A law firm or accounting firm structured as a partnership faces tax issues that differ substantially from corporate employers. Partners are not employees - their income is a distributive share or guaranteed payment, subject to self-employment tax, with no withholding, requiring quarterly estimated payments. The §199A deduction that benefits most small business owners is partially capped for law firms and other specified service businesses above certain income thresholds. And the retirement plan options for partners - particularly defined benefit plans that can shelter far more than 401(k) limits - are one of the most valuable and underused planning tools available.
Guaranteed payments (IRC §707(c)): Fixed amounts paid to a partner for services without regard to partnership income. Treated as ordinary income to the partner and deductible by the partnership. Subject to SE tax. Equivalent to salary for tax purposes - but with no withholding.
Distributive share: The partner's allocated share of partnership income after guaranteed payments. Also subject to SE tax for general partners and active LLC members. Retains the character of the underlying income - ordinary income from legal fees flows through as ordinary income.
Non-equity partner (PSA or income partner): Often treated as an employee or as a limited partner - the classification determines SE tax exposure. If treated as an employee, W-2 wages with FICA. If treated as a limited partner with no management authority, SE tax may not apply to the distributive share.
Law, accounting, financial services, consulting, and other specified service trades or businesses (SSTBs) are subject to a phase-out of the §199A deduction for partners above the income thresholds. For 2026: below $201,750 (single) / $403,500 (MFJ), law firm partners deduct 20% of QBI without limitation. Between the threshold and $201,750 + $50,000 single / $403,500 + $100,000 MFJ, the deduction phases out. Above the phase-out range, the §199A deduction is zero for SSTB income.
For most equity partners at mid-size and large law firms, income exceeds the phase-out range and the §199A deduction is completely unavailable. This is a meaningful difference from non-SSTB businesses of the same size where the 20% deduction reduces the effective top rate from 37% to approximately 29.6%.
The retirement plan options available to partners are more powerful than those available to W-2 employees. A partner in a law firm can participate in the firm's 401(k)/profit sharing plan (up to $70,000 total including employer contributions for 2026) but also establish a defined benefit plan that allows contributions far exceeding the §415 limits based on actuarially determined benefit targets. For a high-income partner in their 50s, a defined benefit plan can support annual contributions of $200,000-$300,000 or more - amounts that dwarf the 401(k) limits and create deductions directly against the highest-rate income.
Cash balance plans - a hybrid defined benefit structure - have become the dominant retirement planning vehicle for law firm partners. The partnership (or an individual partner through a solo defined benefit plan) funds target "account balances" that accrue interest at a specified rate. The contributions are deductible, the accumulated balance is tax-deferred, and distributions are ordinary income at retirement when the partner's marginal rate is likely lower.
General partners and LLC members who perform services pay SE tax on their distributive shares of ordinary business income plus guaranteed payments. At 15.3% on the first $184,500 of SE income and 2.9% above that (2026 - Social Security wage base), SE tax on a $500,000 distributive share is approximately $20,400 (the Social Security portion caps out; Medicare continues). The SE tax deduction - one-half of SE tax paid - reduces AGI. Partners who do not carefully account for SE tax in their quarterly estimated payments frequently face underpayment penalties.
When a partner moves from one firm to another, several tax issues arise simultaneously. Unvested capital contributions at the departing firm may create a loss or a distribution. Accounts receivable for work completed at the old firm but collected after departure create income that the departing partner must report based on their partnership agreement. Work in process (unbilled time) is an asset that may be purchased by the new firm - the tax character of that payment (ordinary income vs. capital gain) depends on how the agreement is structured. Deferred compensation arrangements at the old firm - particularly retirement or withdrawal packages - may be subject to §409A or §736 depending on the structure.