There’s no easy way to prepare your legal practice for tax time, and the majority of lawyers have a lot of burning questions on tax season preparation. What happens when you advance costs for a client? Can you expense costs associated with pro bono work? And which deductions should you be claiming this year? To help, we put together the following guide. In addition to tax prep tips, you’ll find a list of common deductions to keep in mind, and answers to some niche tax questions that leave most legal professionals scratching their heads.
Preparing Your Practice for Tax Time
Let’s start with the easy stuff. Here are three things you should do before you file your 2014 tax return:
Get Your Books Up To Date: You’ll need up-to-date books to file your taxes. To finalize your bookkeeping for the year, gather up your receipts, reconcile your bank accounts, and check that you have all W9s and W2s on file for contractors and employees. We recommend hiring a bookkeeper or an online bookkeeping service like Bench to help you process a backlog of bookkeeping. If you’re going to do it yourself, this guide will help you get your books caught up fast.
Estimate and Pay Your Quarterly Income Taxes: Estimated tax payments are due four times per year: April, June, September, and January. To submit your quarterly payment, simply fill out Form 1040-ES and mail it—along with a check—to the IRS office closest to you. You can also pay online or by phone. To calculate your quarterly payments, you need to first estimate your adjusted gross income, taxable income, deductions, and credits for the year. Use your income, deductions, and credits from last year as a jumping off point. Once you have estimated your income for the year, use Form 1040-ES to calculate the estimated payments.
File for a Tax Extension: This one is optional, but if you don’t think you’ll be able to get your paperwork done on time you should strongly consider filing for a tax extension. While a tax extension won’t get you out of paying your 2014 taxes owed by the usual deadline, it will give you extra time to prepare and file your tax return (and avoid any penalties for filing late). Filing for an extension is easy: submit a one-page form, along with your taxes owed for the year, to the IRS online or by mail. Either you or your accountant can prepare the relevant form and submit it to the IRS. To file for a tax extension, submit the form that corresponds to your business type below by the required date:
- Corporations – March 16, 2015: To qualify for an automatic 6-month extension, use Form 7004.
- Partnerships – April 15, 2015: To qualify for an automatic 5-month extension, use Form 7004.
- Sole Proprietors – April 15, 2015: To qualify for an automatic 6-month extension, use Form 4868.
Need more help? Check out this step-by-step guide on filing for a tax extension on the Bench Blog.
Common Tax Deductions for Legal Practices
You can deduct purchases that are ordinary and necessary for your work. Here’s a list of common tax deductions for lawyers and legal practices that can be deducted on Schedule C, Form 1040, unless otherwise noted.
Home Office: If you’re running your practice from a home office, you may be eligible for the home office deduction. In order to qualify, you need to meet three requirements set by the IRS: exclusivity, regularity, and precedence.
- Exclusivity: You need to use your office solely for business.
- Regularity: Your home office must be used on a regular basis.
- Precedence: You need to spend the most time, and conduct the most important business activities out of your home office.
The simplest way to calculate your home office deductions is to create a standardized deduction of $5 per square foot of your home that’s used for business (up to a maximum of 300 square feet).
Telephone and Internet Expenses: If you use these technologies for both business and personal use, (in a home office, for instance) you can deduct the percentage of the cost based on how much you use them for your business. Keep records to prove the amount of business use (annotated call logs and office hours). If your phone and Internet are used solely for business purposes, then they are 100% deductible.
Business Insurance: The cost to insure your business is fully deductible as a business expense.
Charitable Contributions: You can deduct charitable contributions that are made to qualified organizations on Schedule A (Form 1040). Corporations can deduct these on their corporate tax return, while sole proprietorships, single member LLCs, and partnerships all deduct these costs on their personal tax return.
Retirement Contributions: Contributions made to an Individual Retirement Account (IRA) can reduce your taxable income for the year. Keep in mind that your total contributions for the year can’t exceed your total earned income for the year or the annual maximum level of contributions (whichever is less). The IRS announces these limits each year.
Business Interest and Bank Fees: Interest incurred on business loans and on business credit cards can be deducted as a business expense. Note that if a loan is part business and part personal, you can only deduct the percentage of interest that applies to the business part of the loan. You can also deduct fees and bank charges for your business bank accounts.
Legal and Professional Fees: The costs of professional services, such as fees paid to your accountant or bookkeeper, are deductible as a business expense.
Business Meals: You can deduct 50% of qualifying food and drink costs. To qualify, the expense needs to be a business meal. Hold onto the receipt and jot down the purpose of the meeting and who you met with. Navigating the treacherous terrain of tax time can be daunting for solo and small firm attorneys without an in-house accounting department, but there are a number of resources available to help. Watch our free on-demand webinar featuring Micky Denning of Kahuna Accounting and Evan Birch of Bench Accounting that will help your law firm establish a foolproof accounting system and give you a leg up on tax season.
Tax season is fast approaching. Catch up with Micky Deming of Kahuna Accounting and Clio’s own Lawyer In Residence Joshua Lenon to learn How to Build the Perfect Accounting System for your Firm.
This post was brought to you by Kendra Murphy of Bench Accounting, the online bookkeeping service that pairs you with a professional bookkeeper and uses simple software to do your books for you. Start your free trial today. Note: This article applies to U.S.-based practices only