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September 01, 2019

TCJA Tips for Law Firms

The Tax Cuts and Jobs Act has altered several substantive tax provisions affecting law firms.

Corey Veneziano and Stephen Fuller

The Tax Cuts and Jobs Act (TCJA), signed into law by President Donald Trump in late 2017 and taking full effect in 2018, is easily the most far-reaching and significant change to federal tax policy since the 1980s. From sweeping changes in deductions to fewer tax brackets to a much lower business tax rate, the sea change brought about by the TCJA has been felt in every corner of the U.S. by businesses, industries and individuals alike.

The legal community has indeed been a part of the drama surrounding this new tax law, just like most major industries across the nation. Law firms are now left with a number of questions to ask regarding how to maximize the benefits of the TCJA while minimizing the drawbacks. In this article we address the key areas that law firms should consider.

S Corporations, C Corporations and the Section 199A Deduction

One of the biggest changes facing law firms is the status of the corporation. Many law firms are likely to consider changing corporation status from an S Corporation or partnership (pass-through) status to a C Corporation tax status (where profits are taxed separately from the company’s owners). While many law firms are pass-through entities for tax purposes, the reduction of the top tax rate for C Corporations from 35 percent to 21 percent could prove to be a major incentive for firms to consider a change.

In addition to the 21-percent tax rate, a C Corporation may also offer other advantages. For example, there is no limitation on state tax deductions. At the personal level, the new law created a cap on personal state tax deductions for owners of pass-through entities. The cap is $10,000, effectively eliminating significant deductions for most owners of pass-through entities.

There are drawbacks to using the C Corporation structure for certain law firms. A firm that qualifies for the new 20-percent Qualified Business Income deduction under Section 199A will be better off remaining as a pass-through entity. C Corporations remain subject to two layers of taxes. Additionally, an owner planning to sell may be better off as a pass-through entity if the Qualified Small Business Stock Exclusion will not apply.

Under the new law there is no one-size-fits-all solution. Law firms should closely examine Section 199A of the TCJA, along with all other relevant facts and circumstances, to determine the best tax status for the law firm under the new law.

The 199A deduction generally allows the owners of a pass-through entity to take a deduction for a percentage of pass-through income (subject to various tests). Attorneys generally cannot take the Section 199A deduction as the new law excludes specified service trade or businesses (SSTB) from the deduction. Law firms providing legal services are SSTBs. The limitation does not apply to those with a taxable income below $315,000 if married, or $157,500 if single. (The deduction phases down for SSTB owners whose taxable income is between $315,000 and $415,000 for married filing jointly and $157,500 to $207,500 for single taxpayers). Note the test looks to taxable income (after health insurance, retirement plans, etc.), as measured on the individual’s tax return, not gross income.

Decoupling Meals and Entertainment

One of the widely publicized new features of the TCJA is the restriction now placed on businesses considering the deductibility of expenses used for meals and various forms of entertainment. This is clearly an area of importance to law firms, as client meals and events have long been an important aspect of the marketing efforts of law firms.

Before the TCJA 50 percent of meals and entertainment expenses were deductible. There were broadly drawn definitions and exemptions that often led to 100-percent deductibility. The new rules are much stricter. Entertainment expenses in particular are now 100-percent nondeductible.

Under the TCJA meals should now be separated, from an accounting perspective, from entertainment entirely, as business meals are still considered 50-percent deductible. If the deductions are grouped together—for example, if food and beverages are purchased at a business-related sporting event—the deduction is lost entirely.

The Qualified Transportation Fringe Benefit

The transportation fringe benefit is another area impacting law firms. Employees are still allowed to deduct up to $265 per month, pretax, for parking expenses; however, the employer deduction for parking and other qualified transportation expenses has been eliminated by the TCJA unless the amounts have been included in the employees’ gross income. Law firms will now have to decide whether to continue paying for the parking benefit without any available deduction or to pass the tax burden onto their employees by including it in their taxable income.

Other parking-related expenses incurred by employers may no longer be eligible for a deduction, depending on the parking arrangement. These rules could limit the deductibility of expenses for law firms that own or rent their parking lots. Some of the expenses that could be limited are repair and maintenance, utility costs, insurance, property taxes, interest, snow or ice removal, leaf removal, trash removal, cleaning, landscaping costs, attendant expenses, security and rent/lease payments.

Family and Medical Leave

The new law does provide something more positive for law firms. There are new tax credits available under the TCJA for paid family and medical leave. It is a temporary credit, but it allows employers to claim up to 12.5 percent (or one-eighth) of a qualified employee’s salary while that employee is on family and medical leave as long as that is equal to at least 50 percent of that employee’s usual income.

The Limitation on Deduction of Business Interest

Section 163(j) of the new tax code disallows interest expense that exceeds 30 percent of the firm’s adjusted taxable income. For law firms utilizing debt and operating in a manner that results in low taxable income, payment of interest will need to be considered. There is an exclusion from Section 163(j) for taxpayers who meet the $25-million gross receipts test.

The TCJA results in systemic change. The impact of seeking to institute the entirety all at once cannot be understated. The key is for law firms to get as familiar as possible with this new law as quickly as possible—and to start to adjust based on anticipated future firm needs. As is usually the case, those who act first will be far ahead of those who wait too long to act.

Corey Veneziano is a tax partner with blumshapiro, the largest regional business advisory firm based in New England. As such, he has a wide range of experience in tax compliance, consulting and planning for privately held businesses and their owners. He has provided tax services to clients in a variety of industries, with a focus on professional services. 

Stephen Fuller is a tax partner in blumshapiro’s Tax Department. He has over 10 years of experience providing tax planning, financial reporting and compliance services to his clients, with substantial experience in corporate tax. He has expertise in a wide variety of industries, including professional services, distribution and retail, and financial services.