When you first started, your firm’s payroll was simple. It might have involved just you and a part-time paralegal with a few predictable expenses. You had no complex bonus structure, no partner draws to split, no multi-state taxes to keep track of — just you working hard and taking home whatever was left.
What you’ll learn
What you’ll learn
Key takeaways
- Proper employee classification is critical which means partners, associates, and contractors have different tax and compliance requirements that must be handled correctly to avoid IRS scrutiny
- Multi-state operations require specialized payroll management so firms working across jurisdictions need to register in each state and comply with varying tax rates and labor laws.
- Trust account funds must never be used for payroll meaning mixing client funds with payroll expenses can lead to ethics violations and potential disbarment
But as you built up your reputation, your team began to grow. You hired associates, entered into new jurisdictions, and started offering bonuses tied to billable hours and other compensation models. Your payroll got bigger and more complicated. Now, managing it feels like a full-time job and you’re on the lookout for guidance on keeping it all together.
In this primer, we cover what growing law firms need to keep in mind, payroll practices to help you keep up with compliance, and build a system that supports your staff and your continuing growth.
Classifying legal roles correctly: partners, associates, and contractors
Oftentimes, law firms have employees who fill a mix of roles, each with a different compensation model and compliance requirements. So, one of the first steps to take in effective payroll management is accurate classification.
Equity and non-equity partners
Equity partners receive a share of your firm’s profits, not a traditional salary. You should handle their compensation through draws or distributions, meaning they shouldn’t be on payroll. In other words, it makes a lot of sense to treat them as self-employed for tax purposes, as the IRS doesn’t treat partners as employees.
Even if their title indicates “partner,” non-equity partners receive a salary instead of partner distributions and are classified as W-2 employees.
Salaried associates and paralegals
Associates and paralegals are standard W-2 employees, but their overtime eligibility depends on how they are classified under the Fair Labor Standards Act (FLSA). Associates are FLSA-exempt professionals, meaning they aren’t entitled to overtime pay, even when they work long hours. Paralegals are usually non-exempt and are entitled to overtime if they work late to meet a deadline.
1099 contract attorneys and consultants
If you bring in contract attorneys or consultants for short-term projects, they may qualify as independent contractors if they control how and when they work and offer similar services to other clients. If not, treat them as employees, since misclassifying contractors can draw scrutiny from auditors and tax authorities.
Support staff and administrative roles
Most administrative roles, such as receptionists and bookkeepers, are hourly W-2 employees. Some may qualify as exempt employees if they have supervisory responsibilities or meet exemption criteria, but most don’t. Track hours worked to stay compliant and simplify your payroll processing.
Tracking time and allocating bonuses by billable hours
Once you’ve classified legal roles in your firm, connect time tracking to payroll. Use law firm payroll software that pulls in billable hours automatically to simplify bonus and payroll tax calculations.
Set clear, transparent criteria for performance-based bonuses, so team members know exactly how their efforts translate to compensation. Such clarity also helps you determine payroll costs related to incentives.
How to manage multi-state payroll for attorneys working across jurisdictions
If you have expanded your operation across state lines, law firm payroll management gets more complex:
- Different states have different income tax rates.
- Labor laws and overtime rules can vary by state.
- You need to register as an employer in each state.
- Some cities have unique payroll taxes.
Register in every state where your employees work, and track where the work happens so you can apply the right income tax and follow local labor laws. Use payroll solutions for law firms that support multi-state compliance, and stay current with changing state regulations to avoid stumbling into noncompliance.
Compliance tips for managing trust accounts and IOLTA funds
Ethical management of clients’ money is a major responsibility for lawyers — important enough that the penalties for violations can even include disbarment. To safeguard your clients’ interests and avoid disciplinary action you’ll need to carefully manage trust accounts and Interest on Lawyers’ Trust Accounts (IOLTA) funds. However, the process can be challenging because it involves maintaining detailed ledgers and reconciliations.
To remain compliant:
- Use a separate trust account for client and third-party funds.
- Never use a trust account to cover payroll. This can constitute misappropriation.
- Set up internal controls, such as dual approval or restricted access, to prevent misallocation.
- Review trust accounts regularly to catch any errors early.
Key steps to reporting and audit readiness for law firms
Law firms face strict payroll reporting obligations that require precision and a clear audit trail. To be audit-ready and meet reporting requirements:
Issue W-2s and 1099s accurately and on time
Send accurate W-2s to employees and 1099s to contractors before deadlines to avoid penalties.
Align payroll records with legal standards
Verify that your payroll records match up with trust accounting practices and bar association expectations. This is especially important when documenting and approving compensation.
Stay current on quarterly and state filings
Federal forms, such as the 941, must be filed quarterly, while states may require additional reports for income tax withholding and unemployment insurance contributions.
Maintain transparent and consistent documentation
Document every bonus, partner draw, pay adjustment, or other payroll activity to protect your firm during tax audits or professional reviews.
Simplified payroll across worker classifications
OnPay has made running payroll so easy for our law firm. Whether I’m processing payments for salaried employees, hourly workers, or independent contractors, the system is simple to use. It saves me time and eliminates worry about miscalculations or tax filings. OnPay handles it all!
— Pam Snyder, Sherman-Stoltz Law Group
Avoiding payroll compliance risks in legal settings
There are common payroll management errors to avoid and protect your firm from costly fines and ethics violations.
| Payroll error | What can happen | Safeguards against FLSA or IRS penalties |
| Misclassifying roles | Trigger IRS and FLSA scrutiny | Classify partners and employees by roles, not titles |
| Inaccurate time and overtime tracking | Missed wages, FLSA/state violations | Use reliable payroll services for law firms and choose a time-tracking system that can be linked to payroll |
| Omitting bonuses or fringe benefits | Skewed payroll taxes and audit flags | Include all compensation types in payroll calculations |
| Missing tax filing or withholding deadlines | IRS/state penalties and interest | Automate tax filing where possible |
| Incomplete or inconsistent payroll records | Failed audits open legal risks | Maintain organized, up-to-date records for at least 3-4 years, depending on regulations in your region and field |
These potential pitfalls underscore the importance of payroll precision in legal practice. Between managing 1099 contractors, multi-state compliance, and trust account rules, it can be complex. The good news? With the right systems and processes in place, you can streamline these operations and minimize risk.
Bottom line: Law firm payroll has many moving parts, but it’s manageable
The right tools can help handle much of the administrative burden. For instance, OnPay’s payroll and HR software automates many of the firm-specific nuances, allowing you to focus on practicing law. The platform offers encrypted data security, custom earning types for roles like partner draws, and built-in compliance tools for multi-state regulations. You can also onboard new hires seamlessly and generate detailed reports that align with trust accounting standards and legal finance requirements. Best of luck as you scale your firm, and our team is here to answer your payroll-related questions!
Take a tour to see how easy payroll can be.
Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.