Legal Accounting Frequently Asked Questions

Confused by tax time? You’re not alone. Thankfully, we’ve assembled some easy-to-understand answers to complicated legal accounting issues courtesy of our friends at Bench.co. Although we’ve simplified these explanations, our best advice is to find and work with a great accountant to make sure you properly navigate these and other complex tax areas.

Do Pro Bono Hours Affect Tax Liability?

While pro bono work is great for the community, it won’t have any effect on your tax liability. The value of your time is never tax deductible. However, out-of-pocket expenses are deductible if the pro bono work is for a qualified organization (i.e. a charity, community trust, or veteran’s association).

If I Advance Costs for a Client, are Subsequent Reimbursements Taxable?

When you advance costs, you are essentially creating a receivable from your client. When the client pays, it eliminates this receivable. There is no effect on income, and nothing ever touches your profit and loss statement. Because of this, it is not taxable and not deductible. Keep a detailed record of both the expense and the reimbursement. If the original expense can’t be identified, it becomes income.

What’s the Impact of Reinvesting Capital Back into the Firm on Tax Liability?

Capital that is reinvested into the firm is post-tax money; it’s already been taxed as personal income on the partner’s 1040. You can choose to retain the earnings or contribute them back to the firm. Money that you put into the business can generally be withdrawn without a taxable effect.

How are Capital Distributions to Partners Taxed?

So long as earnings find their way into the partners’ hands, they will be taxed. This means that earnings can be retained or distributed but either way they’ll be taxable. Let’s look at an example: Say that when a partnership earns $100, $50 goes to each partner. One partner draws $10, and one draws $20. The capital accounts will now be $40 and $30, but both partners are taxed on $50 that year. Partners need to track earnings, their allocation, and any distributions. They file a 1065 but don’t pay any tax. Instead, each partner is taxed on their share of earnings on their personal return, Form 1040. As you can see, there’s no easy way around it; preparing your legal practice for tax time requires focus, the support of a great bookkeeper and accountant, and a lot of determination! Want to learn more about how to build an accounting system for your law firm that will make tax time a snap? Check out our free on-demand webinar featuring Kahuna Accounting and Bench Accounting.

Catch up on all these integral accounting elements your firm needs, and more, in our free, on-demand webinar with Micky Deming of Kahuna Accounting and Clio’s own Lawyer In Residence Joshua Lenon; Building The Perfect Accounting System for your Law Firm. Tax season is fast approaching, don’t be afraid to catch up now. 

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