A strong fourth quarter at a law firm is good news for the practice and, often, a tax problem that arrived too late to manage well. The decisions that actually move a firm’s tax position — compensation timing, estimated payments, entity-level choices — mostly have to be made before year-end, not during the scramble in December. The firms that stay ahead of this aren’t the ones with better accountants in December. They’re the ones reviewing the same handful of questions every quarter, while there’s still time to act on what they find.
December is too late for decisions that have to happen during the year.
Before the next partner meeting, four questions belong on the agenda ahead of the usual year-end tax conversation.
Why December Is Too Late for Some Tax Decisions
Tax planning conversations at most firms happen in the fourth quarter, by habit more than by design. The problem is that several of the decisions with the biggest tax impact aren’t available in the fourth quarter at all, or are only available at a worse price than they would have been earlier in the year.
Compensation structure for shareholder-employees in an S corporation has to reflect what actually happened over the year, not get reverse-engineered in December to hit a number. Estimated tax payments are due on a quarterly schedule — paying in December to cover a shortfall from earlier quarters still exposes the firm to an underpayment penalty for the quarters that were actually underpaid. Retirement plan decisions, major equipment or practice-management purchases timed for a tax benefit, and entity-level elections frequently carry deadlines that fall mid-year or earlier. A firm that only looks at tax planning once a year finds most of its real options already closed by the time it looks.
Actual Income Versus the Plan
Every firm that does any tax planning at all builds some version of an income projection early in the year — often during the same conversation as the prior year’s tax filing. The mistake is treating that projection as fixed rather than revisiting it each quarter against what’s actually happening in the practice.
A quarterly review should ask a plain question: is the firm tracking meaningfully above, below, or in line with what was projected in January? A firm running well ahead of plan because of a strong litigation settlement or a surge in transactional work has a different set of decisions available than one running behind because of a slow intake quarter — and both situations are far easier to act on in July than in December.
Running ahead of plan
More income than projected raises the current-year tax bill and often makes additional estimated payments, retirement contributions, or timing decisions worth revisiting before year-end rather than after.
Running behind plan
Less income than projected may mean estimated payments are now overpaid relative to the revised picture — worth catching mid-year rather than discovering it at filing.
Tracking to plan
Still worth a quarterly confirmation rather than an assumption — “on track” should be a checked fact each quarter, not a carried-forward impression from January.
A one-time event skewing the year
An asset sale, a lateral partner buy-in, or a single large settlement can distort the whole-year picture even when the underlying practice is tracking to plan — worth isolating from the recurring number, not blended into it.
Estimated Payments and Cash Reserved for Tax
Partners and S corporation shareholder-employees are generally treated as individuals for estimated tax purposes, which means quarterly payments through Form 1040-ES rather than a business-level filing. The general federal standard: individuals who expect to owe $1,000 or more for the year typically need to make estimated payments across the year’s four payment periods, and the safe-harbor relief most firms rely on requires paying at least the smaller of 90% of the current year’s tax or 100% of the prior year’s tax (adjusted upward for higher-income taxpayers) to avoid an underpayment penalty.
The practical risk at a law firm isn’t usually ignorance of this rule — it’s that the estimate was calculated once, early in the year, against a projection that’s since gone stale. If a firm’s income has moved meaningfully since that projection was built, the estimated payment amount should move with it. Catching that gap at the next quarterly payment is manageable. Catching it at the final quarterly payment, or at filing, usually means a penalty that a quarterly review would have avoided.
The operating principle: an estimated tax payment calculated once in January and never revisited is a snapshot of a projection that may no longer describe the firm’s actual year. Reviewing it each quarter against actual income is what keeps the safe harbor calculation honest.
Compensation and Distributions
For firms organized as S corporations, the IRS requires that shareholder-employees receive reasonable compensation for the services they actually perform, before the corporation makes non-wage distributions to them. The reasoning is straightforward: wages carry employment tax, distributions generally don’t, and the IRS has successfully reclassified distributions as wages in multiple court cases when compensation was understated relative to the value of services performed.
What counts as reasonable isn’t a fixed formula — the IRS points to factors including training and experience, duties and responsibilities, time actually devoted to the practice, what comparable firms pay for similar roles, and the firm’s dividend and bonus history. A partner who draws a modest salary and a large year-end distribution, with no documentation connecting the salary to the actual value of hours billed and administrative work performed, is building exposure quietly over the course of the year — not just at the moment the distribution is paid.
A quarterly review doesn’t need to finalize compensation each quarter. It needs to ask whether the current wage-to-distribution ratio, if it continued at the same pace through year-end, would still be defensible against those factors — and if not, adjusting it during the year is a far better position than adjusting it after the fact.
A Hypothetical Walk-Through of Why the Timing Matters
Here’s an illustrative, non-client example of how this plays out. Say a firm projects $900,000 in partner income in January and sets estimated payments and a compensation structure around that number. By the third quarter, a large contingency matter settles well ahead of schedule, and actual income is tracking closer to $1.3 million for the year. Nothing about the firm’s tax planning has changed since January — the number it was built around simply isn’t accurate anymore.
If nobody revisits the projection until December, three things have quietly drifted out of alignment: the estimated payments made in the first three quarters were sized for the smaller number, which can trigger an underpayment penalty on those specific quarters regardless of what gets paid in the fourth; the shareholder-employee’s compensation, if it was set based on the January projection, may now look understated relative to the much larger distribution the higher income supports; and any decision that depended on knowing the real income number — a retirement plan contribution ceiling, a major purchase timed for a deduction — may have already passed its window.
Catching the same gap in the third quarter instead of December means the fourth-quarter estimated payment can be sized correctly, compensation can be adjusted while there’s still a full quarter of wages to reflect it, and any remaining time-sensitive decisions are still on the table. The facts didn’t change by catching it earlier — the options available in response to those facts did.
State and Multi-State Exposure
A law firm’s state tax exposure isn’t static even if the partners haven’t moved and the office address hasn’t changed. Remote work arrangements, matters handled for clients in other states, a partner relocating, or expanding into a new jurisdiction can all shift where income is sourced or where a filing obligation now exists. This is exactly the kind of change that’s easy to miss during the year and expensive to discover at filing.
A quarterly check doesn’t need to be a full state nexus study every time. It needs to ask a narrower question: has anything changed this quarter — a new remote hire, a matter in a new state, a partner’s residency — that should prompt a conversation with the firm’s state tax advisor before the quarter closes. State tax authorities vary enough in their specific rules that this is an area where a firm’s own state tax advisor, not a general framework, should confirm the actual filing obligation.
Decisions to Surface Before the Next Quarter Closes
Compare actual income to the January projection
Flag whether the firm is running ahead, behind, or on track, and whether that changes any decision that still has time to be made this year.
Confirm estimated payments still match the revised picture
If income has moved since the last calculation, the next quarterly payment is the moment to correct course, not the last one.
Check compensation against distributions, with documentation
Ask whether the current wage level, continued through year-end, still holds up against the reasonable-compensation factors — and adjust now if it doesn’t.
None of this replaces a year-end tax conversation — it makes that conversation shorter, because most of the decisions that used to get crammed into December have already been reviewed and acted on along the way. The specific entity structure, compensation formula, or estimated-payment amount that’s right for any individual firm depends on that firm’s actual facts, and should be confirmed directly with Slate & Summit or the firm’s CPA rather than applied generically from a framework like this one.
Source framework
The estimated-tax and reasonable-compensation concepts referenced in this guide align with IRS guidance on estimated taxes and the IRS guidance on S corporation compensation and medical insurance issues. State tax treatment varies by jurisdiction and should be confirmed with your state tax authority or advisor. This is a planning framework, not individualized tax advice — your firm’s specific entity structure, compensation, and estimated-payment decisions should be reviewed with a qualified CPA or tax advisor.
Frequently Asked Questions
How often should a law firm actually revisit its tax projection?
Quarterly, at minimum — tied to the same cadence as estimated tax payments, so any gap between the projection and actual income gets caught before the next payment is due rather than at filing.
What counts as “reasonable compensation” for a shareholder-employee?
There’s no fixed formula. The IRS looks at factors including training and experience, duties performed, time devoted to the practice, what comparable firms pay for similar roles, and the firm’s distribution history. A quarterly check against these factors keeps the wage-to-distribution ratio defensible.
Does this framework tell me which entity structure is right for my firm?
No. Entity selection depends on firm-specific facts — ownership structure, income level, state of operation, and more — and should be decided with a CPA or tax advisor who has those facts, not generalized from a quarterly review framework.
What happens if estimated payments fall behind during the year?
Catching it at the next quarterly payment and adjusting the remaining payments is far better than waiting until filing, when an underpayment penalty may already apply to the quarters that were short, even if the full-year total eventually gets paid.
Ask Slate & Summit what should be on your firm’s next quarterly tax-planning agenda before another quarter closes.
Bring your current income tracking, your estimated payment schedule, and your compensation structure. We’ll walk through what’s still actionable this quarter and what’s already locked in for the year.
Related: Law firm finance · Fractional CFO & strategic advisory
