Linda Artesani explains how law firms calculate and record partner equity, which is defined by partnership agreements and ownership percentages. She recommends a clear balance-sheet structure with separate accounts for contributions, distributions, and reimbursements, and warns against misclassifying distributions as expenses. Partners typically withdraw up to 30% of profits while using tools like QuickBooks and REACH reporting to track revenue and automate payouts.
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Hi there. Linda Artesani, Artesani Accounting and The Proper Trust. This month we're going to talk about attorney partner equity, and this is a great topic, especially if you're in a larger firm where you've got multiple partners in the firm. It's truly a calculation. It's a way to value each partner's interest in a law firm. So there's always a partnership agreement in place. And it will define the percentages of ownership of each partner. So if there's multiple partners, as you get working with these larger firms, there may be multiple partners, and the partner equity can either be defined— it should be defined in that document. It can sometimes be based on how many years the partner has worked at the firm, or it might even include a percentage of profits that are generated by the firm in that particular time frame or in those years. That's the most simplistic method of determining compensation for the partners. So there's a couple of transactions or accounts you may see on your balance sheet that you'll see delineated out. And hopefully when you're looking at your records as an attorney, you're going to see these spelled out in a way that you'll see the name of the partner, If there's only one person that owns the business, obviously that's the person that will be the name on the equity account. But also you want to see separated partner contributions, partner distributions. And when you get multiple owners, you want to see that the names are separated out there. And then sometimes you might even want to see the percentages so that it kind of helps us as we guide our way through the accounts there. A partner contribution to a limited liability partnership or an LLC, a limited liability corporation, is considered the same way as if you're a partner in a— not a partner, but a shareholder in a corporation. So those percentages are outlined inside the partnership agreement when it comes to partnerships. And it will also help us determine who's the lead partner. Managing partner is usually what they're called. And any contribution that is money put into the business will be placed in that account, and it's not a taxable event. Had this conversation with a client not too long ago where they were putting some money in the business to infuse the business with some funds, and they were concerned about having to pay taxes on that money. And I told them that it's not a taxable event. You're putting the money in— money that you already pay taxes on— you're putting it in for whatever purpose. Maybe there's a large expense coming up or something. So you're putting that money into the firm as a, as a contribution. So it's not taxable. Partner distribution on the flip side of that is the taxable event. So it's, it's an amount that you're going to calculate that you're going to get paid. And a lot of times this will be outlined in any compensation plans for the attorneys. If there's multiple attorneys at a firm, it will be spelled out what partner gets what percentage. And typically we see that as well, which is why I like to use software for this, is in the calculations. You really want to track the revenue coming in by attorney. If you're using software, it makes life a lot easier, especially if all the billing happens in that software, and you can separate out maybe the originating attorney and the responsible attorney. But also when it comes to compensation overall. Most programs don't really do a great job at doing that calculating of those amounts, especially since most attorneys like to be creative and start out with a basic plan and then deviate from it, and it makes it a little bit more complex, which is why we end up using outside software like a REACH reporting. Excel works too, but though that will make it a little bit more manual. Which we like to stay away from. We like to have it— spreadsheet sync, for example, is Excel, but it pushes the data out of QuickBooks. So in the long run, all that data really needs to be housed in QuickBooks where it's validated and reconciled and balanced, so we know the data is accurate. And then we, as we make the payouts to the partners, we lock that data so that that data cannot change. That's sometimes a sticky point when you get a new client, you look at the records and you see that the numbers don't align up with the payouts, and that will cause an issue as well. So how do you state this on the balance sheet? So we like to see the parent account partner equity and subbed out partner distribution and partner contribution. We also like to have some subcategories. So sometimes health benefits are paid out of the business, and we might want to see that as a subcategory because that is a distribution. They took the funds out of the firm to pay for the health insurance, it doesn't become an expense for the business if they're that partnership. So we have to put that back up as a partner distribution. But we like to subline that out, because when they do their personal taxes, they want to know that number as well as they calculate it out, because then they get that, that expense on their side. Also, it's really with distributions, any— when you look at any withdrawal that the attorney has made, that's not coded to a partner, not coded to an expense, an actual expense for the business. We see it sometimes in the form of an ATM withdrawal. An attorney will take the money out of the firm, personal use. Then we definitely would put that as a distribution. If they pay a personal credit card— shouldn't do any of these things, but if you do, that would have to come out as a personal distribution. Anytime they take money out, you just want to keep the lines really you know, black and white here. There should be no gray area. You want to firmly put in place that this isn't an open bank account that they can just fund themselves. You want to have it stated properly that there's just scheduled distributions to come out, be it monthly, quarterly, however it's designed in your document. You really want to have it laid out that way where there's not extra money coming out, especially if there's multiple partners. It's a partner distribution, is never an expense on the books. It's always money taken out. We just— you'll see that stated on the balance sheet. So know that as well. Some partners may have a partnership agreement and they have an LLC, but then they'll pay themselves to an outside company that they have set up as an S corp, and then they will have a payroll in there and then pay themselves. So they actually have their distribution go into this other company, and then they're paid through that other company. That's perfectly. It's an actual normal situation that we have seen with attorneys that have a very intelligent way of doing that and paying taxes, because on any distribution you have to pay your estimated taxes, and that you might need some help calculating, but you should have a plan in place to do that. It's also smart to kind of put that in a side account so you've got that part of that distribution going into another account. personally so that you have that money saved for when you have to pay those quarterly estimated taxes. And as a general rule, how much should you pay yourself at your firm? And it really depends on a few factors. How much profit is there? Obviously you don't want to be paying yourself when there's not enough money to pay yourself. So you want to look there first. And then a good guideline really is Most partners will take up to 30%, and they leave some money in the firm to let it be there to generate, to pay bills. Cash flow forecasting is always really important if you're using this simplistic method of paying yourself. You know, you want to really take a look at that. Make it regular. Make it an agreed-upon— make sure you've got it in writing. These are all really important things, and obviously you all know this because you're attorneys. So I'm speaking to the choir, so to speak. But it's a common question that we get asked as accountants and bookkeepers is like, you know, where do I put this in the, in the books? And if you are a straight-up partnership, those distributions should be placed underneath that account on the balance sheet. So it doesn't affect your bottom line at all, but it will affect— it's not an expense. So just remember that it's not an expense. And then of course, any money coming in that you need to put in as well. It's not taxable, but you put it in as a contribution. So it's pretty simple. It can get confusing sometimes, and we have seen people try to book that in as an expense, but it's not an expense. It's never an expense, you know, unless you're an S corp, you have wages, then it's an expense. But in the case of these partnerships, it's not an expense. So I hope that tip is helpful, and I hope you all have a wonderful, happy, happy New Year and happy holidays, and we'll see you all next month. Thank you. Bye now.
