Becoming an equity partner at a law firm is a major career milestone — one often seen as the pinnacle of success in the legal profession. It can also be the catalyst for your future wealth creation. But beyond the associated prestige and influence, partnership also has profound financial implications, both positive and potentially challenging. Whether you’re contemplating or have entered equity partnership, understanding the financial landscape is essential to maximize your financial potential.
Significant Income Opportunity
Equity partners often earn significantly more than senior associates or non-equity partners. In large firms, this can mean seven-figure annual incomes. Income and ownership growth are often heavily dependent upon business origination.
Greater Financial Complexities
A higher earning opportunity also comes with greater income variability, higher deductions, and more complexities. The first financial step in becoming an equity partner is to understand the difference between your higher income and what you keep after taxes and partner-related expenses. There is often a larger gap than initially perceived due to a number of factors including:
- Higher taxes to account for self-employment taxes.
- Mandatory retirement plan contributions that can exceed $60,000/yr.
- Capital account contributions.
- Firm charitable contributions that are deducted from your earnings.
- Your personal payment for your health, life, and other insurance benefits.
Your Income Components
- The Draw: As a partner, you typically receive a monthly draw that is designed to give you a regular monthly income. These amounts are not guaranteed. However, they are typically a fraction of your total income which helps to reduce the risk of this income component.
- Distributions: In addition to your draw, you will likely receive profit distributions. These distributions can be significant but are not guaranteed. Distribution payments are often staggered and frequently extend into the following year. Such delays in distribution payments can require careful cashflow management, particularly relative to the timing of your tax payments.
Taxes
- K-1 Income: You will no longer receive a simple W-2 tax form. Instead, you will receive a K-1 with far more complex tax reporting.
- Self-Employment Taxes: Now that you are an owner of your firm, you are subject to self-employment taxes. This doubles the tax rates (to as high as 15.3%) that you previously paid for Social Security and Medicare as a W-2 employee.
- Estimated Tax Payments: You will need to make estimated tax payments which are due four times a year. You must make adequate payments each quarter to avoid tax penalties and interest.
- Your Draw and Distributions vs. Taxable Income: One complexity in estimating your taxes is the fact that your taxable income can differ from the income you receive, depending upon the firm’s profitability.
- Multi-State Tax Returns: If your firm conducts business in more than one state, you will need to file tax returns for multiple states.
Expenses You Pay
As an owner of your firm, a number of expenses will be deducted from your earnings. Some are elective and others are mandatory. Common items include:
- Health, Life, and Other Insurance: Firm partners often pay the full cost of their personal insurance coverage.
- Mandatory Retirement Plan Contributions: Many firms require all partners to contribute to retirement plans. Mandatory contributions can exceed $60,000 per year.
- Charitable Contributions: Any charitable contributions made by the firm are paid by all partners on a pro-rata basis.
Capital Contributions
Many law firms require incoming partners to contribute a sum of money as part of their partnership agreement. This amount can range from tens of thousands to hundreds of thousands of dollars. You can often extend payments over a period of years, and some firms offer financing programs. However the payments are structured, your required annual cash outlays need to factor into your financial planning.
Long-Term Wealth Building: An Ownership Path
Despite the risks and upfront costs, becoming a partner can be a powerful wealth-building opportunity. This is the time to become diligent to ensure your achievements become the cornerstone of a prosperous future. Critical actions include:
- Developing a strategic financial plan for success.
- Identifying tax optimization opportunities.
- Capturing and investing meaningful savings.
Please contact us for the advice you need in managing your current and future finances to maximize your long-term wealth potential.
