Reasonable Compensation for Law Firms and Attorneys

This article is intended to provide some fundamental guidance for attorneys and law firms whenever employee-owner compensation is at issue. In many instances, this focus will relate to ownership decisions regarding the overall allocation and character of enterprise profits, but the same concepts and analytical framework can be of benefit in the assessment of reasonable compensation for other purposes, such as the valuation of a non-compete agreement and in the segregation and measurement of personal/professional versus enterprise goodwill for dissolution of marriage purposes in jurisdictions where this aspect is in play. (See Identifying and Measuring Personal Goodwill in a Professional Practice, by Mark O. Dietrich, CPA/ABV, AICPA CPA Expert, Spring 2005.) Another emerging area where these principles are often applied is in the evaluation of excess or inadequate compensation challenges by the Internal Revenue Service, with respect to closely held C corporations or Subchapter S corporations, respectively. The issue with S corporations paying too little in wages to the owners to allow them to take a larger share of enterprise profits as distributions not subject to employment taxes has received significant recent attention from the Internal Revenue Service on behalf of the Social Security administration. This article provides guidance on what factors would be considered in determinations of reasonable compensation for this purpose.