Tax liability occurs because of a taxable event, which is frequently is fiscal year-end financial taxes. However, there are other scenarios in which law firms can incur tax liability, including royalty income, stock or asset sales or business mergers that cause profits.

In legal terms, tax liability means the government has a client on assets, which are typically those in the business bank account. However, there are situations in which the tax liability is tied to property.

Determining the amount of tax liability is dependent on a number of factors, including^[1]:

• How the firm’s entity is structured (LLC, Corporation, etc.)
• Accounting method utilized (cash or accrual)
• Expenditures and capital expenses
• Health care tax credit
• Employee benefit expenses
• Retirement contributions
• Income/Revenue

Whether or not you have business dealings of locations in another state that could constitute a nexus can also affect tax liability, making the firm subject to the jurisdiction and tax laws of that state.

Determining the final tax liability amount for law firm’s can have various pitfalls for those not experienced in accounting and the ever-changing tax laws. Failure to pay the correct amount of tax liability can result in a failure to pass an audit, issues with the IRS or a need to make additional payments. Consulting with an accountant is traditionally the recommended course of action for firms who want to determine their tax liability.

References

1. Business and Tax Consideration for Practitioners and Small Law Firms