Tax reform and law practices: Key considerations affecting your firm
Since the passage of the Tax Cuts and Jobs Act of 2017 (TCJA), businesses and tax advisers alike have been sifting through the changes to understand the impact and opportunities under the new legislation. Law practices, due to the nature of their businesses, have several key considerations. Sean Keating, RSM tax partner, provides his insights on some of the areas firms should assess.
Are there changes to consider related to the meals and entertainment deduction?
There are new limitation rules, so law firms should review the tax treatment of their meals and entertainment (M&E) expenses to identify exceptions. One of the major areas of change relates to how M&E must be reported on client billings. Firms can still bill clients for this expense, but the invoice must now detail the specifics of those costs, rather than the previous broad general charge. Law firms should review their billing practices and invoicing procedures to make sure processes have been updated to meet the new tax law’s requirements.
Are there other deduction or credit areas law firms should be aware of under the new law?
Law firms may provide employees with parking and other transportation fringe benefits. Previously, those benefits were not included in the employee’s gross income, but they were still deductible for the employer. The TCJA has eliminated the deduction for qualified transportation expenses (including parking) unless the amount is included in the employee’s gross income. Firms must now decide whether to forego the deduction (thereby increasing partners’ taxable income), or if instead the increased tax burden will fall to the employee.
In addition, there are some new employee benefits that firms can take advantage of, such as the paid family and medical leave credit. This provision allows eligible employers to claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave if the rate of payment under the program is 50 percent of the wages normally paid to an employee.
Should law firms reconsider their tax structure?
Owners of law firms generally will not qualify for the new 20 percent pass-through deduction; as a consequence, they might consider the implications of converting to C corporation status to take advantage of the lower corporate rate. This transition and analysis can be complex, and there are many factors to consider. In addition, law firms should also review their unrelated business activities and revenue streams to determine whether any of the potential income related to these activities could qualify for the 20 percent pass-through deduction. While the income from legal service may not qualify, other income might. For instance, does the firm own real estate, such as the practice’s office building? Some portion of that income might qualify for the deduction, particularly when some portion of the rental is to an unrelated tenant. For additional information, listen to Tax reform: Additional guidance on pass-through deductions.
What steps should law firms take to address the TCJA’s impact on their businesses?
Firms should review how they categorize and track expenses in order to update their processes accordingly to maximize opportunities. In addition, law practices should assess their current invoicing processes to make sure they are aligned with the new law. Also, firms should stay informed on ongoing guidance on the new laws. Our tax advisers continue to monitor ongoing direction from the IRS and will post updated insights on our tax reform resource center. And finally, firms should contact us or your tax adviser for assistance.
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