Does it make sense to become a solo practitioner?
The law school critics predict doom if you make that choice. But to reach that conclusion they rely on data that is problematic and thus likely to mislead anyone who relies on it alone. But other, perhaps better, data – generated by the U.S. Census Bureau – shows that solo practitioners likely are doing reasonably well.
Let’s walk through the numbers.
First, the law school critics point to data from the IRS (summarized in a book by Professor Ben Barton of the University of Tennessee called Glass Half Full (“GHF”)) suggesting that in today’s (2012) dollars the income of solo practitioners has fallen dramatically relative to what lawyers earned in the late 1980s.
To reach this conclusion the critics select carefully from Barton’s IRS data. They start at the peak of lawyer earnings in that earlier period – 1988 – when the economy was in the midst of a bubble led by real estate and leveraged buyouts. No doubt, then, there was plenty of work for lawyers. In 2012 dollars lawyers in solo practice apparently (I say “apparently” because of problems with the data discussed below) earned (on average in means) about 70K then (in 2012 dollars) and in 2012 they apparently earned 49K. That would be a pretty steep drop (if it is accurate). One way of putting would be to say that lawyers in solo practice now only earn about 70% of what they once earned measured in buying power.
But hold on.
The very year after that 1988 high point the bubble burst and in 1989 solo’s were only earning 61K (again, in 2012 dollars). And if you go back a few years from 2012 to the near peak of the recent credit bubble (say, 2005) solo’s were earning 57K. In other words they had, over a 26 year period, lost only a tiny amount in buying power. Of course, I am cherry picking, too, in order to highlight the problem that can arise with this particular data set.
Since the critics rely on this data to suggest that there has been a massive structural shift against the interests of solo practitioners (using words like “collapsing economics” to describe the plight of solos) and lawyers generally it’s important to see that, in fact, that’s not really true.
Take another example. Go back a few years earlier in the data (by the way, thanks to Professor Barton for sharing his full data set with me – he did the hard work – and of course the conclusions I draw from the data are purely my own). In 2012 dollars, solo practitioners were earning 41K in 1982. In 2012 they were earning 49K. In other words, remove the impact of the real estate/LBO bubble of the late 80s and remove the impact of the credit bubble of the mid-2000s and solo practitioners incomes have, in fact, improved significantly over time relative to inflation.
But there are also problems with relying solely on the IRS data in GHF that go beyond this kind of cherry picking by those who choose to cite to GHF. While Professor Barton views the IRS data as the “best available” (in part, he explained to me, because it is longstanding and has been consistently collected over many years), it has its limits. This particular data set is, in fact, only a proxy for lawyers in solo practice and a proxy with some important qualifications.
1) Data Pollution. The data derives from an occupational category called “Legal Services” (described more fully here). It is not, in fact, a category that includes only lawyers. “Legal Services” includes numerous other non-lawyer occupations such as paralegals, patent agents, notaries, process servers and title officers. Thus, when it is said that there are 350,000 solo practitioners based on the fact that the IRS reports that approximately 350,000 tax returns were filed in the category Legal Services, we know that, in fact, the number of lawyers is smaller than that number. Because those non-lawyers likely earn less than lawyers it is likely that their inclusion skews the data towards lower incomes. In other words there are fewer solo practitioners than 350,000 and they earn more money than the data in the Legal Services category suggests (that is, more than 49K in 2012).
The IRS has confirmed this problem with me in an email from Emily Gross of the Statistics of Income Division of the Service: Our data follows NAICS codes and as you note, Legal Services includes both law offices as well as “other legal services”. “Other legal services” includes categories such as Notary public services, paralegal services, process servicing services, and real estate settlement offices. There is no way to separate Offices of Lawyers from the other data in the NAICS code 541100. The file is sorted according to these codes.
As an indication (but only an indication) of the potential impact of this mixing of classifications, the Census Bureau tracks the number of establishments categorized as “Offices of Lawyers.” They report there are only 174,000 such entities in 2012. These would include partnerships and incorporated entities. That result is, in fact, much closer to the data that the Census reports in its American Community Survey I discuss below for “self employed unincorporated” lawyers. The Census Bureau also reports a relatively small number of “other legal services” and the number do not add up to the 342,000 returns the IRS reports for the overall category. Unfortunately the IRS’s Ms. Gross confirms to me that there is no way to resolve this discrepancy with the IRS data.
2) Classification Mismatch. The data for filers in Legal Services is also only for “sole proprietorships” – a business entity that is neither incorporated nor a limited liability company. Sole proprietorships are not necessarily the same as solo practioners. It is possible since the 90s, and fairly common now, for solo practitioners to use a limited liability entity such as an LLC, a corporation or other form, in which to carry out their practice.
Census data I discuss below indicate a significant increase in “incorporated” self-employed lawyers in parallel with a decrease in unincorporated self-employed lawyers over the last 15 years.
If a solo practioner uses a limited liability entity, their earnings will not automatically appear in the IRS data presented by Barton.
A related problem is that while sole proprietorships are by definition owned by one person they can, and often do, hire other employees. A lawyer could hire associate lawyers, for example, as employees of the sole proprietorship. That means that some returns can show up in the Barton IRS data that do not represent true solo practitioners. The IRS data indicate that Lawyer sole proprietorships pay billions in salaries (not including salaries to the owner of the firm) suggesting the impact of these types of firms is not insignificant.
Further complicating matters, single member LLC’s (not the same as a solo practice as the LLC can hire associates who are not members) can elect to file a return as a “sole proprietorship” and more than a million LLCs do so every year across all occupational classifications. So those single member LLC’s could show up in the GHF data (and likely do) meaning the data overstate the number of solo’s.
Fortunately, the alternative Census Bureau data set I describe below provides a fix of sorts for some of these problems.
3) Gross Revenue v. Net Income. The “income” figures used in GHF and relied on by law school critics are what the IRS calls “net income” – in other words, the number is generated by the taxpayer him or herself after applying deductions to business receipts. (These returns are unaudited except in very rare circumstances.) The income for business receipts is, of course, much higher than the net income number.
For the tax year 2013, for example, “Legal Services” sole proprietorships generated approximately $40 billion in reported “Business Receipts” but only about $17 billion in net income. And in recent years that “Business Receipts” per return number has held up well against inflation. As an example, it was $120K per return in 2001 (measured in 2013 dollars) and $116K per return in 2013. That number is a much closer approximation to what the Census data I discuss below shows (the remaining delta between 116 and the higher Census results may be explained by the other issues described here). That seems to make sense – if the Census (like anyone else) asks you what you make each year you are likely to provide a pre-tax number that is akin to the “Business Receipts” gross revenue category on Schedule C for a sole proprietorship.
4) Cheating. Finally, of course, one has to ask, understandably, whether or not anyone should rely on the numbers that Americans provide the IRS. There are certainly well known incentives to under report income and over use deductions, in other words, to cheat. Given the very low rate of actual criminal prosecutions for tax fraud and the near certainty that one can reduce one’s tax obligations the incentives weigh on the side of under reporting income and over use of deductions. It turns out that lawyers as a class may be less likely to engage in outright cheating.
But it’s not really a question of whether or not lawyers cheat on their tax returns. It’s a question of whether they are capable of taking better (honest) advantage of deductions or other IRS rules that then help bias both the gross receipts and the net income numbers downward. That makes the IRS data a less reliable metric for anyone trying to understand the plight of solo practitioners. As one possible indicator, of the approximate 350,000 returns filed for sole proprietorships in the Legal Services category in tax year 2013 some 70,000 show no net income at all even though they generate more than 1.6 billion dollars in business receipts – somehow they found a way for all that revenue to disappear. (Data for TY 2013 and other years here.)
So, if the IRS data has problems, is there better data available? Well, the Census Bureau generates data that I think may provide a more accurate picture of what solo practitioners earn. It comes from the American Community Survey (“ACS”) (which goes back to 2001) and from the Decennial Census (“DC”) (for earlier years though limited to 10 year reporting periods). Mike Simkovic helpfully has extracted the relevant data from the ACS for all lawyers working full time (the vast majority) here and with both ACS and DC here (this time including part time lawyers and also breakdowns according to race and sex). Mike discusses some more detailed aspects of the ACS here.
This data has several advantages over the IRS data.
First, instead of relying on a category as broad as “Legal Services” the ACS data divides into two (relevant) classifications: lawyers who are self employed but unincorporated and lawyers who are self employed but incorporated.
This data, in other words, is lawyers only – no pollution from other occupations.
Further, it is a survey of individuals. When the two classifications are added up one gets about 300,000 individuals, or about 23% of the 1.3 million licensed lawyers in the US. That is higher than some estimates of the number of solo practitioners but lower than others. My guess is that many of those in the second category – self employed but incorporated – are not true solo practitioners because they use those entities to hire other lawyers who work for them – they are self employed meaning their own firm hires them but they, in turn, hire others as well. That may also explain, as we will see shortly, why the incomes in the second category are higher than in the first.
(The second category has one other complication – it only includes incorporated entities so it may not include LLCs. In fact, that may explain the bias downward in the Barton IRS data – practicing as a solo in a sole proprietorships is no longer the most sensible way to practice law and now that a variety of limited liability entities are available solo’s have shifted into that category which goes untracked in Barton’s data set. As I noted above it is tracked by the Census Bureau: in 1990 (just as the LLC form was being recognized along with other limited liability forms like the professional corporation) 213,000 unincorporated self-employed lawyers and only 77,000 incorporated but in 2014 there were only 167,000 unincorporated and 160,000 incorporated.)
As the ACS chart of all lawyers working full time (again, the vast majority) indicates, those in the first category (self employed and unincorporated – probably our best proxy for solo practitioners) have seen (mean/nominal) incomes grow from $116,000 in 2001 to $165,000 in 2014 (full time). And those in the second category (self employed but incorporated also full time) have grown from $151,000 to $186,000.
In buying power terms incomes in the first category rose from $155,000 to $165,000 and in the second fell from $201,000 to $184,000. Thus, it appears the second category has fallen behind. But a closer look indicates this is a bit misleading. That category has more volatile results and if one uses 2013 as a benchmark (when their income was reported as $197,000) those lawyers keep even with inflation.
Of course, the results in both categories fall when part time lawyers are added. The impact, though, is relatively minor. Instead of staying ahead of inflation over the last fifteen years, for example, those in the unincorporated category stay dead even. You can also go back to 1990 (with the help of the Decennial Census data) and you find that lawyers in that same category stay even with inflation.
Keeping even with inflation might not seem like an achievement but it means that relative to how others are doing in an era of an allegedly stagnant middle class (a controversial proposition), lawyers in solo practice are holding their own. Much of the critics’ argument that law school is in need of a drastic overhaul has been based on the idea that law schools are producing graduates unable to hold their own even relative to less well educated workers. There seems little basis to this conclusion given this data as opposed to the anecdotes that many of the critics rely on.
And, of course, holding your own as a lawyer at an annual income of $147,000 or $165,000 or $184,000 puts you way ahead of most of the country’s workforce (where the mean household income is about $73,000).
That means there is little basis to the case that some kind of tectonic shift in the lives of lawyers has taken place. It suggests that for lawyers, at least, the glass is more than half full. It also implies that whatever their ups and downs in the market place law schools are continuing to produce trained professionals who are in demand in the marketplace.