How Law Firm Partners Can Reduce Their State Tax Burden

If you’re a law firm partner in a high-tax state—like California, New York, New Jersey, or Illinois—chances are you’ve felt the sting of your state income tax bill, especially after becoming a partner. For attorneys who receive K-1 income and pay their own estimated taxes, the state tax burden can be one of the most frustrating parts of partnership compensation.

And while there’s no magic solution to eliminate state taxes altogether, there are smart planning strategies that can materially reduce your exposure—if you understand the rules and act early in the tax year.

This article walks through the primary levers law firm partners can use to reduce their state tax liability, including PTET elections, credit planning, residency considerations, and income-sourcing strategies.

Why State Taxes Hit Partners Harder

As a partner, you’re likely paying:

• State income tax on all your K-1 income, regardless of whether you received it

• Tax in multiple states, depending on where the firm operates or where clients are located

• No longer benefiting from automatic payroll withholding or employer-paid tax planning services

Adding to the challenge, the $10,000 cap on the State and Local Tax (SALT) deduction—enacted under the 2017 Tax Cuts and Jobs Act—means high earners get little or no federal deduction for state taxes paid.

For many law firm partners, this creates an effective tax cliff: 35–45% marginal tax rates, even with disciplined planning.

But several states and firms have implemented tools that can help.

1. Leverage the PTET Election (Pass-Through Entity Tax)

The Pass-Through Entity Tax (PTET) is a workaround created in response to the SALT deduction cap.

Here’s how it works:

• Instead of individual partners paying state income tax personally, the partnership pays the tax at the entity level.

• This entity-level payment is fully deductible for federal tax purposes (because it’s a business expense, not an individual SALT deduction).

• The partner then receives a credit on their state return, offsetting or eliminating their personal tax liability in that state.

Result: You reduce your federal taxable income, which in high-tax states can mean savings of $10,000 to $50,000+ per year, depending on your K-1 income.

States with PTET Programs (as of 2024):

• California

• New York

• New Jersey

• Illinois

• Connecticut

• Oregon

• Massachusetts

• Minnesota

• Georgia

• And others (programs vary by year)

More than 30 states now offer some version of PTET. The rules vary widely—some are elective, some are mandatory, and others offer different credit mechanisms.

Key Questions to Ask Your Firm:

• Does the firm elect into PTET in each applicable state?

• Do I need to opt in individually (as in California)?

• When is the election deadline and what are the payment dates?

• Will PTET payments affect my distribution schedule or tax draws?

Action Step: Coordinate with your firm's finance department and CPA early in the year to ensure you're opted in where applicable and projected to benefit.

2. Use Resident and Nonresident Credit Planning

Many law firm partners work in one state and live in another—or generate income from multiple jurisdictions. In these cases, you may be double-taxed unless you carefully plan how to claim credits.

Example:

• You live in New Jersey and work in New York.

• Your firm allocates income to New York, but New Jersey taxes worldwide income for residents.

• You must pay both—but New Jersey allows a credit for taxes paid to other states, subject to limitations.

The devil is in the details. Credits are not always dollar-for-dollar, and some states do not allow credits for entity-level PTET taxes, which can lead to surprise liabilities if not planned carefully.

Action Step: Have your CPA prepare a multi-state income allocation and credit calculation before the year is over, not just at filing time.

3. Consider Where Income Is Sourced

Most state income tax rules follow source-based taxation for nonresidents.

That means:

• If your firm generates income from California clients, California may tax your share of that income, even if you don’t live or work there.

• Likewise, if your work is performed remotely in a lower- or no-tax state (like Florida or Texas), that income may be excluded from higher-tax jurisdictions—if sourced correctly.

Firms don’t always get this right. Many law firm finance teams take a blanket approach to K-1 allocation, which can overstate your income sourced to high-tax states.

Action Step: Ask how your income is being sourced across states and whether it reflects your actual work location and client mix. If you’ve recently relocated or transitioned to remote work, you may be eligible to reduce your nonresident state exposure.

4. Evaluate Strategic Relocation

This is a longer-term play, but for partners earning substantial K-1 income, changing your state of residency can create six-figure lifetime tax savings.

Popular low- or no-income tax states for law firm partners include:

• Florida

• Texas

• Nevada

• Tennessee (for individuals)

• Washington (depending on capital gains treatment)

However, establishing residency isn’t just about changing your address. High-tax states like New York and California aggressively audit former residents and apply “statutory residency” rules, which can trigger tax even after you think you’ve left.

To successfully change your domicile, you must:

• Spend fewer than 183 days per year in the old state

• Establish a new home, driver’s license, voter registration, etc.

• Move bank accounts, advisors, and your day-to-day life

• Maintain documentation to prove your move

Action Step: If you’re considering relocation, work with a CPA who specializes in residency planning and state audits. The burden of proof is on the taxpayer.

5. Don’t Overlook Local and City Taxes

In addition to state income tax, many cities impose additional levies on partners.

Examples include:

• New York City: Unincorporated Business Tax (UBT)

• San Francisco: Gross receipts tax

• Philadelphia: Net profits tax and Business Income and Receipts Tax (BIRT)

• District of Columbia: Unincorporated Business Franchise Tax

These taxes are often separate from your individual return and may require quarterly estimated payments.

Action Step: Ask your firm’s tax team or outside advisor whether your partnership is subject to any local-level tax filings. Many partners miss these entirely, resulting in interest and penalties.

Summary: State Tax Planning Checklist for Law Firm Partners

StrategyPurposePTET ElectionConvert nondeductible state taxes into federal deductionsCredit PlanningAvoid double taxation in multiple statesIncome Sourcing ReviewAllocate income correctly across jurisdictionsRelocationLong-term strategy to lower or eliminate state income taxLocal Tax ComplianceAvoid penalties from missed city-level filings

Final Thoughts

Law firm partners—particularly those in high-income brackets—have more tax complexity than ever. And while federal tax planning often gets the spotlight, state-level strategies can be just as impactful.

Whether it's electing into PTET, properly allocating income across states, or considering a move, proactive planning is the key to reducing your total tax liability and avoiding unpleasant surprises.

The biggest mistake partners make? Waiting until tax season to think about it.

State and local tax planning should happen in January through September, not just in April. Elections, estimates, and sourcing decisions are time-sensitive and hard to unwind after the fact.

Want to build a personalized strategy to reduce your state tax exposure?
Schedule a consultation with Balanced Capital and make your K-1 income work harder for you.