Managing a law firm is a complex endeavor, and when you’re juggling multiple business entities, the intricacies multiply. While each entity might have its purpose—whether it’s asset protection, tax advantages, or flexibility—the real challenge lies in maximizing tax efficiency across them all.
Many lawyers with multiple entities miss key opportunities to optimize their tax strategy. The good news is that with the right approach, you can leverage these entities to reduce your tax burden, streamline income distribution, and save more of your hard-earned revenue.
Let’s dive into actionable tax strategies that will help you maximize your tax efficiency as a lawyer managing multiple business entities.
1. Optimize Income Allocation Between LLCs, S-Corps, and C-Corps
If you operate more than one business entity—whether they’re LLCs, S-corporations, or C-corporations—it’s crucial to carefully consider how you allocate income across them. Each entity type is taxed differently, and with a well-structured strategy, you can reduce your overall tax liability.
How it works:
- LLCs: Pass-through entities, where the income flows directly to the owners’ personal tax returns, which can lead to high self-employment taxes.
- S-Corps: Allow you to pay yourself a reasonable salary and then distribute the remaining profits as dividends, which are not subject to self-employment tax.
- C-Corps: Taxed at the corporate level, with potential double taxation (at the corporate level and again when dividends are paid out).
Pro Tip: Use S-Corps strategically to avoid paying self-employment taxes on the entire profit. By paying yourself a reasonable salary and taking the rest as dividends, you’ll only pay payroll taxes on the salary portion, resulting in significant tax savings.
2. Use Salary vs. Distribution Strategies to Minimize Self-Employment Tax
One of the most effective ways to reduce your tax liability when managing multiple entities is to carefully structure how you pay yourself. As an attorney, you likely wear different hats in each entity—whether as a managing partner, business owner, or independent consultant. Each role can be compensated differently for tax purposes.
Here’s how you can minimize self-employment tax:
- Pay yourself a salary from an S-corp or C-corp. Salaries are subject to payroll taxes (Social Security and Medicare), but the business can deduct these as a legitimate expense.
- Take distributions from your S-corp or LLC. These distributions are not subject to self-employment tax, allowing you to reduce your tax burden.
Example: If your firm generates $300,000 in profits, you could allocate $120,000 as a salary (subject to payroll taxes) and take the remaining $180,000 as distributions. The savings on self-employment tax alone can be significant.
Pro Tip: Make sure your salary is reasonable in the eyes of the IRS—paying yourself too little could trigger an audit.
3. Review Business Loans and Interest Payments for Potential Deductions
If your law firm or one of your entities has taken out a business loan, don’t overlook the tax benefits that come with interest payments. Interest on business loans is often tax-deductible, and this applies across all your entities, as long as the loan is used for business purposes.
Here’s what you should know:
- The interest portion of business loan repayments is fully deductible.
- Loans taken out by one entity can often provide tax benefits to another entity if there’s a legitimate business connection between the two.
Example: If your LLC took out a loan to purchase equipment or expand office space, the interest payments could be deducted, lowering your taxable income for that entity. This strategy can apply even if another entity (such as your S-corp) is benefiting from the expansion.
Pro Tip: Keep clear records of how loans are used across multiple entities to justify the deductions.
4. Explore Income Shifting Between Entities to Reduce Your Tax Burden
Income shifting is a strategy that involves moving profits from one entity to another to reduce overall taxes. If you manage multiple business entities, this technique can help you take advantage of lower tax rates or defer taxes entirely.
Here’s how income shifting can work:
- Shift income from a high-tax entity (e.g., a C-corp) to a low-tax entity (e.g., an S-corp or LLC) by paying for services, rent, or management fees.
- Ensure the transactions are legitimate, well-documented, and made at fair market value to avoid IRS scrutiny.
Example: Your law firm (S-corp) could pay another entity you own (an LLC) for consulting services or rent. This shifts income to the LLC, potentially lowering your overall tax rate if the LLC is taxed at a lower rate.
Pro Tip: Make sure all income-shifting transactions are properly documented with service agreements and invoices to withstand IRS scrutiny.
5. Use Intercompany Transactions to Maximize Tax Efficiency
If your entities regularly do business with one another—whether through shared services, rent, or management fees—intercompany transactions can be an effective way to lower taxable income for one or more entities.
Here’s how to maximize intercompany tax efficiency:
- Charge management fees for services rendered between entities (e.g., administrative support or legal services).
- Lease office space or equipment from one entity to another.
- Share resources and expenses between entities in a way that minimizes the overall tax burden.
Example: If you own both a law firm and a property management company, you could have the law firm lease office space from the property company. The law firm deducts the rent payments as a business expense, while the property company benefits from rental income that could be taxed at a lower rate, depending on its structure.
Pro Tip: Make sure all intercompany transactions are conducted at fair market value to avoid issues with the IRS.
Why It’s Important to Have a Tax Strategy for Multiple Entities
Managing multiple entities can be a powerful tool for protecting assets, expanding your business, and gaining flexibility, but without a solid tax strategy, it can also create unnecessary complexity and tax liability.
By strategically optimizing income allocation, salary vs. distribution, and intercompany transactions, you can significantly reduce your tax burden and free up more resources to reinvest in your firm’s growth.
Streamline Your Taxes—Talk to an Expert in Law Firm Tax Strategies
At Prestige Accounting and Consulting, we specialize in helping lawyers with complex business structures. Our team of tax experts can develop a customized tax strategy that maximizes your savings while ensuring you remain compliant with tax laws. Whether you have an LLC, S-corp, or C-corp—or all three—we’ll work with you to streamline your finances.
Contact us today to schedule a consultation and get your personalized tax strategy in place before year-end.