Key Takeaways
- The IRS stops treating you as an employee the day your firm reports you on a Schedule K-1 instead of a W-2. This happens even if your draw looks and feels exactly like the paycheck you had as an associate.
- Self-employment tax can run as high as 15.3% on your K-1 income. Unlike your associate years – the only difference is that nobody withholds it for you.
- The IRS expects quarterly estimated payments starting the first spring of your partner year. Missing that first deadline is the most common mistake we see, and it’s an expensive one.
- Your guaranteed payment might be taxed based on where the firm’s clients are, not where you sit. A partner working from one state can still owe tax to another, if that’s where the firm earns most of its revenue.
- Becoming a partner opens up deductions you didn’t have as an employee, from self-employed health insurance to retirement plans that can shelter far more than a 401(k) alone.
Every promotion season, a wave of newly named partners gets the same memo. Payroll is stopping. A Schedule K-1 is coming instead, and nobody explains what that actually means for a tax return.
The conversation with new clients in this position tends to go the same way. The firm sent a notice. The paycheck changed. Nobody says when the IRS actually wants money from you once this change takes effect, and that question usually doesn’t get answered until the estimate deadline is already close. This article is that answer.
Why Did My Firm Stop Giving Me a W-2?
Under a long-standing IRS position, a partner can’t also be an employee of that same partnership. Once your firm admits you as a partner, it reports your compensation on a Schedule K-1, which the firm files as part of its own tax return, Form 1065. From that point on, the IRS typically treats your entire draw as self-employment income rather than wages.
That holds even when your pay is a fixed number that looks and functions like a salary. In partnership tax terms, a fixed draw like that is usually called a guaranteed payment. Guaranteed payments to a partner who performs services are generally subject to self-employment tax, just like a share of the firm’s profits would be.
Not Every Firm Handles This the Same Way
Not every firm treats a promotion the same way, because the rule depends on whether you hold a genuine partnership interest, not just the title. A firm can call someone a “non-equity partner” without giving them an actual stake in the partnership itself. This means they have no capital account and no formal admission under the partnership agreement. If the interest is structured that way, the IRS still sees an employee underneath the title, so the firm can legally keep that person on W-2 payroll. Other firms grant a real partnership interest the moment someone makes partner, which is exactly what forces the K-1 immediately. Your offer letter and your first pay cycle will tell you which structure your firm actually uses. Everything below applies once a K-1 is what you’re actually receiving.
The Promotion Itself Usually Isn’t Taxable
Getting promoted usually isn’t a taxable event by itself. Your admission might come with a profits interest, a right to share in the firm’s future profits. That’s different from a claim on what the firm is already worth. Receiving a profits interest generally isn’t taxable, as long as IRS safe harbor rules are met. What actually changes your taxes is how your ongoing pay gets treated going forward, not the promotion itself. What changes your taxes is how your ongoing pay gets treated going forward, not the promotion itself.
Why the Limited Partner Exception Usually Doesn’t Apply
One more point deserves caution. The tax code technically exempts limited partners from self-employment tax on their share of partnership income. A limited partner, traditionally, is someone who invests in the business but doesn’t help run it. In practice, the Tax Court applies a functional test, one that looks at what a partner actually does, not what a title says on paper. A partner who actively practices law inside the firm generally can’t rely on that exception. The IRS has litigated this area actively in recent years. Treat any structure that promises to make partner income exempt from self-employment tax with real skepticism, and model it with an advisor before relying on it.
What Actually Changes: Associate vs. Partner
| Senior associate (W-2) | Income partner (K-1) | |
|---|---|---|
| Income reporting | Form W-2 | Schedule K-1 (Form 1065), often from multiple states |
| Payroll taxes | 7.65% FICA withheld; firm pays the other half | Self-employment tax of up to 15.3% on net earnings, paid by you |
| Income tax withholding | Withheld each paycheck | None; you make quarterly estimated payments |
| Health insurance | Pre-tax through the firm’s cafeteria plan | Premiums typically flow to you; deducted as self-employed health insurance |
| Retirement | Employee 401(k) deferral plus any match | Deferral plus employer-side contributions through the firm’s plan, often with a cash balance plan layered on top |
| State filings | Usually one resident state return | Resident return plus nonresident returns or composite filings in the firm’s other states |
| Tax deadline pressure | Mostly April | Four estimate deadlines a year, plus extended K-1 timing |
How Much Self-Employment Tax Will You Actually Pay?
Self-employment tax combines two rates. The first is 12.4% for Social Security, which stops once your net earnings pass $184,500 for 2026. The second is 2.9% for Medicare.
An additional 0.9% Medicare tax kicks in above $200,000 of self-employment income for single filers, or $250,000 for joint filers.
Net earnings are generally 92.35% of your self-employment income, and half of the base tax is deductible against your income tax.
A Worked Example
Here’s why that matters in dollars, not just percentages. Take a first-year partner filing single, with a $450,000 distributive share (their proportional cut of the firm’s profit for the year), all of it self-employment income:
- Net earnings from self-employment: roughly $415,600 (92.35% of $450,000)
- Social Security portion: $22,878 (12.4% of the $184,500 wage base)
- Medicare portion: roughly $12,050 (2.9% on the full net earnings figure)
- Additional Medicare tax: roughly $1,940 (0.9% on net earnings above $200,000)
- Total: roughly $36,900, with about half of that deductible against income tax
Compare that with the roughly $17,900 of employee-side payroll tax the same person likely paid the prior year, on a $350,000 associate salary.
The jump isn’t just about higher income. As an associate, you paid half of FICA, the payroll tax that funds Social Security and Medicare, and the firm quietly covered the other half. Now the full amount lands on one return, with nothing withheld along the way. Your own numbers will differ based on filing status and what else is on your return. That’s exactly why new partners typically want this modeled before the first estimate comes due.
How Do Quarterly Estimated Taxes Work in Your First Partner Year?
This is where first-year partners tend to get caught off guard. With no withholding, the IRS generally expects payments four times a year: mid-April, mid-June, mid-September, and mid-January. Underpay, and a penalty starts accruing like interest on the shortfall.
The planning anchor is what’s known as the safe harbor. Taxpayers whose prior-year adjusted gross income topped $150,000 can generally avoid underpayment penalties by paying in 110% of last year’s total tax, through withholding and estimates combined. In a promotion year, that safe harbor is especially useful. Your prior-year tax was based on associate-level income, not your new partner draw. Many new partners pay estimates against that 110% floor, hold the difference in reserve, and true it up at filing once a full partner year is on the books.
Timing depends on when the promotion took effect. A clean January 1 start means a full K-1 year from day one, with the first estimate due that April. A mid-year promotion is messier: W-2 withholding for part of the year, none after. That withholding still counts as paid evenly across the year, which helps, but it rarely covers a full partner-level jump on its own. Either way, the cheapest first move is a projection done in the quarter the promotion takes effect, not a guess made the following April.
Our subscription tax service also means you get a year-round strategy so you can discuss how the impact of a change in your job title will affect your tax return. Explore our Tax Service Subscription Pricing
Earlier Is Cheaper
One newly admitted partner at an Atlanta firm came to us in October of their promotion year. They’d made no estimated payments since their W-2 withholding stopped that June. A two-payment catch-up plan against the safe harbor, followed by the regular January estimate, kept the penalty exposure to a few hundred dollars instead of the several thousand it was building toward. Therefore, we always say that earlier action is usually cheaper in terms of penalty costs.
Which Deductions Open Up Once You’re on a K-1?
The K-1 isn’t all bad news. There are also a few deductions that become relevant in year one.
- Self-employed health insurance. Premiums that used to run pre-tax through the firm’s plan generally can’t work that way anymore. Instead, premiums paid through the partnership are usually reported to you, then deducted above the line as self-employed health insurance, subject to the standard rules. This can cost you slightly more than before, since the deduction lowers your income tax but not your self-employment tax, unlike the old pre-tax setup, which reduced both.
- Half of your self-employment tax. This is deductible automatically. In the example above, that’s roughly $18,000.
- Unreimbursed partner expenses. If your partnership agreement requires partners to cover certain business costs personally, bar dues or a portion of business development, for example, those can sometimes be deducted on Schedule E. The agreement’s actual language matters here; costs the firm would otherwise have reimbursed generally don’t count.
Retirement Contributions Scale Up Considerably
Retirement contributions scale up considerably as well. For 2026, the employee deferral limit is $24,500, and the total defined contribution limit is $72,000 per plan. As a partner, employer-side contributions to the firm’s plan effectively come out of your own earnings.
Many large firms layer a cash balance pension plan on top of the 401(k). That’s a plan type that guarantees a set future benefit rather than tracking an account balance. Depending on your age and the plan’s design, that combination can push deductible retirement savings well past the standard limit. New partners often leave this on the table simply because nobody flagged the election window in time.
The QBI Question: Maybe, Probably Not Yet
The qualified business income deduction, or QBI, is a maybe, and probably not yet. Two separate walls stand between a new partner and this 20% deduction on pass-through income. First, guaranteed payments for services are statutorily excluded from qualified business income entirely, while a distributive share of profits can qualify. If your entire draw is a guaranteed payment, as it usually is for a new partner, QBI generally isn’t available on that income, regardless of what you earn. Second, law is classified as a specified service trade or business, so even distributive share phases out at higher incomes. Under the One Big Beautiful Bill Act, the deduction is now permanent. For 2026, it generally disappears once taxable income exceeds roughly $276,750 for single filers, or $553,500 for joint filers. In practice, QBI usually becomes a live question later, once guaranteed payments give way to a distributive share. That mostly applies to married partners whose household income falls inside that range.
Why Are You Getting K-1s From Different States?
Large firms practice in many states, and partnership income is generally apportioned to wherever the firm actually earns it. As a partner, a slice of your income gets sourced to each of those states. Each one may want a return from you.
Firms handle this in one of two ways, sometimes both. Many file composite returns, paying tax on your behalf so you don’t have to file separately. Others withhold state tax at the partnership level and leave any additional nonresident filing to you. Your K-1 package and the firm’s own tax matrix will show which method applies where. Either way, your resident state generally allows a credit for taxes paid to other states, so the same dollar usually isn’t taxed twice, even though the paperwork multiplies. A first-year partner filing eight or ten state returns is normal, not a red flag. At Fusion CPA, our multi-state tax team handles exactly this as a year-round tax strategy, not just a quick-fix around the April deadline.
Are Guaranteed Payments Taxed Where You Work, or Where the Firm Earns Its Revenue?
Here’s the part that surprises nearly every new partner. You’d expect your guaranteed payment to be taxed based on the state where you personally work, the same way an employee’s wages are. In most states that have actually addressed this question, that’s not how it works. Instead, the payment gets taxed based on where the firm’s business actually is.
The Multistate Tax Commission, a body that studies how states tax multi-state businesses, has been developing model guidance on this exact issue since 2023. Only about half the states have explicit rules at all. Among those that do, the more common approach sources a partner’s guaranteed payment for services the same way it sources distributive share, by the partnership’s own apportionment. For a law firm, that apportionment runs mostly on where its revenue is earned. A smaller group of states instead source guaranteed payments like ordinary compensation, to wherever the partner physically does the work.
When two states in your situation use different methods, the same dollar can be subject to double taxation. The usual resident-state credit doesn’t always untangle that cleanly, that’s why working with an experienced expert that understands how to interpret the intricacies is crucial to protecting your earnings.
Why the State Where You Sit Doesn’t Control
Why doesn’t the state where you sit control the outcome? A partnership doesn’t pay income tax itself. Its income, and the geography behind that income, passes through to the partners. For state tax purposes, a partner is generally treated as carrying on the firm’s business everywhere the firm carries it on. A partner at a firm doing business in Georgia has Georgia-source income through the firm itself, no flight to Atlanta required.
In states that follow this approach, a guaranteed payment isn’t treated as a paycheck for showing up at a desk. It’s treated as a priority slice of the firm’s income, paid out before the remaining profit gets split. That slice takes on the geography of the firm’s income, the same way a distributive share does. That geography comes from the firm’s own apportionment formula, and for service businesses those formulas now tend to follow the clients rather than the lawyers.
Suppose a firm’s receipts are 70% Georgia-based, because that’s where its clients sit. A new partner receives a $400,000 guaranteed payment. In a state that sources this way, roughly $280,000 of that payment counts as Georgia-source income. That holds true even if the partner works all year from an out-of-state office, on out-of-state matters.
What Changes Again When You Become an Equity Partner?
For most new partners, the guaranteed-payment structure above is a phase, not a destination. The next promotion, from income partner to equity partner, reshuffles the picture again. Guaranteed payments typically give way to a distributive share of the firm’s net income. That can reopen the QBI question, usually comes with a capital contribution or a financed buy-in, and starts a capital account that will matter for decades. Self-employment tax generally continues either way. That transition deserves its own full treatment; which your CPA can consider as part of your tax plan.
What About the SALT Cap and the Firm’s PTET Election?
State income tax on partner-level pay is real money, and the federal deduction for it, commonly called the SALT deduction for state and local taxes, is capped. For 2026, that cap sits at $40,400. It phases down by 30 cents for every dollar of modified adjusted gross income above roughly $505,000, hitting a $10,000 floor around $606,000 of income. Most partners at large firms land at or near that floor, which makes the personal deduction close to useless for them.
The workaround runs through the firm rather than the individual. Most states with an income tax, Georgia included, now offer a pass-through entity tax election, commonly called PTET. It lets the partnership pay state income tax itself and deduct it as a business expense, keeping that deduction outside your personal cap entirely. Whether your firm elects this, in which states, and how the resulting credit lands on your K-1 is a firm-level decision. It’s worth sitting with your CPA to ensure you have some level of understanding of it anyway, since it can meaningfully change your own estimate taxes.
Read our Georgia PTET guide for an idea of how the election and its deadlines work.
How Fusion CPA Can Help
A new K-1 changes more than one line on your return. At Fusion CPA, our tax team works with newly promoted partners across different states. We cover projecting the first year’s self-employment tax, setting estimates against the safe harbor, sorting out which states actually need a filing, and reviewing the firm’s PTET matrix to ensure compliance.
If you’ve just made partner, we usually start with a review of last year’s return, to see what the new structure actually changes. From there we handle ongoing personal income tax planning in line with your specific partnership agreement. Whether you’ve just made partner or need help optimizing your financial architecture as an equity partner, our team can support you.
Schedule a Discovery Call to talk through your situation.
About the author
Trevor McCandless, CPA, MTax is the founder and CEO of Fusion CPA, a tax, outsourced accounting, and advisory firm serving business owners and high-achieving individuals across 40+ states from offices in Atlanta GA, Tampa FL, San Juan Puerto Rico, and Park City Utah. He works with owners on entity structure, owner compensation, and the multi-state exposure that arrives quietly with a growing team.