Client Profile
| Industry | Law Firm (Litigation Practice) |
| Annual Revenue | $1,500,000 |
| Entity Type | S-Corp + Cash Balance Plan Trust |
| State | New York |
| Key Metric | Partner age 52, net income $980K, 3 associates |
| Annual Tax Savings | $95,000 |
The Problem
This litigation attorney was operating as a single-member LLC taxed as a partnership. All $980,000 in net profit was subject to self-employment tax at 15.3% on the first $168,600 and 2.9% plus the 0.9% Additional Medicare Tax on income above $200,000. The prior accountant had never discussed entity election or retirement plan optimization beyond a standard SEP-IRA contribution.
At age 52, the partner wanted to accelerate retirement savings dramatically but was constrained by the $69,000 annual defined contribution limit. The firm employed three associate attorneys and two paralegals, creating both opportunities and complications for plan design.
AE Tax Strategy
1. S-Corp Election with Optimized Reasonable Compensation Under IRC §1366
We elected S-Corp status under IRC §1368 and set reasonable compensation at $310,000 based on comparable litigation partner compensation data. The remaining $670,000 in distributions avoided the 15.3% self-employment tax. Net FICA savings after accounting for employer-side obligations: $38,000 annually. We documented the reasonable compensation analysis with three independent salary surveys and BLS data to withstand IRS scrutiny.
2. Cash Balance Pension Plan Under IRC §401(a) and §412
We implemented a cash balance defined benefit plan under IRC §401(a) alongside the existing 401(k) profit sharing plan. The cash balance plan allowed an actuarially determined annual contribution of $195,000 for the partner based on age 52 entry and a target retirement at 62. Combined with the 401(k) maximum deferral of $30,500 and profit sharing of $46,000, total annual retirement contributions reached $271,500. The deductible retirement contributions reduced taxable income by $271,500 at a combined federal and state marginal rate of approximately 21%, producing annual tax savings of $57,000. Cross-testing ensured associates received the minimum required gateway contribution of 5% of compensation.
Before & After Comparison
| Tax Category | Before | After | Savings |
|---|---|---|---|
| Self-Employment Tax Savings | $0 | $38,000 | $38,000 |
| Cash Balance Plan Deduction | $0 | $41,000 | $41,000 |
| 401(k) + Profit Sharing Optimization | $9,000 | $25,000 | $16,000 |
| Total (Annual Ongoing) | $9,000 | $104,000 | $95,000 |
Key Takeaways
- Law firm partners operating as LLCs taxed as partnerships pay unnecessary self-employment tax on distributions that could be sheltered through S-Corp election.
- Cash balance pension plans allow substantially higher annual contributions than 401(k) plans alone, especially for owners over 50, with actuarial limits often exceeding $200,000 per year.
- Reasonable compensation for an S-Corp must be defensible with market data. Litigation partners in major metros typically justify compensation in the $280,000 to $350,000 range.
- Cross-tested plan designs allow owners to receive disproportionately higher contributions while satisfying nondiscrimination requirements for employees.