If your law firm is a C corporation, it will probably be classified as a “personal service corporation.” This means that your corporation will not be able to take advantage of the marginal tax rates that are available for the typical corporation and, as such, every dollar of taxable income will be taxed at the top rate of 35%. In addition to that, the Illinois corporate tax rate is now 9%. So in total, a C corporation’s income tax can be as high as 44%.
Most law firms, as well as most service organizations, report their income on a cash basis versus the accrual basis. On the cash basis of accounting, you report as income all cash received and report as expenses all cash paid. While on the accrual basis, income is reported as earned and expenses as incurred. The law firm that reports on a cash basis of accounting will not have to report as income their uncollected accounts receivable or report as expense their unpaid accounts payable. Typically, accounts receivable far exceed accounts payable and, as such, the cash basis of accounting is much preferable for tax purposes.
ORBA’s Law Firm Group can help you monitor your law firm’s cash position at year end to create a zero tax situation. Our advisors will review the corporation’s taxable income during the last week of your year end and control the income such that whatever net income is left in the corporation can either be paid out by way of expenses or bonuses to your shareholders. Cash basis corporations are also allowed to prepay certain expenses and deduct them in the year paid. For example, one month’s rent can be paid in advance and deducted, as well as various other supplies and expenses that are incurred in the normal course of business.
With proper planning, ORBA's Law Firm Group has been able to help clients eliminate all taxation for our law firm and C corporation clients.