When it comes to paying yourself from your law firm, your options are determined by how you choose to structure your business.
Some law firm owners pay themselves with draw payments. This means you’re choosing to pay yourself a portion of your firm’s profits. How much you pay yourself and how often is up to you.
Sole proprietors and single-member LLCs can use this method. It is common across various small businesses because it’s flexible. The owner’s draw can be determined by how the business is doing.
But draw payments have their downsides, too—mostly around taxes.
If the amount you pay yourself from your business jumps all over the place, you’re more likely to draw scrutiny from the IRS. As anyone who’s been through an audit knows, even if it’s determined that you didn’t do anything wrong, audits take up a lot of time and energy.
Draw payments also mean that your taxes aren’t being withheld, so you need to stay on top of quarterly payments and be prepared to foot a large tax bill in April.
An owner in a multi-member LLC or partner must take a distributive share instead of a draw. Distributive shares operate similarly, but must be recorded on a Schedule K-1.
Unlike draws, which are accounting transactions, distributive shares also show up on tax returns.
Earn a salary
S-corporation owners who work in the business they own, such as lawyers in a law firm, can take a salary.
Taking a salary can make your personal finances more predictable and a little less labor-intensive. The same goes for your firm—if you operate on a salary basis, you have more consistent numbers with which to plan your budget.
But determining the right salary can mean more work up-front. The IRS wants you to pay yourself “reasonable compensation.” So you should aim to pay yourself a market-rate salary, and you also need to leave your firm enough money to stay healthy after meeting other financial obligations, like paying your staff.
To decide on an appropriate salary, you’ll want to use your practice management system to help you track metrics to determine what firm financials look on monthly and annual scales. This can also be a good way to look at ongoing patterns and developing trends.
Although a salary gives you less overall flexibility than the draw approach, you can still do some fine-tuning, such as adjusting your salary from one year to the next.
Ultimately, you’ll want to weigh the pros and cons of your particular situation and look at similar firms in your practice area. But whichever approach you choose, leverage the financial data gathered by your practice management system to ensure your payment decisions are grounded in solid numbers.