There are few things that law firm partners hate more than having to lay out a bunch of hard-earned cash for a business expense that they can’t deduct from their income. This is what can happen when a law firm purchases a large amount of “fixed assets” such as computer hardware or software (but also including items like office furniture). These assets need to be capitalized and depreciated over their “estimated” useful life, which is determined by the IRS (not you) and dictates how quickly the costs of the assets can be written off.
That’s where the problem begins — a law firm spends the cash from operations and only gets to take a portion of that purchase as a deduction. This creates phantom income, which is when the firm’s partners have to pay taxes on income but do not receive the cash.
