Tax time can be stressful for anyone, but it can be particularly stressful for new solo or small-firm practitioners filing their first tax returns. The common duties of accounting for a business’ expenses and revenues can be doubly challenging for lawyers, given their management of trust accounts and other tightly-controlled fiscal instruments.
Be warned: The smallest financial error can cause real headaches for lawyers, and not just when dealing with the CRA. For instance, when the Law Society of Upper Canada challenged a 47-cent discrepancy in his first return, Toronto lawyer Omar Ha-Redeye had to hire a forensic accountant to track it down. “Apparently the discrepancy occurred due to a small bank error when charging interest to one of my firm’s accounts,” he said. “Finding it cost me much more in time and money than 47 cents!”
Ironically, when not practising at his firm, Fleet Street Law, Ha-Redeye teaches legal accounting and other courses at Toronto’s Centennial College. (He began teaching legal accounting after wrestling the 47-cent error to the ground.) Ha-Redeye knows something about accounting. Nevertheless, Fleet Street Law still paid the price for someone else’s mistake, and learned firsthand the importance of hands-on financial management.
“It's true that the discrepancy was due to a bank error,” Ha-Redeye said. “But like all new lawyers, I had to learn all of these accounting principles and apply it to practice. It's that applied learning that I share with my students at Centennial College.” This same learning guides Fleet Street Law when it comes to preparing its tax returns – especially now, with the CRA’s filing date approaching.
Joshua Lenon is ‘lawyer in residence’ with Clio, the web-based practice management, time & billing and client collaboration platform. His tax advice for lawyers is simple: “Your tax preparation begins when you get your first expense receipt or your first client payment, whichever comes first,” said Lenon.
“The point is that tax preparation relies on having a properly set-up accounting system in place from Day One,” Lenon explained. “If you don’t, trying to pull the information together at the last minute can be a nightmare – and result in issues that cause problems with the CRA.”
So what is a starting solo lawyer or small law firm to do? Well, Clio is one tool that makes it possible to record all elements of a practice’s financial actions. Another is a small business accounting program like QuickBooks: Its easy-to-use interface, which runs on almost any PC, is also easy for even the greenest of accounting newbies to understand.
However, tech isn’t everything. New lawyers will need filing cabinets to keep their receipts, cheque stubs, and all other financial documents – in properly-labelled and filed folders, thank you very much! Again, this process should ideally start as soon as lawyers hang out their shingles. For lawyers who haven’t done this already, it’s never too soon – or too late – to start with current and upcoming financial documents; taking time to sort and file older receipts stored in shoe boxes when time permits.
Once the accounting and filing system is set up, lawyers should consider hiring a bookkeeper or accountant on a part-time basis if they don’t have the necessary accounting skills and time available to exercise them. “You can often find them through word-of-mouth, by talking to other lawyers,” said Ha-Redeye. “Be sure to find someone who has law firm experience, because there are some extra twists to our profession’s tax filing requirements.”
No matter how tight revenues may be, having even part-time access to a financial expert is a must for starting lawyers and law firms. It’s not just a matter of avoiding tax-related pitfalls – not just income tax, but GST/HST! – but also ensuring that a lawyer/law firm takes every deduction that they are legally entitled to. (If the firm is incorporated, a legal accountant is even more critically important, because corporate tax returns are very complicated.)
“Many people don’t realize just how much of their business expenses are legitimately deductible,” said Joshua Lenon. “Say you’ve got a home office that takes up a quarter of your total living space. Total up your overall costs including hydro, heating, water, maintenance/repair, property insurance and anything else that fits, divide it by four, and you have a legitimate office expense claim that can be applied against your practice’s taxable income.”
Again, it is the law firm’s responsibility to record and document these expenses properly, so that they will stand up to a CRA audit. (“The law society also does spot audits on firms within their first five years, so you’d better be ready for that as well,” warned Ha-Redeye. “That’s something most new lawyers aren’t aware of, but it’s a fact of legal life in Canada.”) Once this data is compiled, along with everything else, it makes good sense to have a legal accounting professional crunch the numbers, so that they are done right.
Finally, having a legal accountant also provides a degree of protection should the CRA have questions once the returns have been processed. Such a professional – if properly chosen at the outset – will have the necessary degree of emotional calm to assess any CRA demands calmly and carefully. They will also know how to negotiate with CRA officials should a refiling be required, minimizing penalties and stress for the lawyers/law firms they represent.
“Remember the old saying that ‘a man who represents himself in court has a fool for a lawyer’?” said Ha-Redeye? “Well, a financially uneducated lawyer who tries to represent themselves to the tax man has a fool for an accountant!”
The bottom line: New lawyers should start preparing for tax time as soon as they begin practising law. This includes setting up a proper financial records system, keeping all receipts and payment stubs, and hiring a legal accountant to keep the books properly and prepare tax returns when tax time comes.
James Careless is a freelance journalist.