Law firms and other professional service firms are experiencing significant challenges during the COVID-19 pandemic. Law firms, both large and small, may be faced with a variety of economic difficulties as their clients are faced with their own economic challenges. Law firm clients are experiencing significant losses, layoffs, and other disruptions. Most significantly for many law firms is that clients are reducing their legal costs by putting deals on hold and staying litigation. In some cases, clients are defaulting on their current accounts payables to law firms, a trend anticipated to continue as the crisis grows. As a result, some law firms across the country are facing considerable revenue losses.
Law firms may face other economic disruptions as many legal and non-legal staff are working remotely. Many law firms may be unprepared to deal with many administrative issues including tax compliance. Unfortunately, in response to these challenges and disruptions, some law firms have begun to lay off legal and non-legal staff, reduce business travel and revoke recent employment offers.
During these stressful and uncertain times, professional service providers should be aware that the COVID-19 crisis creates both tax risks and opportunities.
State and local tax risks
During this particular time, law firms may face several significant state and local tax risks. The majority of law practices operate as pass-through entities. Many state and local governments impose entity-level taxes. Law firms may have cash flow issues that prevent or delay compliance or payment of the myriad of entity-level taxes. In addition, despite the reduced revenue, shareholders, partners, and members may have tax liabilities from 2019.
The sudden dispersion of legal and non-legal staff due to mandatory remote work policies and stay-at-home orders may create additional state and local tax compliance issues. Law firms could find themselves with tax liabilities in new jurisdictions based on the location of remote working employees. Finally, many law firms may be ill-equipped to perform many tax compliance tasks remotely. While most states are extending filing deadlines, the tax return information will eventually have to be reported correctly.
State and local tax opportunities
Law firm managers should be aware that there are numerous state and local programs and policies that offer the opportunities to alleviate tax burdens in response to the pandemic. These programs and policies may provide entity-level and member tax relief. They can also ease compliance challenges. Virtually all states have extended entity-level and individual filing deadlines. Many states are waiving penalties and in some cases interest costs associated with COVID-19.
Additionally, law firms may be eligible for a variety of new and existing credit and incentive programs offered by state and local governments. These include incentives to retain employees, make low or no interest loans, and in some cases provide grants. The COVID-19 pandemic may provide a good opportunity for law firms to review their overall tax spend (particularly income, gross receipts and sales/use taxes) to determine if refund opportunities exist. Law firms may also benefit from a more comprehensive review of their operations to identify tax minimization strategies. Finally, law firms may consider outsourcing some tax and financial reporting operations. Outsourcing of some operations can reduce expenses and may create tax savings.
Law firms are not monolithic. They vary both in size and the number of jurisdictions in which they practice. And, the effects of the COVID-19 crisis are different depending on the location of the firm, size and its particular type of practice. Yet, virtually all law firms should know the potential tax risks and opportunities that arise from the current economic crisis. Addressing state and local tax matters during this period can prevent the proliferation of state tax exposures and can even result in substantial tax and/or cash savings for firms that plan appropriately. RSM’s state and local tax (SALT) team has the industry experience required to provide comprehensive services to law firms at this time.