% of your medical insurance on page 1 of your Form 1040 but other medical expenses for the self-employed would be deductible on Schedule A of the Form 1040 and there you have a threshold of 7.5% of adjusted gross income so you would only a get a benefit from those other medical expenses if they exceed 7.5% of your adjusted gross income. For most people, they do not exceed 7.5%. One possibility for the self-employed is to hire your spouse to work for you and to pay your spouse a salary or other compensation and then that allows you to treat your spouse as an employee and to set up a medical benefits for your spouse, which can then be deducted directly from your Schedule C.
With an S corporation, the same rules apply as being self-employed so you would have to deduct most of your medical expenses on Schedule A and your medical insurance on page 1 of your Form 1040. But with a C corporation, it opens up the possibility of a medical reimbursement plan and this is also called a Section 105 plan. What this allows you to do is to set up an arrangement that can cover a set dollar amount of the health expenses of employees and those employees can include yourself as the officer. The only caveat is that the plan must be nondiscriminatory but it can cover all of owner employees without restriction.
So for example, say a one person company is a C corporation with a medical reimbursement plan and they set up a plan that offers reimbursements up to $5,000 of uninsured medical costs for the owner employee as well as for his spouse and dependents. So as long as the language of the plan provides comparable coverage for all employees, then the owner employee is not taxed on the reimbursements while the corporation is able to deduct them.
Next looking at charitable contributions. For the self-employed, charitable contributions are deducted on Schedule A of the Form 1040 just as for individuals. Similarly, for S corporations, the charitable deductions are claimed on Schedule A of the Form 1040. The C corporation claims the charitable deductions directly on its Form 1120 and it's taken actually as a business expense.