Quick Summary
Starting a law firm is exciting and overwhelming in equal measure. There’s the business registration, the malpractice insurance, the office setup, the marketing, and somewhere in the middle of all of it, the accounting. Most new law firm owners treat accounting as something they’ll figure out later. That’s a mistake. The financial decisions made in the first weeks of a law firm’s existence set the foundation for everything that follows: compliance, profitability, tax preparation, and the firm’s ability to grow. This guide covers what new law firms need to know about accounting before they take their first client.
Highlights
- The accounting decisions made when starting a law firm are harder to undo than most new attorneys realize
- An IOLTA trust account is required the moment you receive client funds, not after you’re established
- QuickBooks out of the box is not configured for law firm use and needs to be set up correctly before recording transactions
- Time tracking from the very first matter protects billable revenue from being lost forever
- Getting the accounting foundation right early is significantly less expensive than fixing it later
The Mistake Most New Law Firms Make
New attorneys starting their own practice are focused on getting clients, delivering great work, and building their reputation. Accounting feels like something that can wait until there’s more money coming in and more time to deal with it.
By the time most new law firms get around to setting up their accounting properly, they’ve already made decisions that are hard to undo. They’ve been running transactions through the wrong accounts. They’ve received client funds without a proper trust account in place. They’ve lost track of billable hours that will never be recovered. And they’ve built habits around their finances that take real effort to change.
The accounting setup for a law firm is not something that can be retrofitted easily once the firm is up and running. It needs to be right before the first client walks in the door, not because the IRS is watching, but because the state bar is.
Register With Your Secretary of State and Get Your EIN
Before any accounting setup happens, the business needs to be legally established. That starts with registering the firm as a business entity with your state’s Secretary of State office.
The registration process varies by state but generally involves filing formation documents, paying a registration fee, and in some states publishing a notice of formation.
Once the business is registered, the firm needs an Employer Identification Number from the IRS. An EIN is required to open business bank accounts, hire employees, and file business tax returns. It’s also what separates the firm’s financial identity from the attorney’s personal identity, which matters for both liability and accounting purposes.
If the firm plans to hire employees, even just one administrative staff member, additional registration is required. The firm needs to register with its state’s department of revenue for state income tax withholding and with the state’s workforce agency for unemployment insurance. These registrations need to happen before the first paycheck is issued, not after. Payroll tax obligations begin with the first employee and the penalties for missing deposits or filings accumulate quickly.
Start With the Right Business Structure
The business structure affects how income is taxed, how partner compensation is handled, and what the firm’s accounting obligations look like.
This is a decision worth making deliberately rather than by default. Many attorneys start as sole proprietors because it’s the path of least resistance, then realize later that a different structure would have been more advantageous. Changing structures after the fact creates accounting and tax complications that are avoidable with some upfront planning.
The business structure also determines what the firm’s accounting system needs to track. A solo practitioner’s accounting looks different from a two-partner LLC, which looks different from a professional corporation. Getting the structure right first means the accounting can be built to fit it correctly.
Open the Right Bank Accounts Immediately
One of the most important early steps for any new law firm is opening the right bank accounts and opening them before any client funds are received.
At minimum a new law firm needs two bank accounts. An operating account for the firm’s own money, where revenue is deposited once earned and from which business expenses are paid. And an IOLTA trust account for client funds that have been received but not yet earned.
The IOLTA account is not optional. The moment a new law firm receives a client retainer, a settlement deposit, or any other funds that belong to a client rather than to the firm, those funds need to go into a properly established IOLTA account. Depositing client funds into the operating account, even temporarily, is commingling, which is a bar rule violation regardless of intent.
Many new attorneys don’t realize this until they’ve already received their first retainer. By then the violation has already occurred. Opening the IOLTA account before taking the first client eliminates this risk entirely.
Set Up QuickBooks Correctly Before Recording Transactions
QuickBooks Online is the right accounting platform for most small law firms. It’s cloud-based, widely supported, integrates with the major legal practice management platforms, and scales as the firm grows.
But QuickBooks out of the box is not ready for law firm use. The default chart of accounts is built for a generic small business. It doesn’t include trust liability accounts, fee income by practice area, client cost advances, or the other categories that law firm accounting requires.
A new law firm that sets up QuickBooks using the default template and starts recording transactions is building its financial records on a foundation that doesn’t reflect how a legal practice actually operates. Fixing that foundation after a year of transactions have been recorded is significantly more work than building it correctly before the first entry is made.
The QuickBooks setup for a new law firm should include a law firm specific chart of accounts, correctly configured IOLTA trust accounts recorded as both bank accounts and liabilities, income categories by practice area, and the integration with whatever practice management platform the firm uses for billing and time tracking.
Choose a Practice Management Platform Early
The accounting system and the practice management system need to work together before the first matter is opened. Choosing a practice management platform early and integrating it with QuickBooks means billing data, trust transactions, and client payments flow correctly into the accounting system without manual entry.
A platform like Clio Manage is built specifically for law firms and handles time tracking, billing, matter management, and client communications in one place. It integrates natively with QuickBooks Online, which means data flows between the two systems automatically.
The alternative is managing billing in one place and accounting in another, manually reconciling the two, and hoping nothing falls through the cracks. For a solo attorney or small firm without dedicated administrative support, that approach creates more work and more risk than it’s worth.
Track Time From Your Very First Matter
Billable time that isn’t recorded is revenue that’s gone forever. There’s no way to reconstruct time accurately after the fact, and the hours that go unrecorded in the early days of a practice add up faster than most new attorneys expect.
Time tracking from the first matter also establishes the habit and the system that the firm will rely on as it grows. Attorneys who start tracking time consistently early maintain that discipline as their caseload increases. Those who put it off tend to continue putting it off.
Beyond billing, matter level time tracking is what makes it possible to understand profitability at the case level. A flat fee that seemed reasonable at intake looks different after the attorney can see how many hours it actually required. Without time tracking that comparison is impossible.
Understand Your Bar Obligations Before You Need Them
Every state bar has financial recordkeeping requirements that apply to law firms the moment they begin practicing. Trust account management, reconciliation requirements, record retention obligations, and documentation standards are all bar requirements, not suggestions.
New attorneys often assume these obligations only apply to established firms or to practices that handle large amounts of client money. They don’t. The rules apply from the first client and the first dollar of client funds received.
Understanding what your state bar requires before you need to comply with it is significantly easier than trying to get compliant after the fact. The requirements aren’t complicated once you understand them. But they do require systems and habits that need to be established early.
FAQ
When do I need to open an IOLTA account? Before you receive any client funds. The moment a client pays a retainer, advance, or any other payment that hasn’t yet been earned, those funds need to go into a properly established IOLTA trust account. Opening the account before your first client eliminates the risk of inadvertently commingling funds.
Do I need QuickBooks right away or can I start with a spreadsheet? You can start with a spreadsheet but you’ll regret it. The longer a firm operates without a proper accounting system, the more transactions need to be reconstructed when the system is finally set up. Starting with QuickBooks configured correctly for law firm use means your records are accurate and compliant from the start.
What practice management software should a new law firm use? There are several solid options but a platform like Clio Manage is widely used, well supported, and integrates natively with QuickBooks Online. For a new firm building its systems, choosing a platform that works seamlessly with your accounting system is worth prioritizing.
How much should a new law firm budget for accounting? That depends on the size and complexity of the firm but accounting is not an area where new law firms should be looking for the cheapest option. The cost of setting up the accounting incorrectly and fixing it later is significantly higher than the cost of getting it right.
Do I need an accountant right away or can I handle it myself? Many new attorneys try to handle their own bookkeeping in the early days. The risk is that law firm accounting has specific requirements around trust accounts and bar compliance that most people without a law firm accounting background aren’t fully aware of. By the time the problems show up they’ve often been accumulating for months.
GROWTH Accounting Solutions works with law firms at every stage, including firms that are just getting started. If you’re launching a new practice and want to get the accounting set up correctly, schedule a free consultation.
Quick Summary
Payroll at a law firm looks straightforward on the surface. Employees get paid, taxes get withheld, filings get made. But law firms require more than that. Understanding what counts as payroll, what doesn’t, and how it all connects to your firm’s financial records is essential for staying compliant and keeping your books accurate. This guide covers everything a law firm needs to know about payroll.
Highlights
- Standard payroll applies to W2 employees including associates, paralegals, and administrative staff
- Partner draws and distributions are not payroll and are treated differently for tax and accounting purposes
- Contract attorneys paid as independent contractors require 1099 tracking, not payroll processing
- Remote staff in multiple states creates multistate payroll tax obligations that vary by state
- Time tracking by matter is what connects payroll costs to matter level profitability
What Actually Counts as Payroll in a Law Firm
Payroll covers your W2 employees. In a law firm that typically means associate attorneys, paralegals and legal assistants, administrative and office staff, and any other person classified as an employee of the firm.
For these people, standard payroll processing applies. Wages are paid on a regular schedule, federal and state income taxes are withheld, Social Security and Medicare taxes are collected, and the firm makes its matching employer contributions. W2 forms are issued at year end.
This part of law firm payroll isn’t dramatically different from any other small business. The complexity comes from everything else.
What Is NOT Payroll in a Law Firm
Partner draws and distributions. Equity partners are owners of the firm, not employees. Their compensation is not processed through payroll. Partner draws are advances against each partner’s share of firm profits and are not subject to payroll tax withholding. Instead, partners pay self-employment taxes on their share of firm income. Partner distributions are the actual allocation of profits, typically done periodically based on the firm’s partnership agreement. Both draws and distributions need to be tracked carefully in the accounting system but neither runs through payroll.
Law firms structured as S corporations handle partner compensation differently. Shareholder-employees of an S corp are required to receive a reasonable salary through payroll, with additional profit distributions handled separately.
Contract attorneys. Many firms use contract attorneys for overflow work or specialized matters. These attorneys are typically paid as independent contractors, which means no payroll processing, no tax withholding, and no employer contributions. Instead their payments need to be tracked throughout the year and reported on a 1099-NEC form at year end if total payments reach $600 or more. Misclassifying a contractor as an employee or missing a 1099 creates tax compliance problems for both the firm and the contractor.
Tracking Time by Matter
One of the most important financial practices a law firm can establish has nothing to do with payroll processing itself. It’s making sure attorney and staff time is tracked at the matter level.
When time is recorded by matter, the firm can connect labor costs to the specific cases that incurred them. That connection is what makes it possible to calculate true profitability at the matter level rather than just at the firm level.
Without matter level time tracking, the firm knows what it paid in total labor costs but has no way to allocate those costs to individual cases. A flat fee matter that ran twice as long as expected looks the same in the books as one that came in under budget. The firm can’t see the difference and can’t make informed decisions about pricing, staffing, or case acceptance.
Time tracking also supports accurate billing. Every billable hour needs to be captured and attributed to the right matter before it can be invoiced to the client. Hours that go unrecorded are revenue that never gets billed.
Choosing The Right Time Tracking Software
For law firms evaluating how to track time at the matter level, a dedicated practice management platform is the right solution. A platform like Clio Manage is built specifically for law firms and handles time tracking, billing, matter management, and client communications in one place. Clio also integrates with QuickBooks Online, which means billing data flows directly into your accounting system without manual entry.
Clio handles implementation as part of the subscription, so getting set up doesn’t require a separate implementation engagement. Your accountant can be present during setup to make sure the integration with your accounting system is configured correctly from the start.
Payroll Taxes: What Law Firms Need to Know
For W2 employees, payroll tax obligations are consistent regardless of industry. The firm is responsible for withholding federal and state income taxes from employee wages, collecting the employee portion of Social Security and Medicare taxes, paying the matching employer portion of Social Security and Medicare taxes, contributing to state unemployment taxes, filing quarterly payroll tax returns with the IRS and applicable state agencies, and making timely payroll tax deposits. Late deposits trigger penalties that accumulate quickly.
Payroll tax compliance is non-negotiable. The IRS takes payroll tax obligations seriously and the penalties for late deposits or missed filings are significant. This is an area where errors are expensive and where having someone who knows what they’re doing managing the process matters.
Remote Staff and Multistate Payroll
Remote work has created a payroll complication that many small law firms aren’t fully aware of. When an employee works from a state different from where the firm is located, the firm may have payroll tax obligations in that employee’s state.
Each state has its own income tax rates, withholding requirements, and unemployment tax obligations. A firm based in one state with a remote paralegal working from another state may need to register as an employer in that second state, withhold that state’s income tax from the employee’s wages, and file payroll tax returns in both states.
Some states have reciprocity agreements that simplify this. An employee who lives in one state but works for a firm in another may only be subject to one state’s income tax. But reciprocity agreements vary significantly and not all states participate.
The more remote employees a firm has across different states, the more complex the payroll tax picture becomes. A firm with staff in three or four states is managing payroll obligations in each of those states simultaneously, each with different rates, deadlines, and filing requirements. Getting it wrong is easy and the cost of fixing it after the fact is significantly higher than getting it right from the start.
Matter Level Costing: Connecting Payroll to Profitability
For firms that want to understand true profitability at the matter level, the starting point is tracking the income each matter generates and the direct costs it incurs, including labor.
When attorney and staff time is recorded by matter in a platform like Clio Manage, that time data becomes the basis for a labor distribution. Each attorney’s and staff member’s compensation is allocated to the matters they worked on based on the hours they recorded. The result is a labor cost per matter that reflects what it actually cost the firm to handle that case.
Combined with direct out of pocket costs, filing fees, court costs, expert witness fees, and other expenses paid specifically for that matter, the firm now has two of the most important inputs into true matter level profitability: revenue and direct costs including labor.
A flat fee matter that generated $3,000 in revenue but required $1,500 in labor costs and $400 in direct expenses made $1,100. Without the labor distribution that number is invisible. With it the firm can make informed decisions about pricing, staffing, and which types of cases are actually worth taking.
This level of visibility requires accurate time tracking, consistent direct cost recording, and an accounting system set up to capture and connect both. For most small law firms that’s achievable with the right setup in place. If you’re using QuickBooks Online, you must be subscribed to QBO Plus or higher in order to track costs at the matter level.
FAQ
Do law firm partners pay payroll taxes? Equity partners generally do not pay payroll taxes through the firm’s payroll system. Instead they pay self-employment taxes on their share of firm income when they file their personal tax returns. The specific tax treatment depends on how the firm is structured legally.
What happens if we misclassify a contract attorney as an employee? Misclassification creates payroll tax liability for taxes that should have been the contractor’s responsibility, plus potential penalties and interest. The IRS takes misclassification seriously and audits in this area are not uncommon. If you’re unsure how to classify someone, it’s worth getting a definitive answer before the relationship begins rather than after.
Do we need a separate payroll system or can QuickBooks handle it? QuickBooks Online includes payroll functionality through QuickBooks Payroll that integrates directly with your accounting records. For many small law firms this integration works well because payroll data flows automatically into the firm’s books. Whether a separate system is needed depends on the complexity of your compensation structure.
How do we handle payroll for a remote employee in another state? Start by determining whether your firm has nexus in that state, which generally means the obligation to comply with that state’s tax requirements. Then register as an employer in that state, set up the correct state income tax withholding, and add that state’s unemployment tax to your payroll obligations. Getting this set up correctly from the employee’s first paycheck is significantly easier than correcting it retroactively.
How far back do we need to keep payroll records? The IRS requires payroll records to be kept for at least four years. Some states have longer retention requirements. Records should include all compensation paid, taxes withheld, payroll tax deposits made, and documentation supporting contractor classifications.
GROWTH Accounting Solutions handles law firm accounting and payroll exclusively. Feel free to schedule a free consultation with one of our experts.
