Law Partner Compensation Models: Tax and Planning Considerations

Equity vs. Non-Equity Partners and Bonus Structures

As law firms grow, so do the complexities of compensating their partners. Choosing the right partner compensation model is more than a matter of internal fairness—it impacts tax obligations, firm governance, and long-term planning. Whether your firm is considering adding new partners or revising your current compensation structure, understanding the implications of equity vs. non-equity roles and how bonuses are handled is critical.

We help professional services firms navigate these decisions strategically—with both financial goals and tax efficiency in mind.

Understanding Equity vs. Non-Equity Partners

Equity Partners

Equity partners are owners in the firm. They typically:

  • Share in the profits and losses,

  • Make capital contributions,

  • Participate in governance and voting rights, and

  • Take on more liability, depending on the firm structure.

From a tax perspective:

  • Income is typically reported on a K-1 (as a partner, not an employee),

  • They’re subject to self-employment tax, and

  • They don’t receive W-2 wages—so no payroll withholding or eligibility for certain employee benefits.

Non-Equity Partners

Non-equity partners are often senior professionals with a partner title but without ownership in the firm. They typically:

  • Receive a fixed salary and/or performance bonuses,

  • Have limited or no voting rights,

  • Don’t contribute capital, and

  • May or may not have a path to equity.

For tax purposes:

  • Income is reported on a W-2,

  • The firm must withhold payroll taxes, and

  • They’re eligible for benefits like 401(k) matches, healthcare, and paid time off.

Key Planning Considerations

Firms must clearly define roles, rights, and obligations of each partner type in the partnership agreement. Lack of clarity can lead to disputes or tax misclassification issues down the line.

Structuring Bonus Plans: Aligning Incentives

Both equity and non-equity partners often receive bonuses tied to performance, but the structure can vary significantly.

Common Bonus Structures

  • Profit-sharing bonuses are typically used for equity partners based on firm performance.

  • Revenue-based incentives reward individual or team billings.

  • Milestone bonuses are tied to client acquisition, project completions, or operational goals.

  • Discretionary bonuses are awarded based on leadership team decisions.

Tax Impact of Bonuses

  • W-2 employee (non-equity partners) bonuses are subject to standard payroll taxes and withholding.

  • Equity partner bonuses typically flow through as part of partnership income and are reported on Schedule K-1. They are not treated as wages, so no withholding applies.

Best Practice Tip
Have a written bonus plan in place that outlines eligibility, performance metrics, payment timing, and claw-back provisions. This can reduce confusion and legal exposure while motivating partner-level professionals effectively.

Legal and Operational Considerations

As firms expand, blending equity and non-equity roles can provide flexibility. However, without careful documentation and tax planning, the hybrid model can create issues, including:

  • Misclassification Risk: The IRS may reclassify non-equity partners if they’re treated too similarly to employees without proper tax handling.

  • Retirement Planning: Equity partners may need different exit strategies—like buyouts or deferred compensation agreements.

  • Succession Planning: The firm must decide how new equity is granted, priced, and transferred over time.

Key Questions to Evaluate Your Compensation Model

  • Are your equity and non-equity roles clearly defined in legal documents?

  • Do your bonus structures align with both firm goals and IRS guidelines?

  • Are you leveraging compensation models to attract and retain top talent?

  • Is your model tax-efficient for both the firm and the partners?

Choosing the Right Partner Structure

Choosing the right partner compensation structure involves much more than setting pay levels—it’s about governance, retention, incentives, and compliance. An experienced advisory team can help you evaluate your options, model different scenarios, and document everything appropriately.

We work with professional service firms across the country to design partner compensation models that make sense for their size, goals, and tax profile.

Need help reviewing or restructuring your partner compensation model?
Contact LMJ CPAs today to schedule a consultation.

Law Firms, PayrollArpita Joshi