Question 1

I formed an attorney PC in California three years ago and just realized it’s been taxed as a C-corp the whole time. Can I file a late S election under Rev. Proc. 2013-30, and what would the tax savings look like compared to the C-corp treatment I’ve been paying?

Accepted Answer

Yes, you can almost certainly fix this, and the tax savings going forward, plus potentially the recoverable amounts depending on timing, can be substantial. Here is both the late-election mechanics and the math.

First, the legal hook: Rev. Proc. 2013-30 gives you 3 years and 75 days from the intended effective date of the S election to file a late Form 2553 and get the election approved retroactively. So if your PC was formed in 2023 and you want the S election effective for 2023, you have until roughly March 31, 2026 to file the late election under Rev. Proc. 2013-30. If you want the S election effective for 2024, you have until roughly March 31, 2027. The window is generous but it does close.

The filing mechanics are straightforward. You write ‘FILED PURSUANT TO REV. PROC. 2013-30’ across the top of Form 2553 in red ink (or bold). You attach a reasonable cause statement explaining why the election wasn’t filed timely — common acceptable reasons include ‘unfamiliarity with the requirement to file Form 2553 separately from state entity formation,’ ‘reliance on prior tax preparer who failed to advise,’ ‘recently engaged tax counsel who identified the issue,’ or similar. You include statements signed by all shareholders consenting to the election. You mail the form to the appropriate IRS Service Center.

The IRS approval rate for properly documented Rev. Proc. 2013-30 elections is very high — close to 100% when the procedure is followed correctly. You’ll receive a CP261 notice from the IRS within roughly 60-90 days confirming the election was accepted and indicating the effective date.

Now the harder question: can you recover the C-corp tax you’ve already paid?

The answer depends on what the IRS will do once they accept the late election. Once approved, your PC is treated as an S-corp from the effective date forward. For years that were already filed as C-corp returns (Form 1120), you’ll need to amend. File Form 1120-X for each prior C-corp year to claim a refund of the C-corp tax. The IRS treats this as a ‘change in entity classification’ rather than as an amended return per se, but the practical effect is the same — you’re asking for the C-corp tax back and requesting that the income be picked up on amended individual returns (Form 1040-X) as S-corp pass-through income.

Let’s run the math on a sample year. Assume your PC had $400K of net income in 2023. As a C-corp, you took $200K as W-2 salary and left $200K of profit. C-corp tax: $200K × 21% federal = $42K. California corporate tax on $200K: $200K × 8.84% = $17.7K. Total entity-level tax: ~$60K. The remaining $140K stayed in the corporation (or was distributed as a dividend, generating further tax at the shareholder level).

As an S-corp for the same year: $200K W-2 salary plus $200K K-1 pass-through to you personally. No entity-level federal tax. California has a 1.5% minimum franchise tax on S-corps: $200K × 1.5% = $3K (with $800 minimum). Total entity-level tax: $3K. The K-1 income gets taxed on your personal return at ordinary rates — but that tax would have been owed anyway under the C-corp model when the cash was distributed as dividend or salary.

The pure entity-level savings: roughly $57K per year ($60K C-corp vs. $3K S-corp). For three years of overpaid C-corp tax, recovery potential is roughly $170K, subject to statute of limitations on refund claims (generally 3 years from filing or 2 years from payment, whichever is later under §6511).

There’s a complication. The S-corp K-1 income that should have been reported on your personal return wasn’t, because you reported the PC’s income on Form 1120 as a C-corp. The amended individual returns will increase your personal taxable income by the K-1 amounts that weren’t previously reported. The personal tax cost of the K-1 income (federal + state at your bracket) partially offsets the corporate refund.

Net recovery estimate. Roughly $30K-$50K per year of net cash recovery after both corporate and individual return adjustments, depending on your bracket and how the C-corp dividend distributions were handled at the time. For three years of cleanup, that’s roughly $100K-$150K of net recovery.

The California complications. California treats S-corps differently from the federal treatment in some respects. The 1.5% franchise tax on S-corps (with $800 minimum) is unique to California. The state also has its own conformity rules — the state-level S election follows the federal election automatically once federal is approved, but the state’s franchise tax applies regardless. Coordinate with California Franchise Tax Board on the state filing side; you may need to file amended state returns (Form 100 for the C-corp years switching to Form 100S for S-corp years).

The §199A complication. Legal services are an SSTB. For your federal personal return, the K-1 income from the law practice is subject to the SSTB phase-out under §199A. Single filer threshold for 2023 was $182,100 (deduction begins phasing out) through $232,100 (full elimination). If your taxable income exceeded $232,100, you got $0 of QBI deduction regardless. If your income was below the threshold, you might claim 20% of the K-1 income as a QBI deduction on the amended return. Either way, model it in the recalculation.

Reasonable compensation challenge. Switching from C-corp (where the IRS sometimes argues for HIGHER salary to make the most of tax) to S-corp (where the IRS argues for HIGHER salary to make the most of FICA/Medicare) creates a strange dynamic. Your historical $200K salary on $400K of profit is probably defensible as reasonable comp for an owner-attorney; if it’s too low, an examiner could argue some of the K-1 reclassification on the amended return should be W-2.

My specific recommendation for your situation:

1. File Form 2553 under Rev. Proc. 2013-30 with effective date as far back as the 3-year-75-day window allows (probably retroactive to 2023 if you formed the PC in 2023). The IRS will likely approve.

2. Wait for the IRS CP261 acceptance notice before amending anything.

3. Once approved, file amended Form 1120-X for each C-corp year, recharacterizing the entity as S-corp and requesting refund.

4. File amended Form 1040-X for each year picking up the K-1 income that should have been reported, paying the additional personal tax owed.

5. File amended California Form 100 transitioning to Form 100S for each state year. Coordinate with FTB.

6. Going forward, run S-corp payroll properly: W-2 for your reasonable comp portion (run through real payroll with Form 941 quarterly), K-1 for the profit-sharing portion (issued via Form 1120-S Schedule K-1 at year-end).

7. Consider adding a defined benefit plan or solo 401(k) (PC version) to absorb more of your high income and reduce both your taxable amount and your §199A exposure.

8. Review your accountable plan, IOLTA mechanics, multi-state nexus, and reasonable comp documentation as part of the cleanup.

The project timeline. Late S election filing: 2-4 hours of preparation. IRS approval: 60-90 days. Amended returns: 2-4 months of preparation for three years. Refund processing: 4-8 months after filing. Total elapsed time from initial filing to refund check: roughly 12-18 months.

Net expected outcome: significant federal and state tax recovery, plus a clean S-corp structure going forward saving roughly $30K-$60K of tax annually.

The Reed Corporation handles this exact workflow regularly. Late S election, amended returns, state coordination, payroll setup, retirement plan layering. The cleanup is mechanical once you understand the pieces — the bigger payoff is the future years of proper S-corp treatment. A solo attorney pulling $400K of profit who switches from C-corp to S-corp typically saves $35K-$60K per year in tax for as long as the practice continues. Over a 20-year remaining career, that’s $700K-$1.2M of tax savings from one filing.

Question 2

How does §199A SSTB phase-out actually work for attorneys, and is there anything I can do at $550K of MFJ income to capture any of the QBI deduction?

Accepted Answer

Here is the §199A SSTB phase-out specifically for legal services, and then whether you can pull any value out of it at $550K MFJ income.

The §199A statute and the SSTB carve-out.

IRC §199A(d)(2) defines a Specified Service Trade or Business (SSTB) to include any trade or business ‘involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.’

Legal services is explicitly listed. Treas. Reg. §1.199A-5(b)(2)(xiv) elaborates: ‘the performance of services in the field of law means the performance of services by lawyers, paralegals, legal arbitrators, mediators, and similar professionals performing services in their capacity as such.’ This sweeps in essentially every income source from your law practice.

The phase-out math for 2026.

Married filing jointly. Phase-out begins at $403,500 of taxable income. Phase-out range extends to $553,500. Above $553,500, an SSTB owner gets $0 of QBI deduction.

To set these figures in context. For 2024, the SSTB phase-out for MFJ was $383,900 to $483,900. For 2025, it’s $394,600 to $494,600. For 2026, it is $403,500 to $553,500 — OBBBA §70105 widened the MFJ phase-in range from $100,000 to $150,000. These trace back to the original $315,000 to $415,000 range in 2018.

At $550K MFJ taxable income, you’re near the very top of the 2026 phase-out range ($403,500-$553,500) — only about 2% of the deduction survives at that level. Effectively almost nothing, but the key point is that the deduction climbs back quickly as you bring taxable income down toward the lower threshold.

Can we get under the threshold?

The question becomes: how far do we reduce taxable income from $550K toward the lower threshold ($403,500 for 2026), where the full 20% deduction is restored?

You are already just inside the top of the range, so even a modest reduction buys back a meaningful slice of the deduction. To capture the FULL deduction, you need to drop below the LOWER threshold ($403,500 for 2026) — a reduction of about $147K from $550K.

Reduction strategies that work:

1. Defined benefit plan contribution. For a 50-year-old solo attorney pulling $300K of W-2 salary from the PC, a DB plan can absorb $100K-$200K/year of contribution. Each dollar of DB contribution reduces your taxable income dollar-for-dollar. A $150K DB contribution drops your MFJ income from $550K to $400K — below the lower threshold of $403,500, restoring the FULL 20% §199A deduction on your QBI.

DB plan contribution math (partial phase-out). The 2026 phase-out range is $403,500-$553,500 (a $150,000 range). At $400K you’re just below the lower threshold, so you’d get the FULL 20% deduction. But let’s say after DB you land at $450K. You’re $46,500 into the $150,000 phase-out range. Allowable QBI percentage: 100% – (46,500/150,000) = 69%. Your QBI deduction: 20% × QBI × 69% = 13.8% of QBI. For $300K of K-1 income: $300K × 13.8% = $41K deduction. Federal tax savings at the 32% bracket: roughly $13K.

Combined savings of DB plan ($150K × 32% marginal rate = $48K of federal tax savings on the contribution itself) plus the §199A deduction recovery (~$13K) = roughly $61K of total tax savings. Cost of the DB plan: $150K of cash outflow (which goes into your retirement account), plus $3K-$8K of actuarial administration fees.

Net present value of the strategy: you’ve moved $150K from current taxable income to retirement account growth, captured roughly $61K of tax savings, and built retirement wealth. Strong play.

2. Solo 401(k) maximum contribution. For 2026 with you at age 50+, the solo 401(k) limit is $80,000 ($72K base + $8,000 catch-up). If your PC has only you as employee (no staff, or staff covered separately), the full $80K is available. This alone reduces taxable income meaningfully.

Combined with W-2 reduction (since the 401(k) elective deferral comes out of your W-2 reducing wages), the effect on taxable income is $80K reduction.

3. HSA contribution if on an HDHP. Family HSA limit 2026: $8,750 (with $1,000 catch-up if 55+). Triple tax-free: deduction now, no tax on growth, no tax on qualified withdrawals. A no-brainer if you’re on an HDHP.

4. Defer compensation through a non-qualified deferred comp plan (NQDC). If your firm has multiple partners, NQDC plans can defer current year compensation to future years — meaningful for income smoothing across years.

5. Spousal income shifting. If your spouse genuinely works in the practice (managing the office, marketing, bookkeeping), paying a reasonable salary to spouse shifts income out of your MFJ stack. But this only helps if the spousal salary lands in a lower joint bracket — which it does if the spouse otherwise had no income.

For MFJ purposes, the $550K threshold is on COMBINED income, so shifting between spouses doesn’t directly help. What helps is reducing total joint taxable income — through deductions.

6. Charitable contributions. Direct cash to qualified charities: deduction up to 60% of AGI. For a $550K MFJ couple, a $50K cash donation reduces taxable income to $500K — further down into the phase-out range ($403,500-$553,500), where a larger partial QBI deduction is restored (roughly a third of the full amount at $500K, versus almost none at $550K). Donor-advised funds (DAFs) let you bunch charitable contributions: contribute $150K in one year (deductible immediately), distribute to charities over time. Bunching pushes you below the SSTB threshold in the bunching year.

7. State tax mitigation. Pass-through entity (PTE) election in states that have it. Your PC pays state tax at the entity level, deducting it federally and bypassing the $40,400 SALT cap. For California-resident attorneys, the PTE election can save $30K-$70K of federal tax annually. The state tax becomes a deduction at the entity level, reducing K-1 income passed to you and indirectly helping with the §199A threshold.

Strategies that don’t work or are risky:

– ‘Cracking’ the practice into a non-SSTB feeder entity. Treas. Reg. §1.199A-5(c)(2) specifically targets this anti-abuse pattern. The IRS will recharacterize the spin-off entity if it’s principally for §199A purposes.

– Hiring family members at inflated salaries to shift income out of your stack. Not deductible if the salary isn’t ‘reasonable’ for services performed.

– Roth conversions in the same year. Conversions add to taxable income. Counterproductive for this purpose. Save conversions for low-income years.

My specific recommendation for your situation ($550K MFJ, attorney PC):

1. Open a defined benefit plan if you don’t have one. Coordinate with a TPA (third-party administrator) for actuarial setup. Plan to contribute $100K-$200K/year depending on your age and total comp structure.

2. Make the most of solo 401(k) elective deferral and employer profit-sharing. $80K for 50+ ($72K + $8K catch-up).

3. Contribute max to HSA if on HDHP. $8,750 family or $4,400 self-only (2026, plus $1K catch-up if 55+).

4. PTE election in your state if available. California, New York, Illinois, Texas (Texas has no state income tax so PTE isn’t relevant), and most other states with income tax have enacted PTE.

5. Consider bunching charitable contributions through a donor-advised fund. Concentrate $50K-$100K of giving in one year to push below SSTB threshold.

6. Year-end income management. If you’re cash-method, defer December billings to January. Accelerate deductible expenses (equipment, CLE, retirement contributions) into the current year.

With these moves combined, an attorney at $550K MFJ should be able to bring taxable income down toward (or below) the lower SSTB threshold ($403,500), capturing a partial-to-full §199A deduction worth $8K-$15K of federal tax savings. The retirement plan contributions deliver another $50K-$80K of federal tax savings on the deferrals. Total tax mitigation: $60K-$100K of annual savings on top of the standard deductions.

Long-term planning. The §199A deduction was originally scheduled to sunset after 2025 under the Tax Cuts and Jobs Act. The One Big Beautiful Bill Act of 2025 (P.L. 119-21) made §199A permanent and kept the deduction rate at 20%. So planning around the SSTB phase-out matters for the indefinite future — the sunset is off the table.

At $550K MFJ, you’re in the zone where moderate planning saves real money. The Reed Corporation runs this analysis for attorney clients annually — projecting taxable income, sizing retirement contributions, modeling PTE elections, and structuring deductions to improve the §199A position. Tax strategy consulting is exactly this kind of multi-year planning work.

Question 3

I’m a partner in a 5-attorney New York law firm structured as a PLLC taxed as a partnership. The other partners want to make an S election to save self-employment tax. What are the considerations specific to attorneys in New York, and would the S election actually help us?

Accepted Answer

The multi-partner PLLC scenario has several wrinkles that do not apply to solo attorney PCs. Here are the specifics.

The baseline: NY PLLC taxed as partnership.

A New York PLLC taxed as a partnership files Form 1065 federally. Each partner receives Form 1065 Schedule K-1 reporting their distributive share of partnership income. The K-1 income is subject to:

– Federal income tax at the partner’s ordinary marginal rate – New York State income tax at the partner’s rate (top 10.9% in 2026) – New York City income tax for NYC-resident partners (top 3.876%) – Self-employment (SE) tax under IRC §1402 on the partner’s distributive share of trade or business income — 15.3% on the first $184,500 (2026) plus 2.9% Medicare on amounts above, plus an additional 0.9% additional Medicare tax for high earners

The SE tax burden on a partner making $400K of K-1 income from the law firm: roughly $28K-$30K of self-employment tax (15.3% × $184,500 = $28K + 2.9% × $215,500 = $6.3K + 0.9% × ~$200K = $1.8K, for a total around $36K). This is on TOP of the federal and state income tax.

Now the S election scenario.

If the PLLC elects corporate treatment under Form 8832 and then S-corp treatment under Form 2553, the entity files Form 1120-S federally instead of Form 1065. Each partner receives Form 1120-S Schedule K-1 instead of the Form 1065 K-1.

The key difference: only the W-2 salary portion of each owner-attorney’s compensation is subject to FICA/Medicare. The K-1 pass-through portion is not subject to SE tax or FICA/Medicare.

For a partner making $400K of total profit: split into $250K W-2 salary (reasonable comp for a partner) and $150K K-1 distribution. FICA/Medicare on the $250K W-2: roughly $20K-$22K (similar drag to SE tax on equivalent W-2 amount, but capped at the FICA wage base for SS portion). NO FICA/Medicare on the $150K K-1.

The SE tax savings: roughly $15K-$25K per partner per year. For a 5-partner firm, that’s $75K-$125K of aggregate annual savings.

But there are complications for attorneys that need careful thought.

Complication 1: Reasonable compensation challenge.

The S-corp structure works only if the salary portion is ‘reasonable’ for the services performed. Attorney comparables are widely available, and the IRS will examine this carefully on multi-partner law firm S-corp returns. If you set salary too low, the IRS will reclassify K-1 to W-2 — eliminating the savings and adding penalties.

For a New York partner billing $1M-$2M of business and pulling $400K of profit, a defensible salary range might be $250K-$320K. The remaining $80K-$150K as K-1 distribution. The savings are real but smaller than they’d be if you could pay yourself a $50K salary on $400K of profit (you can’t — that fails reasonable comp).

Complication 2: §199A phase-out.

Most partners in a 5-attorney NY firm are likely in the $300K-$700K MFJ income range. The §199A SSTB phase-out for MFJ is $403,500-$553,500 for 2026. So some partners may be partially or fully out of the QBI deduction regardless of entity structure.

The S election doesn’t help the §199A SSTB analysis — legal services is an SSTB whether you’re a partnership or an S-corp. The entity structure doesn’t change the SSTB classification.

Complication 3: New York state tax treatment.

New York generally conforms to federal entity classifications, so federal S election flows through to state. New York State imposes a special fixed-dollar minimum tax on S-corps under Article 9-A: ranges from $25 to $4,500 based on gross receipts. Not a huge cost.

New York City imposes its own UBT (Unincorporated Business Tax) on partnerships and sole proprietorships practicing in NYC. UBT is 4% on net business income. If you switch from partnership to S-corp, you escape UBT — BUT then you’re subject to NYC General Corporation Tax (GCT) for S-corps, which is roughly 8.85% of NYC source income. The math: UBT 4% vs. GCT 8.85% — switching to S-corp DOUBLES your NYC tax. That’s a major hit for NYC-based firms.

However, NYC offers a PTE-like election (NYC PTET) that lets the S-corp pay NYC tax at the entity level, federally deductible. This works around the $40,400 SALT cap but doesn’t change the underlying NYC tax rate.

For a NYC firm, the S election analysis is much more complex because of the UBT-to-GCT switch. The federal SE tax savings ($75K-$125K aggregate) may be offset by the increased NYC GCT. Run both scenarios with detailed numbers.

For a non-NYC NY firm (Albany, Buffalo, anywhere outside the 5 boroughs), no UBT applies, so the S election is cleaner. The federal SE tax savings is the main consideration.

Complication 4: Special allocations.

Partnerships allow special allocations of income, deduction, gain, and loss to specific partners (under §704(b) substantial economic effect rules). S-corps do not allow special allocations — all items are allocated strictly per share ownership.

For a law firm where partners have different income shares, capital accounts, or distribution patterns (common in multi-partner firms with profit-sharing tied to billing or origination), the S-corp structure forces uniform per-share allocation. You’d need to redesign the partnership agreement (or LLC operating agreement) to fit the S-corp constraint — typically by creating different classes of compensation rather than different income allocations.

This is workable but requires rethinking how partner economics are structured. A pure equity-based profit allocation works for S-corp. An eat-what-you-kill model with detailed origination credit doesn’t translate cleanly.

Complication 5: Step-up issues for incoming and exiting partners.

Partnerships allow §754 elections to step up basis when a partner buys in or exits — letting incoming partners avoid built-in gain on the practice’s assets. S-corps don’t have an equivalent §754 mechanism. Departing partners in an S-corp face less favorable basis treatment than in a partnership.

For a growing firm that expects partner turnover, this can matter. For a stable firm with no anticipated changes, less important.

Complication 6: State PTE elections for partnerships.

New York has enacted a pass-through entity tax (NY PTET) that applies to both partnerships and S-corps. Both can elect to pay NY tax at the entity level. So PTE election isn’t a differentiator between partnership and S-corp.

Complication 7: Section 1202 small business stock.

Qualified Small Business Stock under IRC §1202 (potentially excluding gains on sale up to $10M per shareholder for stock issued on or before July 4, 2025, or up to $15M for stock issued afterward under OBBBA’s revised §1202) requires C-corp status. Doesn’t apply to most law practices (which aren’t sold for capital gains), but might matter for some structures.

My specific recommendation for your 5-partner NY firm:

1. Run the NYC analysis carefully if applicable. If you’re NYC-based, the UBT-to-GCT swap likely offsets most of the federal SE tax savings.

2. If you’re outside NYC, the S election typically pays off for high-earning partners. Aggregate annual savings of $75K-$125K for the firm.

3. Make sure all partners agree to uniform per-share allocations (no special allocations). Restructure the partnership agreement to fit the S-corp constraint — typically by paying differential bonuses or fees rather than allocating differential income.

4. Set reasonable comp for each partner based on industry comparables. Document the basis. Use salary surveys.

5. File Form 8832 to elect corporate treatment, then Form 2553 to elect S-corp treatment. Coordinate with NY state authorities.

6. Implement payroll for all partner-officers. Form 941 quarterly, W-2 annually, state withholding.

7. Implement PTE election in NY (and NYC if applicable) to mitigate federal SALT cap impact.

8. Update IOLTA mechanics and bookkeeping to reflect entity change.

Don’t make the S election if: – You’re NYC-based and the UBT-to-GCT swap eats the savings – The firm has highly variable partner profit shares that can’t fit per-share allocation – The firm anticipates significant partner turnover and the §754 mechanism is important – The compliance cost (more complex payroll, separate 1120-S return) outweighs the savings for very small firms

For a 5-attorney NY firm outside NYC with stable partner economics, the S election is usually a win. Run the projected numbers, restructure the partnership agreement, and execute the conversion. The Reed Corporation handles this restructuring for law firms regularly — entity election filings, state coordination, agreement redrafting, payroll setup, and ongoing compliance.

Question 4

I’m a solo attorney with a PC making about $300K of profit. My CPA says I should pay myself a $100K salary and take $200K as a distribution to save on payroll tax. Is that reasonable compensation, and what’s the IRS risk if I’m examined?

Accepted Answer

Your CPA is playing with fire. A $100K salary on $300K of profit for a solo owner-attorney is almost certainly going to lose a reasonable compensation challenge. Let me explain why and what a defensible structure looks like.

The reasonable compensation standard for S-corp owner-officers.

Under IRC §3121(d)(1) and IRS guidance, an S-corp shareholder-officer who performs services for the corporation must be compensated as an employee — with W-2 wages subject to FICA/Medicare. The wages must be ‘reasonable’ for the services performed.

The Tax Court has consistently held that ‘reasonable’ means what an unrelated employee would be paid for the same work. In the leading case Watson v. Commissioner (8th Cir. 2012), the court applied this standard to an accountant and reclassified compensation from $24K to $93K based on industry comparables. The court used factors from the seminal case Mayson Mfg. Co. v. Commissioner: training and experience, duties and responsibilities, time devoted, dividend history, payments to non-owner employees, timing/manner of bonuses, comparable industry payments, compensation agreements, and use of a formula.

For your $300K solo attorney scenario.

A reasonable salary depends on: – Years of experience – Practice area (litigation, transactional, etc.) – Market (NYC vs. small town) – Your role (you’re doing 100% of the legal work) – Comparable salary data

Let me run typical ranges.

NALP and ABA salary surveys for solo and small-firm attorneys typically show median total compensation in the $150K-$250K range for an attorney with 10+ years of experience, depending on market and practice. The IRS will look at your fact pattern — your billing rate, your hours, your practice area.

For a solo attorney generating $300K of profit (which suggests revenue of $500K-$700K after expenses), you’re personally producing most of that revenue. Your billable hour rate is likely $300-$500/hour. You’re billing 1,200-2,000 hours per year. This is the entirety of a senior attorney’s effort — not a part-time gig.

A reasonable salary in this range: $180K-$240K depending on the specifics. Probably not $100K. The $100K salary is on the very low end and would be hard to defend.

The IRS examiner’s playbook on a solo attorney S-corp.

The examiner pulls the firm’s gross revenue and profit. Calculates the implied work involved (1,500+ billable hours at typical rates). Compares your W-2 salary to salary surveys and to what your firm pays staff. If your $100K salary is below the lower bound of comparable salaries, the examiner will propose to reclassify part of your K-1 distribution to W-2.

The IRS uses several reasonable comp methodologies in audits: 1. Comparable salary surveys (RCReports, Robert Half, NALP) 2. The ‘cost approach’ — what would replacement labor cost? 3. The ‘income approach’ — what’s the value of services rendered? 4. The ‘market approach’ — what do unrelated parties pay for similar services?

For an attorney examiner, salary survey data is the easiest evidence. Surveys consistently show senior solo attorneys earning $150K-$250K base compensation.

Likely outcome of reclassification.

Let’s model the audit risk. IRS reclassifies $100K of your K-1 distribution to W-2 (bringing salary to $200K). Additional tax:

– Employer FICA/Medicare on $100K: 7.65% × $100K = $7,650. Wait, actually for the SS portion, you’ve already maxed out at the $184,500 wage base in 2026 — so only the Medicare portion (1.45%) applies on the additional $100K. So employer FICA: 1.45% × $100K = $1,450. Plus 0.9% additional Medicare for high earners.

Let me redo this. The Social Security tax (6.2% employee + 6.2% employer = 12.4%) applies only up to the wage base of $184,500 in 2026. If your current $100K salary is below the wage base, increasing to $200K brings additional SS tax on the increment up to $184,500. So additional SS tax: 12.4% × $84,500 = $10,478. Plus Medicare tax (1.45% employee + 1.45% employer = 2.9%) on the full additional $100K = $2,900. Plus 0.9% additional Medicare on amounts over $200K — minimal incremental for high earners. Plus state unemployment ($200-$500), federal unemployment (capped at $42/employee).

Total FICA/Medicare assessment on the $100K reclassification: roughly $13K-$14K of additional payroll tax.

Plus penalties. Failure-to-deposit penalty under §6656 (2-15% depending on lateness). Failure-to-pay penalty under §6651(a)(2) (0.5%/month, max 25%). Interest at federal short-term rate plus 3%.

For a single year reclassification: roughly $15K-$20K total tax+penalty+interest assessment.

IRS examines typically multi-year. A 3-year audit assessing $15K-$20K per year = $45K-$60K total. Plus your professional fees to defend, which can run $20K-$50K depending on complexity.

Net potential downside on the audit: $65K-$110K compared to the savings from the aggressive salary structure.

Vs. the savings: the $100K salary structure saves roughly $10K-$13K per year of FICA/Medicare compared to a $200K salary. So 3 years of aggressive structure saves $30K-$39K — but the audit assessment is $65K-$110K. Net: the aggressive structure can lose more than it saves once examined.

Not every solo attorney S-corp gets audited. Examination rates for S-corps in the $1M-$5M revenue range are low (1-2%). But if you’re examined, the reasonable comp issue is one of the first things the examiner reviews. Probability of full audit × probability of reasonable comp reclassification × magnitude of assessment = expected cost.

My specific recommendation for your situation.

Set your salary at $200K-$240K for the year. Take $60K-$100K as K-1 distribution. This is a defensible structure.

The savings vs. paying everything as salary: – $200K salary + $100K K-1 distribution: FICA/Medicare on the $200K W-2 (SS capped at $184,500) = 12.4% of $184,500 = $22,878 SS + 2.9% of $200K = $5,800 Medicare, roughly $28.7K of payroll tax. No FICA on the $100K K-1. – $300K all as W-2: FICA/Medicare on $300K = capped at $184,500 for SS portion (~$22.9K combined SS) plus Medicare on the full $300K ($8,700) plus 0.9% additional Medicare over $200K (~$900) = ~$32.5K total. – Savings from the S-corp structure: how much you save depends on where your salary sits relative to the $184,500 Social Security wage base. For a solo attorney with a defensible salary at or below the wage base — say $150,000 on $250,000 of profit — the roughly $100,000 taken as a K-1 distribution escapes the full 15.3% self-employment tax, saving about $7,000 to $8,000 a year. At higher incomes, where a reasonable salary already tops $184,500, that distribution escapes only the 2.9% + 0.9% Medicare, so the annual saving narrows to roughly $3,800. Model your own salary against the wage base before banking on either number.

If you want to be more aggressive: $180K salary, $120K K-1. Some risk but still in the defensible zone. Document your salary basis with comparable survey data.

If you want to be conservative: $240K-$260K salary, $40K-$60K K-1. Smaller S-corp savings, lower audit risk.

What I’d avoid: anything below $150K salary on $300K of profit. Below that, you’re inviting reclassification.

Documentation to maintain.

1. Salary survey data showing comparable solo attorney compensation in your market. Robert Half, NALP, ABA, RCReports, state bar association salary surveys.

2. Job description for yourself as employee of your PC. Hours, duties, billing responsibilities, administrative duties.

3. Board resolution (or written shareholder action for a solo) approving the salary.

4. Documentation of how the salary was calculated.

5. Annual review and update.

6. Your billing records showing the hours and revenue the salary supports.

IRS audit defense.

If you are examined, present this documentation. Be ready to discuss comparable salary data, your role and hours, and the basis for the salary structure. Most examiners will accept a defensible salary structure with proper documentation. The cases that lose at IRS Appeals or Tax Court are typically where the taxpayer set salary at clearly indefensible levels ($25K, $50K on substantial profits).

Long-term planning beyond salary.

For your $300K profit level, also consider:

1. Solo 401(k) maximization. With a $200K salary, your 401(k) elective deferral is $24,500 (or $32,500 with catch-up if 50+), plus employer profit-sharing up to 25% of comp ($50K), with the combined employee + employer total capped at $72,000 (or $80,000 with the age-50 catch-up). Big deduction.

2. Defined benefit plan if you’re 50+. Adds $100K-$200K of additional deferral.

3. PTE election if your state has one. Pays state tax at PC level, deductible federally.

4. HSA if on HDHP. $4,400 self-only (2026) plus $1K catch-up if 55+.

Combined annual tax savings from S-corp + retirement plans + PTE + HSA at your income level: probably $80K-$120K of total tax mitigation vs. running everything as Schedule C self-employment with no plans. Real money.

My bottom line: tell your CPA to revise the salary up to $200K-$240K. Keep the K-1 distribution at $60K-$100K. The reasonable comp risk on $100K salary is not worth the marginal $5K-$10K of additional savings vs. a more defensible structure. The Reed Corporation runs reasonable comp analyses for attorney clients with proper documentation. Get the salary set right the first time and the audit risk is minimal.

Question 5

I’m an attorney handling matters in three states (NY, NJ, CT). I work from my New York office mostly but appear in court and meet clients in NJ and CT. How do multi-state tax issues work for me, and do I need to file returns in all three states?

Accepted Answer

Multi-state attorney tax is one of the messier areas of practice tax. Here is the framework, then how it applies to your specific NY/NJ/CT situation.

The basic multi-state framework for attorneys.

Income tax follows two principles: (1) your state of residence taxes you on your worldwide income, and (2) states where you earn income (the ‘source state’) tax you on income sourced to that state. Resident states give credits for tax paid to source states, generally eliminating double taxation (though the credit can be limited).

For a service business like a law practice, ‘sourcing’ the income to a state typically means where the services are performed. If you sit at your NY office and write a brief for a NJ case, the income from that brief is generally NY-sourced (services performed in NY). If you fly to NJ for a deposition, the income for that day of work is NJ-sourced.

The physical presence test for service providers.

Most states use a ‘where the work is done’ test for service income. So a NY attorney working in their NY office for a NJ client typically owes NY tax (not NJ tax) on that income. Physical presence in NJ (driving there, taking a deposition, appearing in court) creates a NJ tax obligation on the income attributable to those days.

De minimis thresholds vary. NJ historically applies a ‘doing business’ test that requires substantive activity beyond occasional presence — probably 10-15 days/year of physical work in the state before triggering filing obligation. CT has similar standards. Each state’s threshold is different.

Nexus from referral and contingency fees.

If you take a NJ contingency case while sitting at your NY office, the case work generates fees. The fees are typically NY-sourced (work performed in NY) UNLESS NJ asserts source jurisdiction based on the underlying litigation being in NJ. This gets contested. The conservative position is to source contingency fees to the state where the case was tried/settled. The aggressive position is to source to where the attorney sat while working on the case.

Courts have generally sided with the ‘where work was performed’ rule, but some states (NJ in some cases) have aggressively asserted source jurisdiction based on the underlying client location.

Apportionment for multi-attorney firms.

If you’re in a multi-attorney firm with attorneys in NY only but matters across all three states, the firm typically apportions income based on factors like sales (where revenue is earned), property (offices), and payroll (employee locations). For a NY-only firm doing work in NJ and CT, apportionment might allocate most income to NY but some to NJ/CT.

For a solo attorney (presumably your case), apportionment is based on your work location.

Applying to your situation.

Assumption: You’re a NY-resident solo attorney with PC office in NY. You handle NY, NJ, and CT matters.

New York. As a NY resident, NY taxes your worldwide income. All of your law practice income, regardless of where the work is performed, is reported on NY return. Top NY rate: 10.9% in 2026. Plus NYC tax if you live in NYC (3.876%).

New Jersey. As a non-resident with physical presence in NJ for client meetings, court appearances, depositions: NJ taxes the portion of your income attributable to work performed in NJ. You need to apportion. If you spent 30 days of total work-year in NJ out of 240 working days: 30/240 = 12.5% apportionment of your income to NJ.

For $300K of total law practice income, $37.5K is NJ-sourced. NJ income tax on $37.5K (assuming this is single-filer non-resident income): roughly 1.4-3% effective rate (NJ has graduated brackets) = $500-$1,100 of NJ tax. Or you might owe more if you have other NJ-source income.

Filing: NJ Form NJ-1040NR for non-resident.

NY credit for NJ tax paid. NY allows a credit on your NY resident return for taxes paid to NJ. The credit equals the lesser of (a) the NJ tax actually paid on the NJ-source income, or (b) the NY tax on the same income. So if NJ taxed you $700 and NY would tax the same income at $4,000, you get a $700 credit on NY return. Net result: you pay NJ $700 + NY $3,300 = $4,000 total on the NJ-source income — equivalent to what NY alone would have charged.

Connecticut. Same analysis. As a non-resident with CT work days, you owe CT tax on CT-sourced income. CT top rate: 6.99%. Apportionment based on CT work days vs. total work days.

Filing: CT Form CT-1040NR/PY.

Credit on NY return for CT tax.

Filing burden.

You’d file three tax returns: 1. NY resident return reporting worldwide income 2. NJ non-resident return reporting NJ-source income 3. CT non-resident return reporting CT-source income

Plus credits on the NY return for NJ and CT tax paid.

Compliance cost: tax preparation fee approximately $1,500-$3,000 for multi-state returns. Plus the attorney’s tracking effort during the year (logging days in each state).

Is it worth the burden?

For minor physical presence (say, 2-3 days/year in NJ for an occasional court appearance), the tax involved is minimal — maybe $100-$300 of NJ tax. Most attorneys take a practical approach: file only if presence is meaningful. The risk of non-filing is that NJ could later assess tax + interest + penalties on the missed years. But for very small presence, the practical risk is low (NJ doesn’t usually pursue out-of-state attorneys for small amounts).

For substantial presence (10+ days/year), file the non-resident return. The exposure of not filing grows with the income amounts.

Real-world example. Say you handle a substantial NJ litigation case requiring 30 days/year in NJ for depositions, hearings, and trial. Your total law practice income is $400K. NJ-sourced income: $400K × (30/240) = $50K. NJ tax on $50K: $1,500-$2,500. Filing the NJ-NR return is appropriate.

Client location vs. work location.

Some states (MA in some cases, and NJ in some old guidance) have argued that for service providers, income is sourced to where the CLIENT is, not where the service is performed. This ‘market-based’ sourcing is more aggressive but is the trend in state tax. Most states for individual service providers still use ‘cost of performance’ (where the work was done). Check each state’s specific rule.

Legal community jurisprudence on this is sparse. Attorneys haven’t traditionally been the target of state revenue departments. The market-based sourcing issue is more contested for consultants, engineers, and similar professionals than for attorneys.

Practical recommendations for you.

1. Track your work days by state. Use a calendar or time-tracking app (TripLog, Mile IQ) that lets you tag locations.

2. Use total billable days as the denominator and state days as the numerator for apportionment. Or use revenue tied to each matter and source by the state of the underlying matter — pick the methodology with backup data and stay consistent.

3. File NJ NR and CT NR returns if presence is meaningful (10+ days/year).

4. Take credits on NY return for NJ and CT tax paid.

5. Coordinate with your tax preparer to make sure all three returns reconcile.

6. Document your time and locations. Time-stamped emails, meeting records, court schedules — all back up your apportionment.

Referral fees and out-of-state co-counsel.

If you pay referral fees to NJ attorneys for referring NY work, the NJ recipient owes NJ tax on the fee. The fee is deductible to you on Schedule C or your PC’s return.

If you receive referral fees from NJ attorneys for referring NJ work to them, that’s NY-sourced income (you sat in NY making the referral) — UNLESS the NJ underlying case argues NJ source.

Messy. Get specific advice for substantial referral arrangements.

Co-counsel arrangements. If you co-counsel a NJ case with a NJ-based attorney, you’d typically have some physical work in NJ (joint strategy sessions, hearings) that creates NJ source income. The fee-splitting between you and co-counsel is reported per the engagement.

State bar admission considerations.

If you’re admitted in NJ and CT (as well as NY), you might have multi-state bar dues, CLE requirements, malpractice insurance considerations. These are deductible §162 expenses but add to the cost of practicing multi-state.

Pro hac vice. If you handle a NJ case on a pro hac vice (one-time admission), the income is still NJ-sourced based on physical work in NJ.

The PTE election cross-jurisdiction question.

If you’ve made an S election and your PC is in NY, you can elect NY PTE. NJ and CT also have PTE elections for their resident PTEs. As a NY-based PC handling NJ and CT work, you’d elect NY PTE for the NY-source income and possibly NJ/CT PTE for income sourced to those states (if those states have such mechanisms for non-resident-based PTEs — they typically don’t).

More likely: NY PTE handles the bulk of your state tax exposure (because most income is NY-source), and you’d file NJ NR and CT NR returns for the apportioned portions without PTE coverage. The non-PTE state taxes hit the $40,400 SALT cap on your federal return.

My summary recommendation.

For a NY-resident solo attorney with PC handling NY/NJ/CT matters: 1. Most income is NY-source (work performed in NY). Top NY rate 10.9%. 2. Track work days in NJ and CT. Apportion income for any meaningful presence. 3. File NY resident return, NJ NR return, CT NR return if presence is meaningful. 4. Take credits on NY return for NJ/CT tax paid. 5. Consider NY PTE election for the S-corp at the entity level. 6. Annual compliance review with your tax preparer to confirm allocations.

The complexity is real but the actual tax cost difference vs. NY-only is small. Mostly just compliance burden. The Reed Corporation handles multi-state attorney returns for clients in the tri-state area regularly. Set up the tracking systems once, then it’s mechanical year-to-year.

Attorney Professional Corporation Tax: The S Election Every Lawyer Should Make, §199A SSTB Phase-Outs, and the §269A Loan-Out Trap

Attorney Professional Corporation Tax Pc: Why state law forces lawyers into a PC or PLLC

The Form 2553 S election and why every attorney PC should make it

§199A QBI deduction and the SSTB phase-out trap

The §269A loan-out / personal service corporation trap

Reasonable compensation for an owner-attorney — the K-1 challenge

Contingency fees, accrual method, and timing of income recognition

Multi-state nexus, referral fees, and out-of-state appearances

Client trust accounts (IOLTA) and what isn’t income

Expert witness fees, 1099 income, and Schedule C side income

Retirement plan options for high-earning attorneys

Common errors attorneys make on PC tax returns

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