Why Law Firm Owners Overpay Self-Employment Tax Every Year

Executive Summary & Key Points

The Big Picture

Many law firm owners pay more self-employment tax than necessary because of how their firm is structured and how they pay themselves. A profitable firm can create a large tax bill when all of its business profit is treated as self-employment income.

This does not mean every attorney should immediately elect S corporation tax treatment. The right strategy depends on your profit, business structure, payroll, state rules, and long-term plans. But as your law firm becomes more profitable, reviewing your entity and compensation strategy becomes increasingly important.

The Cheat Sheet

• Sole proprietors and many LLC owners generally pay self-employment tax on their net business earnings.
• Self-employment tax generally covers Social Security and Medicare taxes.
• An S corporation election can change how an owner’s compensation is taxed, but it does not eliminate taxes.
• An S corporation owner who works in the business generally must receive reasonable compensation through payroll before taking non-wage distributions.
• Your tax strategy should be reviewed as your law firm’s profit grows. The structure that worked when you started may not be the best structure today.

The Business of Law: Your Business Structure Affects More Than Your Tax Return

When attorneys think about growing a law firm, they often focus on revenue.

How much did we collect this month? How many new matters did we open? Can we afford another employee?

Those are important questions. But there is another number that deserves attention: how much of your firm’s profit is being exposed to self-employment tax.

A solo attorney may start a firm as a sole proprietor or form a single-member LLC. That can make sense when the firm is small. It is simple, relatively easy to maintain, and may require less administrative work.

The problem comes when the firm grows but the tax strategy does not grow with it.

A firm that once produced $50,000 of profit may eventually produce $150,000, $250,000, or more. If the owner continues using the same tax structure without reviewing alternatives, the tax impact can become significant.

That is why law firm self-employment tax should not be treated as something you simply calculate in April. It should be part of your ongoing tax planning.

Understand What Self-Employment Tax Actually Is

Why It Matters

Many law firm owners know they pay self-employment tax, but they do not understand what the tax covers or why it can become so expensive.

Self-employment tax is separate from federal income tax. In general, it represents the Social Security and Medicare taxes that apply to self-employed individuals.

How It Works

When you work for an employer, payroll taxes are divided between you and the employer.

A self-employed law firm owner effectively carries both sides of that responsibility through self-employment tax.

For 2026, the Social Security portion is 12.4%, with the Social Security wage base set at $184,500. The Medicare portion is generally 2.9%, and Medicare does not have the same wage cap.

There can also be an additional 0.9% Medicare tax for higher-income taxpayers once applicable income thresholds are reached.

For self-employment tax calculations, the IRS generally applies the tax to 92.35% of net earnings from self-employment.

This means your total tax bill may involve several different layers:

• Federal income tax
• Self-employment tax
• Additional Medicare tax, when applicable
• State income tax, depending on where you live and operate
• Other state or local business taxes, when applicable

You generally receive an income tax deduction for one-half of your self-employment tax, but that does not make the underlying tax disappear.

CPA Pro Tip

Do not judge your tax burden by your federal income tax bracket alone. When we review a law firm’s tax strategy, we want to understand all of the taxes attached to the owner’s income.

A law firm can have strong profit and still have a poorly designed owner compensation strategy.

Your Entity Type Can Change How Your Profit Is Taxed

Why It Matters

One of the most common reasons law firm owners overpay self-employment tax is simple: they have never revisited their tax structure.

Your legal entity and your federal tax classification are related, but they are not always the same thing.

How It Works

Consider a solo attorney who creates an LLC.

For federal tax purposes, a single-member LLC is generally treated as a disregarded entity unless another tax classification is elected. In a typical situation, the owner reports the firm’s business activity on Schedule C.

If the owner has net earnings from self-employment of $400 or more, the owner generally uses Schedule SE to calculate self-employment tax.

A multi-member LLC is generally taxed as a partnership unless it elects another classification. Partners are generally considered self-employed rather than employees, and active partners may owe self-employment tax on applicable partnership earnings.

An eligible business may instead elect S corporation tax treatment.

That changes the mechanics.

With an S corporation:

• The shareholder who works for the business is generally an employee.
• The shareholder receives wages through payroll for services performed.
• Those wages are subject to applicable payroll taxes.
• Remaining eligible business profit can pass through to the shareholder.
• Non-wage S corporation distributions generally are not subject to self-employment tax.

That last point is where potential savings can occur.

CPA Pro Tip

An LLC by itself does not automatically create S corporation tax treatment.

We regularly see business owners say, “I’m an LLC, so I thought I was already set up correctly.”

An LLC is a legal structure under state law. How the LLC is taxed federally is a separate question. Your CPA should be able to explain both.

An S Corporation Can Reduce Employment Taxes, But It Is Not a Loophole

Why It Matters

The phrase “S corp tax savings” gets thrown around online as if electing S corporation status automatically means paying less tax.

That is too simple.

An S corporation can create meaningful employment tax savings in the right situation, but it also creates additional responsibilities.

How It Works

Suppose, for a simplified example, a solo law firm generates $200,000 of profit before considering owner wages and related payroll costs.

If the business operates as a sole proprietorship, much of that business income may factor into the owner’s self-employment tax calculation, subject to the applicable Social Security wage base and Medicare rules.

Now assume the firm qualifies for and elects S corporation tax treatment.

Instead of treating the owner exactly like a sole proprietor, the firm pays the attorney a reasonable salary through payroll. Remaining eligible profit may then pass through to the shareholder and potentially be distributed without being subject to Social Security and Medicare employment taxes.

That difference can create tax savings.

But there is a critical rule: you cannot simply make your salary artificially low to maximize distributions.

The IRS requires shareholder-employees who perform services for their S corporation to receive reasonable compensation before taking non-wage distributions.

The IRS can reclassify distributions or other payments as wages when an owner has not received appropriate compensation.

CPA Pro Tip

Be cautious when someone tells you that every S corporation owner should take a salary of $40,000, $50,000, or some other fixed amount.

There is no universal “magic salary.”

Reasonable compensation depends on factors such as:

• Your training and experience
• Your responsibilities
• The time you spend working in the firm
• What work you perform
• What comparable firms pay for similar work
• The services performed by other employees
• How the firm’s revenue is generated

For a solo attorney personally generating most of the firm’s revenue, reasonable compensation can look very different from compensation for an owner managing a larger team of attorneys who generate much of the firm’s revenue.

The Biggest Mistake Is Waiting Until Tax Season to Review Your Structure

Why It Matters

Entity planning is most useful when it happens before the year is over.

If your CPA only looks at your business once a year to prepare a tax return, you may learn about tax opportunities after the best planning window has already passed.

How It Works

Your law firm changes throughout the year.

You may:

• Hire another attorney.
• Add a new practice area.
• Increase your rates.
• Improve collections.
• Add a partner.
• Experience a major jump in profit.
• Move into another state.
• Increase your own role in management instead of client work.

Each change can affect tax planning.

This is why we prefer to look at projected annual profit throughout the year rather than waiting for the final number after December 31.

For example, imagine your firm historically earns around $80,000 in annual profit. Then a strong year pushes projected profit significantly higher.

That is a reason to revisit your tax strategy.

It does not automatically mean an S corporation election is right. But it does mean the conversation is worth having.

CPA Pro Tip

Tax planning should use projections, not last year’s numbers.

Your 2025 tax return tells us what already happened. Your current bookkeeping helps us estimate what will happen in 2026.

Clean monthly books make proactive tax planning much easier because we can see changes before year-end.

Tax planning should not be a once-a-year conversation. For a deeper look at how proactive planning works, read our guide to Tax Strategy Planning for Law Firm Owners: How to Reduce Taxes All Year Long 

Do Not Look at S Corporation Savings Without Considering the Cost

Why It Matters

Reducing employment taxes is valuable only if the overall strategy makes financial and operational sense.

An S corporation generally requires more administration than a basic Schedule C business.

How It Works

Depending on your situation, an S corporation may add costs and responsibilities such as:

• Payroll processing
• Payroll tax filings
• A separate S corporation tax return
• Additional bookkeeping requirements
• State-level filings or taxes
• Reasonable compensation analysis
• More formal owner compensation procedures
• Additional CPA or payroll costs

That is why we do not recommend choosing a structure based on one tax number.

You need to compare the potential tax savings against the added cost and complexity.

A small law firm producing modest profit may find that the additional work and fees outweigh the savings.

As profit grows, that calculation can change.

This is also why there is no single profit number where every attorney should become an S corporation. The break-even point depends on your facts.

CPA Pro Tip

Ask your CPA to model both scenarios.

Instead of asking, “Should I become an S corp?” ask:

“What would my estimated total tax and administrative cost look like under my current structure versus an S corporation?”

That gives you a much better answer.

Reasonable Compensation Needs to Be Defensible

Why It Matters

Reasonable compensation is one of the most important parts of an S corporation strategy.

If you pay yourself too much, you may give up some of the employment tax benefit. If you pay yourself too little, you may create unnecessary IRS risk.

How It Works

The IRS looks at what the shareholder actually does for the company.

For a law firm owner, that can include several roles:

• Practicing attorney
• Rainmaker
• Firm manager
• Hiring manager
• Client relationship manager
• Administrator
• Marketing leader
• Strategic decision-maker

Your compensation analysis should reflect those duties.

The IRS also considers the source of the corporation’s gross receipts.

This is especially important for professional service businesses.

If most of your firm’s revenue exists because you personally perform the legal work, your compensation analysis should reflect the value of those services.

If you have built a team and other attorneys or staff generate a meaningful share of the firm’s revenue, the analysis may look different.

The goal is not to choose the lowest salary possible.

The goal is to choose a reasonable salary that you can support.

CPA Pro Tip

Document the reasoning behind your compensation.

Do not pick a number in January and forget about it forever. Your role can change as the firm grows, so reasonable compensation should be reviewed periodically.

Additional Considerations Law Firm Owners Commonly Miss

Self-employment tax is only one part of a good tax plan.

Sometimes business owners become so focused on the S corporation conversation that they miss other planning opportunities.

Here are several areas worth reviewing.

Retirement Plan Contributions

A SEP IRA, SIMPLE IRA, 401(k), or other qualified retirement plan may provide additional tax planning opportunities depending on your firm and employees.

The right plan depends on more than the owner’s desired contribution. Employee eligibility, contribution requirements, payroll, firm cash flow, and long-term goals all matter.

Health Insurance

Health insurance can have special reporting and deduction rules for self-employed individuals and S corporation shareholders.

For example, health insurance paid for a greater-than-2% S corporation shareholder generally requires specific payroll and tax reporting treatment. It should not simply be handled the same way as health insurance for a regular employee.

Estimated Tax Payments

Changing your entity does not mean you stop making estimated tax payments.

S corporation profit generally passes through to the shareholder’s personal tax return. You may still need estimated payments or additional withholding to cover your personal income tax liability.

State Tax Rules

Federal tax savings are only one part of the calculation.

Some states charge additional taxes, fees, or minimum taxes to S corporations. Professional entity rules can also vary by state.

Attorneys should also confirm that their chosen legal structure is permitted under their state’s rules governing law firms and professional entities.

Qualified Business Income

Depending on current tax law and your individual circumstances, pass-through business owners may also need to consider the qualified business income deduction.

Legal services are generally treated as a specified service trade or business for QBI purposes, which can affect the deduction at higher taxable income levels.

This is another reason entity planning should not happen in isolation. Changing salary, business profit, retirement contributions, and other items can affect multiple parts of your return.

Your Books

Perhaps the most overlooked piece of tax planning is bookkeeping.

You cannot make a strong tax projection from inaccurate financial statements.

Your bookkeeping should clearly show:

• Revenue
• Operating expenses
• Payroll
• Owner compensation
• Owner distributions
• Retirement contributions
• Health insurance
• Fixed assets
• Loans
• Other significant transactions

For law firms, operating funds must also remain clearly separated from client trust funds. Money held in an IOLTA or other trust account is not simply law firm revenue because it appears in a bank account.

Good tax planning starts with good accounting.

Frequently Asked Questions

The Bottom Line: Build a Tax Strategy Around the Firm You Have Today

Many law firm owners do not intentionally overpay self-employment tax. They simply continue using the structure they chose when the firm was smaller.

That is where the problem starts.

A tax structure should not run on autopilot while your firm doubles or triples in size. As your profit, team, and responsibilities change, your tax strategy should be reviewed with them.

An S corporation can be a useful tool for some profitable law firms, but it is not a shortcut and it is not right for everyone. The real goal is to understand your numbers, compare your options, document your decisions, and build a system that supports both compliance and growth.

Your tax strategy should answer more than, “How much do I owe?”

It should also help answer, “Is my law firm structured in a tax-efficient way for where we are going next?”

Ready to Find Out If Your Law Firm Is Overpaying Taxes?

We help solo and small law firm owners build stronger financial systems through accounting, tax planning, trust accounting, and ongoing advisory support.

If your firm has grown but your tax strategy has not changed with it, it may be time for a closer look. We can help you understand your numbers, identify planning opportunities, and build a tax strategy that supports the next stage of your firm’s growth.

Schedule a discovery meeting to see if Aligned CPA is the right fit for your law firm.