Law partner compensation is a well kept mystery to most associate attorneys. Although associates are told to work hard and make partner, there is little discussion about how partners are paid and what partnership compensation looks like.
For younger attorneys and others interested in looking for a peek behind the veil on the mechanics of partner compensation, this post breaks down one model on how are law partners paid.
As an equity partner, my income is based mostly on a percentage interest in the firm’s profits.This baseline share is determined at the beginning of the year. My percentage share can vary over the years. It’s based on the new business I generate and my direct client billings.
How do I know how much I will earn this year in order to pay my taxes? Well, I don’t know, not exactly. But I have a ballpark idea. At the beginning of the year my firm projects our likely profits and prepares a budget. Our projections are usually reasonably close.
About 80% of my firm’s profits are distributed to all the partners according to their percentage share.
So if at the beginning of the year I was allotted a 5% share of the firm’s profits for 2018, I would get 5% of those profits.
The remaining 20% is used to give extra pay to partners who had a great year in 2018. Those partners would also be considered for a larger baseline share of the firm’s profits the next year.
Non-equity partners essentially get a salary, which are guaranteed payments. They do not share in the firm’s profits.
There are several tiers of non-equity pay. A good year for a non-equity partner generally results in a bump to the next tier, and hopefully, ultimately to equity partner. They also have a chance for a bonus.
So how do equity partners get paid on a monthly basis if their pay is uncertain until the end of the year? Equity partners take a monthly “draw” on their anticipated earnings.
No taxes are withheld from the monthly draw.
The total amount of the monthly draws received varies based on a partner’s income. Partners earning more have higher draws. However, if you added up the 12 monthly draws for each partner, we would be talking about the monthly draws making up less than half a partner’s yearly income. Generally speaking, the more a partner earns, the lower the percentage of monthly draws to total pay will be. That’s because even though the amount of the monthly draws go up for higher earners, they don’t go up proportionally.
Non-equity partner compensation works the same way. The monthly draws constitute a portion of the total amount of their compensation for the year. At the end of the year, non-equity partners will also get the balance of what is left of their “salary”.
The remaining amounts to be paid to all partners are released in the form of tax draws or at a year-end distribution.
Partners are responsible for sending in quarterly estimated taxes in April, June, September and January. Since partners have to pay taxes on the total amount they will earn in 2018, but are only receiving a portion of that income on a monthly basis, the firm releases additional draws to the partners to assist in paying those taxes.
These three tax draws cash cumulatively represent about 25% of the partner’s total earnings. These amounts are deducted from what the partner would otherwise be paid at year-end. There is no need for a 4th quarter tax draw, as any money left over is paid to the partner in the year-end distribution, generally speaking, and a portion of that goes to 4th quarter estimates. (There are other nuances involved in the year-end amount, which are beyond the scope of this post).
The remainder of partner compensation is paid out at the end of the year. In sum, the formula for the main timing components of partner compensation looks like this:
Total Compensation – Monthly Draws – Tax Draws = Year-End Amount
Costs of my benefits, my chosen retirement contribution, etc. all come out of the year-end amount. Whatever is left over after all deductions are made is paid to me in January, subject to additional partnership restrictions and requirements.
Adjusting For Next Year
At the conclusion of 2018, the firm will review whether any adjustment is necessary to be made to a partner’s allocation of profits in 2019 based on their performance in 2018 or over some longer period of time.
To the readers who are attorneys: how does this model compare to how partner compensation is paid at your firm?