Tax Strategies for Solos & Smalls in a Digital and Web 3.0 World

This is a summary of the #ABATECHSHOW 2023 Presentation by tax attorney Jamie Szal and CPA T. Jayden Doye on  Tax Strategies for Solos & Smalls in a Digital and Web 3.0 World. A few caveats. First, while I’d hoped to employ ChatGPT to assist with summaries of each topic addressed, the output was frequently inaccurate due to truncating concepts or improperly combining them.  So this summary relies entirely on my notes  – and any inaccuracy should be attributed to my own errors in transcription and not the speakers.  Second, this summary is intended to identify issues, not to provide advice.  It goes without saying that you should consult a qualified CPA and/or tax attorney with experience in digital transactions (such as the two Techshow presenters) for guidance on your specific situation.

Overview of Taxes in a Digital World

The shift to a more digital economy presents a unique set of issues when it comes to taxation on legal services by lawyers who start or operate their own firms.  This summary examines the key issues related to taxation of legal services in a digital environment, with a focus on topics like deductions for tech tools, taxes related to virtual legal services and contractors in different states and countries, tax payments related to flat fees and traditional retainers and crypto payments. Let’s go!

Tax Deductions for Law Firm Tech Tools

Businesses that use technology for business operations can deduct the cost of tech support services like email set-up, data recovery, and website maintenance. Law firms should maximize their tax deductions by understanding IRS regulations related to tech tool expenses.  This way, they can ensure they are not overpaying in taxes and can better manage their finances.

Law firms should be aware of the tax treatment related to tech expenses to help them maximize their tax deductions. According to IRS regulations, they may be able to deduct the cost of tech support services including email set-up, data recovery, and website maintenance.

Law firms are increasingly turning to technology in order to remain competitive and better serve their clients. The IRS allows firms to deduct the cost of tech tools that are ordinary and necessary for business operations, as well as tech support services such as email set-up, data recovery, and website maintenance. By understanding these IRS regulations, law firms can maximize their deductions for tech tool expenses and better manage their finances.

Tax Treatment of Flat Fees v. Advance Retainer Fees for Lawyers

When it comes to taxes, flat fees earned on receipt versus advance retainer payments are treated differently.  [Editor’s note:  see this detailed post for guidance on when flat fees are considered earned].   Flat fees must be reported as taxable earned income in the year they are received.  Retainer payments may be spread out over multiple years depending upon when work is completed.  Any unearned portion of retainer payments can be carried over and reported as taxable income when services are provided in future years. Law firms should be aware of these distinctions in tax treatment of flat fees versus retainer fees (or advance payments). to ensure accuracy in reporting their earnings throughout the year.

Tax Treatment of Law Firm Use of Virtual Contractors

All income earned by a virtual overseas contractor is subject to IRS tax laws and must be reported on a 1099 form, with some exceptions. A 1099 is not required for contractors who are not U.S. citizens.  However, U.S. citizens who are living abroad and still perform some work in the U.S. must file a 1099. However, a 1099 is not necessary if the individual is not a U.S. citizen.

 If the contractor can meet the IRS’s definition of a “qualified individual,” they may be eligible for the Foreign Earned Income Exclusion, which allows a taxpayer to exclude up to $102,100 of their foreign-earned income.

Tax Treatment of Virtual Legal Services 

Bear in mind that contractors who perform work for your firm in a different state can create a strong enough connection to subject your firm to tax in that state.  If you provide virtual services in a state other than where your physical office or headquarters are located, there are several possible categories of taxes that may apply:

  • Sales taxes –  In most states, professional services are not subject to sales or use tax.  
  • Gross receipts taxesGross receipts taxes apply to company’s gross sales without allowances for deductions.  Seven states enforce a gross receipts tax (tax on gross sales with no allowance for deduction) which applies to revenues from professional services. The presentation cited one tax case out of Washington (Wash. Det. No. 21-0044)(October 26, 2022) which held that law firms receipts from IP legal services provided to Washington clients must be sourced to (and taxed) in Washington even though the firm was located in another state and had no physical presence in Washington. 
  • Income taxes – These are apportioned among all states where the firm does business, often sourced to the location the benefit is received which is the client’s location. . 

Taxes on Digital Courses and Apps Offered by Lawyers

Taxes on digital courses and apps vary by state. Pre-recorded digital courses are taxable in some states, and live courses are taxable in Florida with a communication tax. Software apps (e.g. client-accessible case management apps) may also be taxable, and revenue is sourced to the user’s location. [Editor’s Note – Additional tax implications of digital courses and apps are discussed in Tax Implications of Productizing Legal Services, MyShingle (September 2018)] 

Taxes and Blockchain Payments for Legal Services

Federal Taxes are relevant to individuals who have received or paid cryptocurrency. Receiving cryptocurrency is considered ordinary income and must be reported on taxes. Paying wages in cryptocurrency is also subject to federal income tax withholding. 

The taxation implications of digital applications and courses are becoming increasingly important in today’s digital world. This is especially true for those who accept, pay and receive cryptocurrency. In this post, we will discuss the federal taxes that are relevant to individuals in this context and explore some of the potential tax implications involved with these activities. Specifically, we will look at the taxation of receiving cryptocurrency, paying wages in cryptocurrency, and other related considerations.

What happens when a lawyer sells or converts crypto received into dollars (which incidentally, some states like Nebraska require) Under federal law, cryptocurrency is classified as property so its sale is taxable as capital gains. Cryptocurrency is generally treated as property for U.S. tax purposes. This means that income from cryptocurrency transactions would be reported as capital gains. Capital gains from the sale of cryptocurrency may or may not be subject to taxes depending on the taxpayer’s state of residence and certain other factors.

Transfers of cryptocurrency between wallets, addresses, or accounts can occur and are non-taxable as long as they belong to the same individual. Mandatory disclosure requirements mandate the documentation of all dispositions of virtual currency and its fair market value.

Finally, there are state tax implications for payment by cryptocurrency.  Many states treat cryptocurrency as a cash equivalent and may subject it to some form of income, property, or sales tax (check your state!).   However, it can be challenging to source the revenue, since anonymity is key in blockchain technology, and states require accurate geographic sourcing to comply with taxes.