Partner Lawyers: How to Optimize Your Share for Maximum Tax Savings
November 19, 2024
Tax Strategy for Trial Lawyers: Special Year-End Moves You Need to Know
As a trial lawyer, your income doesn’t always follow a predictable pattern. Between contingency fees, large settlements, and case-related expenses, your financial picture can fluctuate greatly from year to year. This makes year-end tax planning especially crucial for trial lawyers who want to maximize deductions and minimize their tax liability.
Here’s the reality: Without a proactive approach, you could end up paying more taxes than necessary. With the right strategies in place, you can reduce your tax bill and keep more of your hard-earned money.
Below are the key year-end tax strategies every trial lawyer should implement to set themselves up for success before the year closes.
1. Manage Fluctuating Income from Settlements or Contingency Fees
As a trial lawyer, your income may vary dramatically based on the outcome of cases and the timing of settlements. You might have a great year with large settlements or contingency fees, followed by a quieter one. These income fluctuations make it essential to carefully manage how and when you recognize your income for tax purposes.
Strategies to consider:
- Defer income: If you’ve had a high-earning year and you’re on the cusp of a higher tax bracket, consider deferring settlement income or contingency fees into the following year. This can lower your taxable income for the current year and smooth out income across multiple years.
- Structured settlements: If possible, opt for a structured settlement, which distributes payments over time instead of a lump sum. This can help spread out the tax impact and prevent you from hitting higher tax brackets.
Pro Tip: Income deferral is a powerful strategy, but it requires careful coordination with your firm’s finances. Be sure to consult with a tax professional to plan the timing of income effectively.
2. Maximize Deductions for Travel, Case-Related Expenses, and Expert Witnesses
Trial lawyers often incur substantial expenses related to travel, expert witnesses, and case preparation. These costs are typically fully deductible, which can significantly reduce your taxable income—if you track them properly.
Key deductible expenses:
- Travel: Flights, hotels, meals, and transportation for court appearances, depositions, and client meetings.
- Expert witness fees: Fees paid to experts for depositions, courtroom testimony, and consultations are deductible as business expenses.
- Case-related costs: Document preparation, research services, and legal software subscriptions also qualify as deductible business expenses.
Pro Tip: Prepay any case-related expenses before December 31 to ensure that you can deduct them in the current tax year. This strategy can be particularly useful if you anticipate a higher tax liability this year and want to offset it with deductions.
3. Understand the Tax Treatment of Settlements and Awards
Not all settlement income is treated the same for tax purposes. Understanding how settlements and awards are taxed is essential for accurate tax planning and avoiding surprises at tax time.
Key distinctions:
- Personal injury settlements: These are generally non-taxable as long as they are compensation for physical injuries or sickness.
- Punitive damages and emotional distress: Unlike personal injury settlements, punitive damages and awards for emotional distress (not tied to physical injuries) are usually taxable.
- Lost wages: Settlement amounts awarded for lost wages or back pay are considered taxable income and are subject to both income tax and employment taxes.
Pro Tip: Work closely with your CPA to classify settlement payments correctly and take advantage of any applicable exclusions or reductions in taxable income.
4. Prepay Expenses Related to Ongoing Cases to Claim This Year
One smart way to reduce your taxable income before the year ends is to prepay case-related expenses that will come due early next year. This allows you to claim the deductions now, rather than waiting for the following tax year.
Common expenses to prepay:
- Expert witness fees: If you have ongoing cases that will require expert witnesses, consider paying those fees now to take the deduction in the current year.
- Legal research services: Prepay subscriptions to legal research platforms like Westlaw or LexisNexis for the upcoming year.
- Office expenses: Stock up on office supplies or pay rent early to increase your deductions for the current year.
Pro Tip: Prepaying expenses can help offset a particularly high-income year, especially if you’ve had multiple large settlements.
5. Explore Income-Smoothing Strategies to Minimize Taxes on Large Settlements
If you’ve had a particularly successful year with large settlements, you could be facing a significant tax burden. Income-smoothing strategies, such as deferring settlement payments or spreading them over several years, can help reduce the tax impact.
Here’s how to smooth income:
- Defer settlement payments: If you’ve won a large settlement and are expecting another high-income year, you can defer receiving the payment until the next tax year to avoid being pushed into a higher tax bracket.
- Structured settlements: By opting for a structured settlement, you can receive payments over a longer period, which may help you stay in a lower tax bracket and reduce your overall tax liability.
Pro Tip: Structured settlements also offer the benefit of consistent, long-term cash flow, making them a useful tool for both tax planning and financial security.
Why Year-End Tax Moves Matter for Trial Lawyers
Trial lawyers face unique tax challenges due to the unpredictable nature of settlement income and the high costs of litigation. By taking a proactive approach to year-end tax planning, you can reduce your tax liability, maximize your deductions, and ensure that your finances are in top shape going into the next year.
From managing fluctuating income to maximizing deductible expenses, these strategies are designed to help you keep more of your earnings and lower your tax bill.
Optimize Your Strategy Before Year-End—Contact Us for Trial Lawyer Tax Help!
At Prestige Accounting and Consulting, we specialize in providing tax strategies tailored specifically for lawyers. Whether you need help managing fluctuating income, maximizing deductions, or navigating the tax treatment of settlements, our team of experts is here to help.
Contact us today to schedule a consultation and optimize your tax strategy before the year ends.
