The Financial Burden of Nonequity Partner Status in Big Law
Law firms are creating nonequity partner tiers to retain talented attorneys and boost profitability. However, this strategy often has unexpected financial consequences, leaving nonequity partners with a tax burden akin to that of full equity partners but without the accompanying profits.
Tax Responsibilities Without Full Partnership Benefits
In many large law firms, nonequity partners are treated as full partners for tax purposes, meaning they bear the costs of Medicare, Social Security, and sometimes health levies. This shift can come as a shock, as these lawyers no longer benefit from the employer-subsidized tax obligations they had as associates. Instead, they file taxes as self-employed individuals, shouldering the full extent of payroll taxes.
According to financial planner Eric Scruggs, the financial impact is significant. Many of his nonequity lawyer clients find that the modest increase in pay over their previous associate salary doesn’t fully compensate for the added tax obligations. “The increase in total compensation from the bump in salary and bonus potential is washed out,” Scruggs explains.
Rising Trend: Nonequity Partners in Big Law
Nonequity partnerships are becoming increasingly common across the industry. Almost half of the partners at the 200 largest law firms are now nonequity partners, a rise from 40% in 2013, according to data from American Lawyer. This classification has allowed firms to increase profitability while providing talented attorneys with a “partner” title, even if it doesn’t come with full financial privileges.
To support their attorneys in adjusting to the new tax status, some firms have implemented educational programs. Sheppard, Mullin, Richter & Hampton, for example, runs a “partnership college” designed to educate new nonequity partners on managing their tax and financial responsibilities. “We make sure we mitigate any risks,” says Luca Salvi, the firm’s executive committee chair.
Navigating the Self-Employment Tax Status
Upon promotion from associate to nonequity partner, many lawyers shift from being W-2 employees to K-1 filers. This transition requires nonequity partners to cover the entire cost of Social Security and Medicare taxes—obligations previously split with the employer when they were associates.
Moreover, firms often reduce or entirely withdraw health insurance contributions for these partners. According to Scruggs, many K-1 filers are required to pay 100% of their health premiums, whereas associates typically receive 20% to 50% subsidies from their firms.
Legal Action and Firm Adjustments
In contrast, some firms are revisiting their tax classifications for nonequity partners. McDermott Will & Emery, for instance, transitioned from K-1 to W-2 filings for its income partners in 2020, aiming to reduce the administrative burden on partners and enhance their take-home pay. “Income partners are one of our most valuable assets,” states Ira Coleman, McDermott’s chair. “The change came with costs, but we believe it was the right decision for our people.”
Potential Tax Benefits and Deductions
Despite the drawbacks, there are some potential financial offsets for nonequity partners with K-1 status. Certain tax deductions become available to self-employed individuals that are unavailable to traditional employees, including deductions for unreimbursed business expenses. Additionally, the self-employment health insurance deduction may allow partners with high tax rates to reduce some out-of-pocket costs.
For partners working remotely, tax consultant Ronald Shechtman highlights that the deduction for unreimbursed business expenses, which can include home office costs, has become more valuable. Still, such deductions rarely offset the full scope of the additional tax obligations and health costs.
Long-Term Financial Considerations for Nonequity Partners
For those weighing a move from associate to nonequity partner, the financial impact of a promotion may require careful calculation. Without a substantial salary increase, the additional tax responsibilities may leave new nonequity partners financially worse off. “When you’re going from W-2 to K-1, a 10% raise isn’t going to cut it,” says consultant Derek Barto.
In conclusion, the nonequity partner model has emerged as a double-edged sword for Big Law firms and their attorneys. For firms, it allows for a more flexible compensation structure and improved profitability, but for attorneys, the reality of self-employment taxes and reduced benefits can outweigh the prestige of a partnership title. As more firms adopt nonequity tiers, lawyers considering the transition must weigh the allure of the title against the practical financial impacts.
