October IOLTA Checklist: Close Out the Year Compliant
October 23, 2025
Tax Planning for Contingency-Fee Firms: Why Timing is Everything
October 30, 2025
How to Use Year-End Bonuses Strategically (Without Wrecking Cash Flow)
Law firm owners, take note: handing out year-end bonuses might help you show appreciation—but if done wrong, it can wreck your Q1.
Whether you’re rewarding your team for a strong year or looking for last-minute deductions, bonuses can be a powerful tax planning tool. But they must be handled with intention, documentation, and strategic timing—especially if you’re a cash-basis taxpayer.
In this guide, we’ll break down exactly how to use bonuses the right way—while protecting your cash flow, avoiding IRS scrutiny, and maximizing deductibility.
💰 Why Bonuses Matter at Tax Time
Bonuses paid to W-2 employees are deductible business expenses under IRC §162, as long as they are:
- Ordinary and necessary in your industry
- Reasonable in amount
- Paid by December 31 (for cash-basis firms) or properly accrued (for accrual-method taxpayers)
For law firms, that means year-end bonuses can:
- Reduce taxable income
- Retain high-performing team members
- Offset profitable years without throwing money away on wasteful spending
✅ Reminder: Owner draws and partner distributions are not bonuses. They are not deductible as compensation unless paid through payroll to an S Corp owner-employee.
🧾 Three Types of Bonuses—And Why They Matter
- Discretionary Bonuses – Paid at the firm’s decision without a pre-set formula. These are still deductible if documented and tied to performance or policy.
- Performance-Based Bonuses – Awarded based on pre-defined KPIs like billables, client feedback, or collections. Easier to justify in an audit.
- Holiday Bonuses – Often flat dollar amounts as appreciation. Deductible, but riskier if they look arbitrary or inconsistent.
📌 Tip: Include bonus terms in offer letters or your employee handbook. The IRS may deny deductions if bonuses appear excessive or undocumented.
🧑⚖️ For Attorneys Paying Themselves
If you’re an S Corp owner, you can give yourself a bonus—but only through W-2 payroll. That bonus is subject to payroll taxes, but deductible to the firm and helps ensure reasonable compensation (an IRS audit trigger if underpaid).
If you’re taxed as a sole prop or partnership, owner draws aren’t bonuses, and they are not deductible.
📚 Learn more: Is Your Entity Structure Hurting Your Tax Strategy?
🧮 How Bonuses Impact Payroll Taxes
Bonuses are not tax-free, and they come with costs:
- Employee side: Subject to withholding for income tax, Social Security, and Medicare
- Employer side: FUTA, SUTA, and the employer share of FICA taxes
A $5,000 bonus could easily cost your firm an extra $500–$600 in taxes. Plan ahead to avoid sticker shock—or worse, overdrafts.
📆 Timing for Tax Deductibility
Cash-basis law firms must pay bonuses before December 31 for the deduction to count in that year.
Accrual-basis firms can deduct bonuses accrued in 2025 if paid by March 15, 2026—but the bonus must be approved and documented before year-end.
Real-World CPA Advice for Law Firms
We helped a 4-attorney firm structure a $40K bonus pool in December—but their cash flow looked tight. Instead of a lump sum, we:
- Used a tiered bonus strategy based on billables and firm contributions
- Scheduled 2 smaller bonus payments through payroll before 12/31
- Created internal bonus memos for documentation
- Maintained reserves for Q1 expenses and payroll taxes
Result? Full deduction. No bounce-back in January. And a team that felt seen, not blindsided.
🚩 IRS Red Flags to Avoid
- Bonuses paid in cash or via personal Venmo
- Owner “bonuses” not paid via payroll
- Excessive amounts without justification
- Lack of internal documentation or bonus policy
Even well-meaning firm owners can raise audit risk when “bonus” turns into “guesswork.” The IRS expects business documentation, not holiday cheer.
🧘🏾 Bonus Strategy Meets Cash Flow Strategy
Want to reward your team but unsure how much you can afford? Start by projecting your Q1 expenses, payroll, and tax obligations. Then work backward to determine a realistic and strategic bonus pool.
✅ Bonus Planning Checklist
- Confirm accounting method (cash vs. accrual)
- Review Q4 cash flow and tax projections
- Finalize bonus amounts and timing
- Run bonuses through payroll (never manually)
- Document bonus rationale and policy
- Pay before 12/31 (cash method) or accrue properly (accrual method)
- Set expectations with staff—clearly and professionally
🎯 Final Word from The Lawyers’ CPA
You didn’t build your firm to spend the holidays stressed about taxes or cash flow. When done right, bonuses reward your people and protect your profits.But bonuses are only powerful when they’re planned.
🎁 Want help deciding if your bonus strategy is smart, legal, and cash-flow safe?
Book a 1:1 consultation now and we’ll run the numbers—before your year-end window closes.
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