The simple tax strategy we're using for our legal recruiting business
and new episodes of Khurram's Quorum
Since the last issue, a lot has happened. My recruiting agency closed out 2024, its first full calendar year, with 19 placements.
The agency accomplished more than I imagined, so I set an ambitious goal - 30 placements for 2025. My wife quit her job selling software to join the business as a partner. And we’re expecting baby #2 in April.
We also hired an operations lead to help us scale. Thanks to this team effort, we have 15 partners and associates with accepted offers, offers, and interviews right now.
I’m taking a moment to share some insights on how to run a growing service business. Today is a topic people are afraid of, but shouldn’t be - taxes.
The simple tax strategy we're using for our legal recruiting business
I'm amazed by how many service business owner-operators have little understanding of the tax decisions their accountant makes. It's your money, and it's worth diverting a modest amount of time (a few days a year) from running the business to understand its taxes.
When I met with my new accountant in December to plan tax strategy, I asked to break down options with projected figures in a spreadsheet. He was surprised - "almost no one asks to do this, they tell us they just want it done and don't want think about it." I'm here to get into it.
This is a post about a tax strategy for growing businesses run by an owner-operator. We'll discuss the S corp election and we'll use an example of a service business making $1 million a year. There are lots of ways to make this more complicated or nuanced. This is a general overview of a single tax topic, and it's not legal advice.
My previous accountant advised that it was "moderately aggressive" to take the S corp election last year. By working with a new accountant who is more responsive to business objectives, I'll save a little more than $20,000 in taxes through the S corp election.
One of the most basic ways to improve your tax position is by electing S corp treatment. An S corp is not a business entity like an LLC, but they are often confused. If you're an individual owner with a LLC, you can either get taxed as a corporation, or the LLC is disregarded and you're taxed as a sole proprietorship.
You get clobbered with taxes as a sole proprietorship at high incomes. If your LLC is taxed as a sole proprietorship, you have to pay Medicare and Social Security (referred together as FICA tax under the Federal Insurance Contributions Act). You pay both the employer and employee contributions: 15.3% (12.4% for Social Security and 2.9% for Medicare) on the first $168,600 of net earnings and 2.9% for Medicare on net earnings above that amount.
When you take an S Corp election, you treat some of the business revenue as W-2 income - that reduces your taxable income.
With an S-corp election, you still pay the employer and employee portions of FICA taxes, but only on the W-2 income, not the entire business revenue.
Since the W-2 portion is a fraction of the total revenue, that has a major impact on total cost. But it gets better.
Many businesses (not law firms, among others) can take the Qualified Business Income (QBI) deduction. It's a straight-up deduction of 20% of the business income. Pretty cool.
But even if you take the QBI deduction as a sole proprietor, you still have to pay FICA taxes on all of your revenue.
But for S corps, while the W-2 portion of income reduces how much income remains to apply the 20% QBI deduction, that remaining income is characterized as distributions which are not subject to FICA taxes.
Two qualifications to make:
1. Your QBI deduction in relevant part is limited to 50% of your W-2 past certain income thresholds (I won't discuss limitations on QBI that apply to asset-heavy industries).
2. Your salary must be "reasonable". You might have read about the FICA tax limitation to W-2 income and said great, I'll just pay myself $20,000. The IRS can recharacterize your distributions as income if you're greedy.
As it happens, taking a healthy W-2 also has a benefit for my retirement contributions. In another post, I'll describe the decision on choosing a retirement plan last year and the six-figure contributions I've made as a result.
In my case, I've saved tens of thousands of dollars for this past tax year through the S-corp election. And it's building a foundation of knowledge that will create greater wealth and control in the coming years.
Talk to your CPA about the applicability of the S corp election for you, and take an active interest in your taxes.
New Episodes of Khurram’s Quorum
I had a great string of podcast guests:
Lora Krsulich is an associate at Goodwin and a rising star. After clerking in the Central District of California and the Ninth Circuit, Lora litigated at Susman Godfrey before joining Goodwin. She shares her story of finding her voice and confidence in law as a first-gen lawyer, and the values she's followed as she's pursued success and excellence.
031: Tim Yoo on what lawyers can learn from pro-wrestling, applied mathematics, and tennis
Tim Yoo is a partner at Bird Marella and probably one of the few lawyers who can reference both the second fundamental theorem of calculus and The Undertaker. This free-ranging conversation explores how lawyers can use basic concepts from applied mathematics for decision principles and strategy. We also cover what lawyers can learn about storytelling and character development from professional wrestling.
Pratik Shah is the Practice Head of Akin’s Supreme Court and appellate practice. Pratik breaks down his achievements and shares the values and principles he used to challenge himself and create opportunities. This conversation explores three underdiscussed topics, the market for appellate litigation, the business of appellate litigation, and the seismic shift in appellate practice in the past couple decades. We also explore how to make decisions about the kind of practice to join and build.
Vishal Shah is the founder of Shah Litigation, a high-stake employment litigation firm. This is a unique opportunity to examine the strategy and values a biglaw associate used to launch and grow a successful law firm. We talk about the decision to switch to the other side of the v., how he researched the opportunity to identify his niche, his approach to a national trial practice, the unique dynamics of the plaintiffs' bar, and business development strategy.