Most attorneys work tirelessly to advance their careers and earn a particular salary. So don’t let some common tax mistakes end up costing you money. Whether you are a partner at your law firm, work as a solo practitioner, or are an attorney working for an employer, there are a number of common tax mistakes lawyers consistently make. We will discuss those mistakes, overlooked deductions, and the top tips that will save you money.
Deductions for expenses related to your law practice must be both ordinary and necessary. Ordinary means that the expense is for something commonly used and accepted as an expense for someone in the legal field. A necessary expense is one that is helpful and appropriate for your field. Some typical deductions that are both ordinary and necessary and are easy to determine such as office rent and office supplies. However, there are some expenses that are often overlooked:
If you are a partner:
Unreimbursed Expenses: If you are a partner in your firm, expenses related to your business that your law firm does not reimburse you for, which you paid for personally, may be a deduction you can take on your personal return. Common examples may include cell phone expenses, mileage, or portions of business-related meals and gifts. If you are a partner, you are eligible to take these deductions on Schedule E of your personal return. Claiming business expenses against partnership income on Schedule E reduces both the taxable income and the self-employment tax.
Capital Account Loans: Interest paid on capital account loans is another expense you are eligible to take on Schedule E of your personal return. A capital account loan is a loan for money you borrowed to purchase a share in your firm or to make further capital contributions. Deducting this interest expense on Schedule E allows for the same tax benefits described in Unreimbursed Expenses.
State Taxes Your Firm Pays on Your Behalf: Several law firms operate and earn income in a variety of states. Partners typically choose which states they will file personal returns for themselves, versus which states they choose to participate in, composite elections. Composite elections allow the firm to file a tax return and pay any necessary tax liabilities on the partner’s behalf. Many partners may miss the deduction for state taxes paid on their behalf, particularly when composite elections and filings have been made. You are eligible for an itemized deduction for these payments which may be deducted on Schedule A of your personal return. It is important to keep in mind that the new Tax Cuts and Jobs Act (TCJA) that was passed in December 2017 will affect this deduction. Under TCJA, the annual deduction for state and local taxes is now limited to $10,000.
If you are a sole proprietor:
Home Office Deduction: It is very common for sole proprietors to run their practice out of their personal residence. You may take a deduction for a home office if the area is used exclusively for your law practice and nothing else. This could be a dedicated room or even a portion of a room. This deduction typically involves allocating a portion of all the expenses it takes to run your business from your home, based on the square footage of the dedicated space versus the total square footage. Examples of expenses that may be eligible for this allocation include mortgage interest, real estate taxes, utilities, and repairs, among others.
There is also a simplified method available for calculating the home office deduction in which you multiply the dedicated space’s square footage by $5. This method can allow for a maximum annual home office deduction of $1,500. While this amount may appear less than the amount using the allocation method described above, there are often other tax advantages. For more information on home office deductions, please refer to Ellen Boulle-Lauria’s blog, “Working From Home? What Qualifies as a Tax Deduction?”
Self Employed Health Insurance: If you are paying for medical, dental, or long-term care insurance for you and your family you may be eligible for a deduction. If you have a profit for the year, the amounts paid for these expenses typically can be taken on page one of your personal return as an adjustment to income. This can be very advantageous because it can directly reduce taxable income and is not subject to itemized deduction limitations.
If you do not have a profit for the year, all is not lost. You may be eligible to take these expenses as itemized deductions. For 2018, medical expenses may be taken as an itemized deduction if the total for the year exceeds 7.5% of your adjusted gross income. This is set to change to 10% of your adjusted gross income beginning in 2019.
If you are an attorney working for an employer:
Unreimbursed Expenses: If you are an attorney that works for an employer and you have unreimbursed business expenses, the TCJA may have a major impact on you. Under prior law, you would have been eligible for potential itemized deduction for these expenses. The TCJA has eliminated the potential itemized deduction for this category of expenses. If this applies to you, you should discuss this issue with your employer and see if they would be willing to implement an accountable reimbursement plan. If they do, you would be eligible to be reimbursed without including these reimbursements as income and your employer would then be able to take advantage of the business deduction on their own return.
Tax regulations are frequently changing, and taxpayers’ often have unique situations. We can help you discuss your unique situation, determine eligible deductions, and help you select which methods are most advantageous to you. If you have any questions, please contact Angela Chaney or our tax advisors at 301.231.6200.