How To Pay Yourself When You Own A Law Firm
When running a law firm, there are many different financial aspects you should take into account, from profits and overhead to taxes and payroll. However, it’s equally important that you don’t forget to pay yourself either. Failure to do so may be an indicator that you do not value your time and value, are disorganized in your daily business operations, and could also lead to missing out on valuable tax incentives.
Despite this, a recent study published in Business News Daily found that “just over half (51%) of business owners pay themselves a salary”. This is something that needs to change – especially as running a business could become unsustainable if you aren’t earning an income yourself.
While there are various strategies you can use to pay yourself as an entrepreneur, the following methods have proven to be the most successful.
Method #1: Drawing Payments.
If you are a sole proprietor or single-member LLC owner, you can pay yourself by drawing money out of your business’s capital account. This is particularly beneficial as this withdrawal of money can be taken out of the business without it being subject to taxes until year end. It would also still need to be filed as income on personal tax returns.
Method #2: Distributive shares.
According to the Legal Information Institute, owners in multi-member LLCs or partnerships cannot take draws from the business accounts. Instead, they must take a distributive share. This is most accurately described as “a partner’s distributive share of income, gain, loss, deduction, or credit.” They will show up in regular tax returns.
Method #3 Pay yourself a salary.
Salaries are the most popular form of remuneration for business owners. This is because they are a more consistent and reliable form of income. Salary payments are also easier to manage, making it easier to stay in control of your law firm’s financial health. Finally, paying yourself a salary could also mean that you qualify for a tax break out of your total business income. This is because salaries classify as a deductible business expense.
How much can I pay myself when I own a law firm?
Once you’ve decided upon the appropriate payment method, the question shifts to just how much you should pay yourself. Unfortunately, there is no specific answer to this question, given that it depends upon your firm’s unique financial situation and both short- and long-term goals.
Many experts suggest running law firms based on the “Rule of Thirds”. This method dictates that:
- ⅓ of business revenue should go towards employee payments, including taxes and benefits.
- ⅓ of business revenue should be spent on overhead costs, such as marketing and rental fees.
- ⅓ of business revenue goes towards profit or re-investment.
This means that your salary must be taken from ⅓ of your business’s revenue.
Many business owners are quick to realize that employees must be compensated fairly for their time; especially in an industry with high turnover rates. Despite this, they are often too willing to cut back on their own pay, despite the value they bring to the table.
For example, according to Xero, many entrepreneurs will take home a “basic” wage when their business is in its infancy – taking only enough to cover basic living expenses. This ensures that their “business has maximum investment while reducing the amount of start-up capital needed”.
This is not sustainable long-term, and plans must be put in place that enables you to increase your income as your firm’s profitability grows. For example, if your law firm’s revenue increases by 5%, so should your salary. However, as your firm grows over time, it’s likely that you’ll find it easier to pay yourself, especially if you find ways to improve your firm’s financial health.
Want to start running your firm like a business? At FinOp Group, our team of experienced CPAs provides full-service law firm accounting solutions, including tax planning, payroll, budgeting, and billing. This means that you can focus on what truly matters, running a stellar law firm. Schedule your free consultation today!