How to Use Leverage to Your Firm’s Advantage
ADAM LEVINE, CPA, CFP®
Leverage is a familiar concept in the financial world— with both positive and negative connotations. However, leverage is less frequently found being utilized in law firm management. That is unfortunate because, when properly implemented, leverage is less about risk and more about improved efficiency and greater profitability.
It Takes a Team
For a law firm, leverage means allocating work to the right people at the most cost-effective level possible. For example, instead of having a partner research a relatively simple legal matter, ask a first-year associate to do the work instead. This frees up the partner’s time for business development work or complex, full-realization-type matters that ultimately are more financially lucrative.
Many firms find that the most efficient way to allocate work and create leverage is by building client teams. Teams should be made up of people with complementary skills — including partners, associates, paralegals, and administrative staff— who are focused on a common goal for which they will be held accountable.
Whether your firm currently works this way or is new to the team approach, successful leverage depends on several factors. First, your firm’s culture must encourage team-based results and rewards. Firms that compensate primarily for billable hours will have a hard time convincing attorneys to share their workload with colleagues.
Second, teams should be guided by clearly stated goals that the team members have agreed upon in advance. Goals might be project-based — such as reviewing documents — or longer-term, such as prevailing in a litigation matter. To ensure goals can be reached, draw up an action plan with specific assignments that take into account each team member’s qualifications, work load and billing rate.
To ensure your firm is using leverage successfully, the managing partner or firm administrator should meet regularly with team leaders to analyze their work from a variety of perspectives. For example: Were the team’s total hours and dollars within budget? Was the engagement staffed correctly? Could the workload have been distributed more cost-effectively?
In other words, teams should be held responsible for allocating their workload to the most efficient and cost-effective levels. By analyzing and correcting past mistakes, your firm can achieve better results on future engagements.
A Systemic View
If you are going to use leverage to your firm’s advantage, client teams are only a starting point. No matter its size, every firm has certain systems in place that affect the efficiency and profitability of its operations. How clients are accepted or rejected, how matters are assigned and how bills are processed and collected are all examples of important systems. Each of these functions should be assigned to the most cost-effective, appropriate-level people and all routine responsibilities should be documented.
If you need to reassign attorneys and staff, be sure to consult with them about their professional goals and interests first. Otherwise, you risk losing good people. And know that, in some cases, the most cost-effective, appropriate person for a function may be someone who does not even work in your office.
Embrace the Concept
Leverage is not something that law firms can implement half-heartedly. The more broadly you embrace the concept, the more profitable your firm is likely to be. To better understand the potential savings associated with leverage, or for questions, contact Adam Levine at [email protected] or call him at 312.670.7444. Visit orba.com to learn more about our Law Firm Group visit our Law Firm Group page.
Estimating Taxes for Law Firm Partners
ROB SWENSON, CPA, MST
With ownership come certain tax responsibilities. For example, the IRS requires partners, members or shareholders in any firm structured as a “pass-through” entity — a partnership, LLC or S corporation — to calculate and pay quarterly estimated taxes if they expect to owe $1,000 or more. That is because pass-through entities do not pay tax at the entity level. Instead, law firm partners personally owe tax on their pro rata share of the firm’s taxable income, regardless of whether income is distributed or not.
Accuracy is Critical
Partners need to estimate their tax liabilities as accurately as possible. If you underpay, you will be subject to penalties. If you overpay, you are essentially making an interest-free loan to the IRS.
To calculate your estimated taxes, project your adjusted gross income (AGI), deductions and credits to arrive at your taxable income for the year. Alternatively, you can use last year’s tax liability. Once you have arrived at a number, subtract expected withholdings on any wages (yours and, if you file jointly, your spouse’s) and pay the remainder in four equal installments. See the table for 2015 filing dates.
If you expect to receive income unevenly throughout the year, you can use the annualized income installment method to match your estimated tax payments to your actual income during each period. Essentially, this is a pay-as-you-go method that calculates each installment based on the payment that would be due if your tax liability through the most recently completed period were annualized.
To avoid underpayment penalties, your estimated tax payments must total at least 90% of your tax liability for the year. Or you can use the IRS’s safe harbor option. This allows you to avoid penalties by paying 110% of last year’s tax liability (or 100% if your 2014 AGI was $150,000 or less.) Note that, if you miss or underpay an installment, you will still be subject to underpayment penalties, even if you end up with a refund for the year.
If your income this year is difficult to predict or it is expected to be substantially higher this year than last, it could make sense to pay estimates based on last year’s tax liability to minimize your estimated tax payments. But if you use this safe harbor, you will need to be prepared for a big tax bill on April 15. Even though you will avoid underpayment penalties, you will still need to pay your remaining tax liability when you file your return. If, on the other hand, you expect your income to be lower this year, you are better off using 90% of this year’s tax liability as long as you can estimate it with reasonable certainty.
What happens when partners realize during the year that they have not paid enough estimated taxes? It may still be possible to avoid penalties. If you expect your income to be higher in the latter part of the year, use the annualized installment method and increase your remaining estimated tax payments.
Another strategy is to increase withholding from any wages (such as yours or your spouse’s wages) to make up the difference. Unlike estimated tax payments, amounts withheld from wages are treated as if they were paid ratably over the year, regardless of when they’re actually withheld. So you can use increased withholdings late in the year to make up for an estimated tax shortfall in the beginning of the year.
Crunch the Numbers
To ensure that your estimated tax payments are accurate and timely, project your 2015 taxes as early in the year as possible. You can use your 2014 return as a guide but, if you are a new partner, last year’s return will not help much. Ask your firm to provide you with income projections for the year and consider using the safe harbor to reduce your payments and simplify the projection process.
Income period (2014) Estimated tax due
Jan. 1 to March 31 April 15, 2015
April 1 to May 31 June 15, 2015
June 1 to Aug. 31 Sept. 15, 2015
Sept. 1 to Dec. 31 Jan. 15, 2016