If you’ve recently become a law firm partner, you may have received a Schedule K-1 and wondered, “what is this document and how does it affect my taxes?” Many new partners are surprised by how different their tax experience becomes.
A K-1 (IRS Schedule K-1 Form 1065) is a tax document that reports your share of a partnership’s income, deductions, and credits. Some law firm partners receive a K-1 each year instead of a W-2, while others in hybrid or PC structures may receive W-2 wages in addition to K-1s.
Why do Law Firm Partners Get a K-1?
As a partner, you’re no longer classified as an employee, you’re now considered self-employed and a part-owner of the firm. That means that the firm doesn’t withhold income or payroll taxes for you, making you responsible for paying estimated quarterly taxes. Your earnings are reported on a K-1 form instead of a W-2.
This shift can be confusing, but understanding your K-1 is the first step to gaining financial control and avoiding IRS surprises.
What Does a K-1 Include?
Your K-1 will include a breakdown of your share of the firm’s financial activity. This will probably be ordinary business income, guaranteed payments, interest, dividends and capital gains, deductions or losses, tax credits, and your share of liabilities. Each line item can have different tax implications so it’s essential to read your K-1 with a financial advisor or CPA who understands partnership taxation. Guaranteed payments and distributed share can both be subjected to self-employment tax for general partners. This distinction matters when calculating self-employment tax and retirement plan contributions.
What’s The Difference Between a K-1 and W-2?
A K-1 doesn’t include any tax withholdings, since you are self-employed as a partner, generally nothing is withheld from an employer as it is when you’re an employee with a W-2. This means it is required to file quarterly estimated taxes to avoid being charged a fine by the IRS at the end of the year if you owe more than a certain percentage of your income. Some firms do, however, offer voluntary withholding or adjusted draws to help cover quarterly estimated payments, and some states mandate partnership withholding for nonresident partners.
Although your income is reported on a K-1, you may still be eligible to participate in your firm’s 401(k) or defined benefit plan. Partners are considered employees for retirement plan purposes, and contributions are typically based on net self-employment income. Solo 401(k)s are generally not allowed, but firm-sponsored retirement plans remain a valuable savings tool for partners.
When Will You Receive Your K-1?
K-1s are typically issued by March 15th, but some firms delay filing if they extend their partnership to tax returns. That’s why law firm partners often have to file personal tax extensions even if they’re ready to file otherwise.
How To Use Your K-1 to File Taxes
You or your tax preparer will use the K-1 to report your business income on your personal return, which is usually Schedule E. You will also use your K-1 to calculate your self-employment tax, apply any credits or deductions, and then adjust your tax payments for the next year. If your firm distributes less than what’s reported as your taxable income, it's possible to owe taxes on income you didn’t receive in cash, which is known as phantom income, and it requires careful cash flow and tax planning. Phantom income highlights the importance of tax distribution provisions in partnership agreements to mitigate surprises.
How Can a Financial Planner Help With K-1s
A financial planner experienced with law firm compensation can help you interpret your K-1 and, in coordination with your CPA, plan for your taxes by projecting your quarterly estimated tax payments. A financial planner will also help you understand how your capital account and firm profits impact your financial goals, and create a holistic view of your finances to reflect your long-term goals. Financial planners can also help you to structure your retirement contributions and investments in tax-efficient ways, again in coordination with your CPA.
Your first K-1 is a milestone and also a sign that your financial life just got more complex. Understanding what a K-1 is, how it works, and how it fits into your broader wealth strategy can help you avoid costly mistakes and build long-term financial stability as a partner. Book a consultation today.
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