Tax Tips for the Solo

Tax issues for solo practitioners and small law firms are pretty much the same as those for other businesses. In order to reduce your chances for an audit, report all income, and don’t over-deduct your expenses. The IRS pays close attention to Form 1099 reporters, so make sure all of that income gets reported on your Form 1065 partnership return, Form 1120S income tax return, or your Schedule C if your firm is not a partnership or S-corporation. From the expense perspective, your firm is allowed to deduct reasonable, ordinary, and necessary business expenses. For general law-firm operation, that means rent, office supplies, telephone costs, legal research charges, bar association dues, and other expenses that help you help your clients.

The IRS gets very picky about a few things, though, and a front-line revenue agent conducting an exam will go by the book and disallow certain expenses if you do not properly substantiate them. In particular, mileage expenses, food expenses, and promotional expenses are particularly troublesome to those experiencing an IRS audit. For each of these expenses, a short rule of thumb is to keep all receipts and a log recording the “who, what, when, where, and why” of the expense.

Internal Revenue Code Section 274(d), for example, requires taxpayers who deduct mileage to keep a log detailing the mileage, the starting point and destination, and the business purpose of the trip, or the entire deduction is subject to disallowance. Even the normally more-reasonable Appeals Officers will sustain a disallowance if a taxpayer cannot substantiate a mileage expense. For meals, a taxpayer is permitted to deduct only 50 percent of the expense, and must keep a contemporaneous recording of who attended the meal, the business purpose of the meal, and what was discussed. Legibly writing these details on the receipt is permitted. Because of huge abuses in the past, revenue agents closely scrutinize promotion expenses for all three of the basic requirements: are the promotion expenses ordinary, necessary, and reasonable? Generally, the test is one of production—i.e., do the (usually high) promotion expenses actually result in increased clients and revenues?

Additionally, employment taxes are an important part of running a business. The IRS closely monitors employment tax payments. If they are not paid, the IRS (and the state taxing agency) is quick to enforce collection of the taxes due. Sometimes collection action will occur within two quarters of nonpayment. This can cause some undercapitalized businesses to “pyramid” in the nonpayment of taxes, which only makes an IRS revenue officer more determined to get the business into compliance through lien filings, bank levies, and other direct collection action, or to shut it down.

The IRS considers the nonpayment of payroll taxes equivalent to making the United States an unwilling business partner or lender. Unlike debts to a business partner or lender, though, Trust Fund Recovery Penalties assessed against “responsible persons” who “willfully fail” to collect and pay payroll taxes are not dischargeable in bankruptcy.

Solo practitioners and small law firms, like other businesses, should consult with a Certified Public Accountant or qualified tax lawyer for tax help. Remember, this year you have until April 18 to file. For more information, visit www.irs.gov.

David A. Sprecace is a solo practitioner in Denver, providing legal services in federal (I.R.S), state, and local tax controversy and litigation; business and bankruptcy litigation; and business planning, formation, and operation.