7 Things to Know Before You Start a Small Law Firm
Starting a small law firm? Learn the 7 essential tax and business facts you need to know before you hang your shingle, from entity choice to quarterly taxes.
Starting a small law firm is an exciting step, but it comes with a steep learning curve on the business side, especially taxes. Before you hang your shingle, here are seven things you need to know to avoid costly mistakes and set your firm up for success.
1. Your Entity Choice Affects Your Taxes More Than You Think
Many solo attorneys start as a sole proprietorship because it’s free and easy. But that means you’ll pay self-employment tax (15.3% in 2026) on all your net earnings, plus income tax. An S-corp or LLC taxed as an S-corp can save you money once your income is above $40,000 to $60,000. With an S-corp, you pay yourself a reasonable salary (subject to payroll taxes) and take the rest as distributions, which are not subject to self-employment tax. However, you’ll need to file payroll taxes and run payroll, which adds administrative cost ($50 to $200 per month for a payroll service).
Practical step: Talk to a CPA or tax attorney before you register. Ask them to run a projection for your expected income to see if an S-corp election is worth it.
2. You Must Pay Quarterly Estimated Taxes
As a business owner, no one withholds taxes from your income. The IRS expects you to pay estimated taxes quarterly (April 15, June 15, September 15, and January 15). If you don’t, you’ll face underpayment penalties, which are roughly 7% to 8% of the unpaid amount per year, plus interest. To avoid this, set aside 25% to 35% of every client payment you receive, depending on your tax bracket and state.
Practical step: Open a separate savings account for taxes. Transfer a percentage of each deposit immediately. Use IRS Form 1040-ES to calculate your estimated payments, or have your accountant do it.
3. You Can Deduct Startup Costs, But There’s a Catch
The IRS allows you to deduct up to $5,000 in startup costs in your first year, but that deduction phases out dollar-for-dollar once your total startup costs exceed $50,000. Startup costs include market research, advertising, training, and legal fees to set up your business. If your costs are higher, the remainder must be amortized over 180 months (15 years).
Practical step: Keep every receipt from your first year. Categorize them as startup costs vs. operating expenses. Your CPA can help you maximize your deduction.
4. Your Office and Equipment Have Different Tax Rules
If you rent an office, that rent is fully deductible as a business expense. If you buy equipment like computers, desks, or a copier, you can deduct the full cost in the year you buy it using Section 179, up to $1,160,000 for 2026 (subject to your taxable income). Alternatively, you can use bonus depreciation to deduct 80% of the cost immediately. But if you work from home, the home office deduction is available only if you use a space exclusively and regularly for business. The simplified method gives you $5 per square foot, up to 300 square feet, for a maximum of $1,500 per year.
Practical step: Decide whether to buy or lease equipment based on your cash flow. If you buy, track the date and cost for Section 179. If you work from home, measure your office space and document its exclusive use.
5. Client Trust Accounts Have Strict Tax and Ethical Rules
If you handle client funds, you must keep them in a separate IOLTA (Interest on Lawyers’ Trust Accounts) account. These funds are not your income, so you don’t pay taxes on them. However, you must track them meticulously. Commingling client funds with your operating account is both an ethical violation and a tax nightmare. Interest earned on IOLTA accounts is typically paid to the state bar foundation, not to you, so you won’t report it as income.
Practical step: Open an IOLTA account at a bank that offers no-fee or low-fee options. Use accounting software like QuickBooks or Clio to track client funds separately from your operating account.
6. You Can Deduct Continuing Legal Education (CLE) and Bar Dues
Your professional development is tax-deductible. CLE courses, bar association dues, legal publications, and even your malpractice insurance premiums are all deductible business expenses. This includes travel to conferences, as long as the primary purpose is business. For example, if you attend a three-day legal conference in another city, you can deduct airfare, hotel, and 50% of meals.
Practical step: Track all CLE expenses and bar dues in a separate category. Keep receipts for any travel, and note the business purpose on your calendar.
7. You Need a Bookkeeping System From Day One
Many attorneys wait until tax season to organize their finances, which leads to missed deductions and errors. A good bookkeeping system helps you track income, expenses, and client trust funds in real time. You can use software like QuickBooks ($30 to $100 per month) or a legal-specific tool like Clio Manage ($49 to $99 per user per month) that integrates with accounting. Alternatively, hire a part-time bookkeeper for $200 to $500 per month.
Practical step: Set up your chart of accounts this week. At minimum, track these categories: client trust, operating income, payroll, rent, equipment, marketing, CLE, and insurance. Review your numbers monthly.
FAQ
Q: When should I switch from a sole proprietorship to an S-corp? A: Generally, when your net income exceeds $40,000 to $60,000 per year. At that point, the payroll tax savings outweigh the administrative costs. Run the numbers with your CPA.
Q: Can I deduct health insurance premiums for myself and my family? A: Yes, if you’re self-employed and your business is profitable, you can deduct health insurance premiums for you, your spouse, and your dependents. This deduction reduces your adjusted gross income, and it also reduces your self-employment tax.
Q: What happens if I miss a quarterly estimated tax payment? A: You’ll owe a penalty based on the amount you underpaid and the time it was unpaid. The penalty is roughly 7% to 8% annualized. You can avoid this by making your payments on time or by using the safe harbor rule: pay at least 100% of last year’s tax liability (110% if your income is over $150,000).
Q: How long do I need to keep tax records? A: Keep records for at least three years from the date you file your return, but for legal practices, it’s wise to keep them for six years. If you have assets that depreciate, keep records until the asset is fully depreciated or sold.
The Bottom Line
Starting a small law firm is about more than practicing law; it’s about running a business. Taxes are a critical part of that. By choosing the right entity, paying estimated taxes, tracking deductions, and setting up a solid bookkeeping system, you can avoid costly penalties and keep more of your hard-earned money. Take one step this week: schedule a consultation with a CPA who works with law firms. It’s an investment that will pay for itself many times over.