How do taxes work as an income partner at a big law firm?

By Joel Chouinard, ChFC®

January 20th, 2025

Making partner at a big law firm is a major achievement, but it also comes with significant changes to how you get taxed. When you become a partner, you switch from being an employee of your firm to becoming an owner of your firm. From an IRS standpoint, there is a big difference between the two. On one side, as an associate, your wages are reported to you on form W2, and your firm withholds federal, state (if applicable), and Social Security/Medicare taxes on your behalf. Pretty straightforward. As a partner, your income is now reported to you on form K-1, and your firm no longer withholds taxes on your behalf. It’s your responsibility to remit those taxes to the IRS each quarter.

Understanding how you get taxed as an income (or nonequity) partner is crucial to avoiding underpayment penalties and minimizing the impact of taxes on your cash flow. This article will show you how to do that.

*Note that if your firm treats income partners as W2 employees, this article won’t apply to you.

 

Law Firms Are Pass-Through Entities

Law firms themselves don’t pay taxes. That’s because they are set up as pass-through entities. In the simplest terms, “pass-through” means that the net income (or loss) generated by the firm is passed on to its partners, pro-rata, according to their share of the partnership. As an income partner of your firm, you get your piece of that income, even if you don’t technically own equity in the firm. Your income is now reported to you on form K-1, and you are liable for the taxes due on that income.

 

Income Partner Compensation

As an income partner of a firm, your income will likely come from two sources: guaranteed payments (or draws) and a performance bonus.

• Guaranteed payments: This is the set amount that your firm agreed to pay you for your services for the year. It is usually equal to or slightly higher than your base salary as a senior associate and is paid bi-monthly, just like a regular paycheck. I’ve also seen some firms split income partners’ compensation between guaranteed pay and mock “profit distributions” each quarter (although the sum of their draws and distributions still equals their guaranteed pay for the year).
• Performance bonus: Just like associates, income partners can receive an annual bonus based on their performance. Although there is some discretion for firms to include non-billable performance metrics (e.g., business development), the bonus requirements will likely resemble associates’ requirements.

 

Income Partner Taxation

As I mentioned above, your firm stopped withholding taxes on your behalf when you became an income partner. It is now your responsibility to make your tax payments directly to the IRS through quarterly estimated payments. Before we talk quarterly payments, let’s discuss the three components that comprise income partners’ tax liability:

1. Federal taxes: The federal tax is assessed on your taxable income and is based on your filing status and your tax bracket.
2. State taxes: Depending on the state in which you reside, you may also be levied a state tax on your income. Even if you live in a state with no income tax, you may be responsible for a portion of your firm’s state tax liability in the states where the firm has offices. For example, a partner in Dallas, Texas, may owe California or New York taxes if their firm has offices there. The good news here is your firm is likely filing a composite return, which allows them to withhold a portion of your pay for state taxes.
3. Self-employment taxes: As an associate, you were responsible for half of the Social Security and Medicare taxes, and your firm was responsible for the other half. As a partner, you are now responsible for the whole thing, which is 15.3%. After all, you are technically the employer now, so you must cover that part too! Thankfully, the Social Security tax (12.4%) is capped after you reach a certain level of income ($176,100 for 2025), so your entire income is not subject to the full 15.3%. However, the Medicare tax (2.9%) is subject to your full taxable income. There is even a Medicare surtax of 0.9% for individuals making above $200,000 and married couples making above $250,000.  For more information about the self-employment tax, check out the IRS website.

 

Quarterly Estimated Payments

Since your firm no longer withholds taxes on your behalf, it’s now your responsibility to remit your taxes to the IRS. This is done through quarterly estimated tax payments. Generally, you and your accountant will calculate your estimated tax liability for the year and divide it into four equal payments due each quarter on April 15^th, June 15^th, September 15^th, and January 15^th.  That’s because the IRS assumes that you earn your money equally throughout the year and assesses underpayment penalties for taxpayers who do not pay enough each quarter. Therefore, making four equal payments is the failproof approach, hence why many accountants recommend it.

 

Cash Flow Issues

The tricky part with making four equal tax payments is that, as a partner, your income is uneven throughout the year. You may receive a somewhat stable income through the first three quarters of the year through guaranteed payments but then get a massive bump in Q4 with your year-end bonus (or a profit distribution for equity partners).

Example

Let’s use an example of how this could play out for an income partner at a big law firm. Assume you make $450,000 as guaranteed pay and a potential $100,000 bonus, paid out in December. In this case, the IRS assumes you will earn $137,500 each quarter ($550,000/4), and your quarterly payments should reflect that. In reality, though, you will earn $37,500/month ($450,000/12), except in December, when you can get your potential bonus. If you break it down per tax quarter, you will receive $112,500 of compensation in the first quarter (January 1^st to March 31^st), $75,000 in the second quarter (April 1^st to May 31^st), $112,500 in the third quarter (June 1^st to August 31^st), and potentially $250,000 in the fourth quarter (September 1^st to December 31^st), if you get the full bonus. The cash flow issues arise when you earn less in a certain tax quarter, but your tax liability remains the same (e.g., in the example above, in the second tax quarter, you only receive $75,000 of income but will owe taxes based on $137,000 of income.

 

Tax Planning Considerations For Big Law Income Partners

Thankfully, there are ways to alleviate some of these cash flow issues. Let’s discuss a few strategies.

Create a “Tax” Savings Account

Since taxes are no longer withheld from your paycheck (other than for state composite returns), your paychecks might actually look bigger than before. But in reality, some of that money isn’t yours, it’s the IRS’. To ensure you don’t spend the money before your quarterly payment is due, I recommend opening a separate savings account and labeling it “Quarterly Taxes.” As a self-employed individual, this strategy has worked great for me.  Depending on what your accountant recommends, send a percentage of each paycheck to that account. You can even use a High-Yield Savings Account to earn some interest on that money while it’s sitting there. When quarterly taxes are due, use the money from that account to make your payment.

 

Create a “Partnership Transition” Fund

Taxes are not the only thing that will change when you become an income partner. Your benefits will likely no longer be subsidized by your firm, and you may be required to make a large profit-sharing contribution to your 401(k) ($46,500 in 2025). This could further exacerbate your cash flow issue. One way to minimize the impact of the transition to partnership is to create a transition fund that will act as a cushion for the leaner months. My recommendation is to build a fund big enough to pay your first two quarterly estimated tax payments, so you’re always ahead. One way to fund this account is to use your previous year’s bonus. Note that this does not replace the need for putting aside money each paycheck for taxes. Otherwise, you’ll be right back to square one when your Q2 payment is due.

 

Annualized Income Installment Method

One strategy to minimize the impact of uneven cash flow while avoiding underpayment penalties is to use the Annualized Income Installment Method. Under this method, the IRS allows you to pay taxes as you earn your income each quarter. However, to do so, you must file Form 2210 (Schedule AI), so it's crucial that you work with a competent tax and financial professional to help you determine your quarterly estimated payments. If using this method is not an option, then knowing your estimated underpayment penalties could be useful. If those amount to only a few hundred dollars for the year, it might make sense to pay them to avoid the cash flow crunch in the leaner quarters.

For a complete guide on how to prepare your finances ahead of making partner, check out this article.

 

Final Note

Navigating the world of partnership taxation as a big law income partner requires careful planning and attention to detail. By understanding the nuances of self-employment income and quarterly payments, you can optimize your cash flow strategy and ensure compliance with the IRS. It’s critical that you hire a qualified tax and financial professional to create a personalized plan that aligns with your specific financial situation and goals.

 

 

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