Over the past few years, many attorneys in various legal settings have lost their jobs as a result of budgetary constraints and cutbacks. A question frequently posed by these displaced lawyers is how to handle the business implications of temporarily freelancing or doing outsourced work for other lawyers while searching for a full-time position. Although each situation is unique and one should consult a tax advisor for an in-depth analysis, here are some issues to consider.
An attorney performing outsourced work for another lawyer or law firm should consider the need for malpractice insurance. In some instances, if one is temporarily “of counsel” to another firm, that firm’s insurance may extend to the services. Discuss this possibility when the services are contracted for. However, it is more likely that the displaced attorney will be considered an independent contractor, retained only for a particular matter. In this situation, obtain your own coverage; if the work is less than full time, the cost of the coverage may be low when compared to coverage for a full-time or fully employed attorney. Wisconsin Lawyers Mutual Insurance Co. (WILMIC) and other companies offer insurance policies for part-time employment and can discuss the underwriting issues with the displaced lawyer.
An attorney who is freelancing only until obtaining permanent employment probably does not need to go through the steps to set up a separate business entity, such as a limited liability company (LLC) or a service corporation. From an income tax perspective, a single-member LLC is not any different than a sole practitioner. If the attorney has adequate liability-insurance coverage, an LLC will not offer any significant additional protection for legal liability claims, and general business claims likely will be minimal for a temporary freelance engagement.
com Scott kohlerandfranklin Scott B. Franklin, Marquette 1995, is with Kohler and Franklin LLC CPAs, Milwaukee.
Forming a corporate entity requires establishing a new business organization with the accompanying payroll tax accounts at the state and federal levels, something that adds layers of complexity for a temporary business operation. Keep in mind, as well, that Wisconsin Supreme Court Rule 20:5.7 requires limited-liability-practice entities to register with (and pay a filing fee to) the State Bar and to have a minimum level of liability insurance.
Obtaining an Employer Identification Number
If a displaced lawyer does establish a freestanding business entity (an LLC or a service corporation), that entity is required to obtain a federal employer identification number (EIN). The entity must report all revenue collected on a tax return filed using that EIN (even a single-member LLC filing on Form 1040 Schedule C must show the LLC’s EIN). Whenever the tax identification number of the displaced lawyer’s practice is requested for the purpose of issuance of a Form 1099-MISC, the lawyer provides the EIN instead of his or her Social Security number. Freelancing attorneys who have not set up formal entities do not need to obtain or use an EIN as long as they themselves have no employees. However, disclosing one’s Social Security number increases the risk of identity theft.
EINs are free and can be obtained online in less than 15 minutes at www.IRS.gov. It probably is a best practice to obtain and use an EIN even for a temporary freelancing assignment. The EIN never expires and can be used later if the attorney once again becomes a free agent.
Resources for Displaced, Freelancing Attorneys
A lawyer’s net income is subject to full state and federal income taxation. Freelancing attorneys who operate as sole proprietorships or single-member LLCs merely file a Schedule C with their personal tax returns. They will be responsible for the self-employment tax (up to 15.3 percent) on top of income taxes because they do not have an employer paying the 7.65 percent match. All legitimate business expenses paid in the pursuit of the freelance income are deductible, although there are limits on the deductions for meals and entertainment. If the lawyer is working out of his or her residence and meets the requirements, a home-office deduction may be available as well.
An incorporated freelance venture must file a corporate tax return, and the attorney should consult with a tax advisor regarding the pros and cons of being an S corporation instead of a C corporation for this limited venture. Tax planning is strongly encouraged to ensure a corporate entity does not incur unexpected entity-level income taxes. A corporate practice might also incur state and federal unemployment taxes and worker’s compensation insurance obligations that an LLC or solo would not face.
If the freelancing attorney expects to generate sufficient net income from the temporary practice, it may be worthwhile to consider sheltering some of that income in a retirement plan. Although establishing a traditional 401(k) or other tax-qualified plan might not make sense for a short-term situation, SIMPLE IRAs or SEP IRAs are low-cost options that could easily shelter a few thousand dollars. The displaced lawyer should discuss the various elections and deadlines with a tax preparer. Traditional or Roth IRA accounts are also available with minimal effort, but they have limited contribution levels.
Any business venture should establish its own bank account for all revenues received and expenses paid. This ensures proper segregation of business activities from personal activities in the event of an audit or other review of the moonlighting business. If an attorney expects to be using credit cards for many expenses, it is a good idea to get a business-use-only card. An IOLTA (interest on lawyers trust account) account will be required for holding client funds. Many small businesses track their income and expenses using software such as Quicken or QuickBooks. For a short-duration moonlighting practice with limited financial activity, such software may not be necessary; keeping detailed notes in a manual check register and using Excel or another spreadsheet program to categorize items for tax-reporting needs might be adequate.
Many of the above considerations are the same issues that a lawyer needs to consider when opening up a long-term practice. The trick for a temporarily displaced attorney is deciding which tasks should be done right away (or at all) given the expected length of the job search and whether the short-term situation will perhaps end up being a full-time independent practice. It’s always easiest to set things up properly from the start instead of trying to correct problems later on.