Law Firms: Don’t Delay Year-End Planning

This blog post was previously published on November 13, 2018. It was updated on November 14, 2019.

As you know by now, the Tax Cuts and Jobs Act contained a few unwelcome surprises for lawyers and other professionals. Law firms need to understand the qualified business income (QBI) deduction, including whether they qualify for it, and whether any wage bonuses need to be paid during 2019 in order to qualify for it.

Do you qualify for the 20% QBI deduction?

Pass-through entities include subchapter S corporations, partnerships and some limited liability companies, and owners of some pass-through entities will receive a 20% deduction on QBI. But the benefits of the new QBI deduction are severely limited for “specified service trades and businesses” (SSTB), including lawyers. This deduction is limited for lawyers who make over $160,700 for single filers ($163,300 in 2020) or $321,600 for those filing jointly ($326,600 for 2020).  For those with more than $210,700 for individuals and $421,400 for joint filers, the deduction starts to phase out.

Does your firm offer non-STTB services, such as through a title company or stenography service? Unfortunately, final IRS regulations also severely limit the ability of law firms to segregate the income from those services. If a non-STTB division provides more than 80% of its services to the law firm and is at least 50% owned by the same owners as the firm, then its taxable income cannot be segregated from the firm’s STTB income. If the division falls under those limits, some of its income may be segregated, with the 20% QBI deduction applicable.

Ultimately, few law firms will benefit from the QBI deduction. Talk with your professional before the end of there the year to see how it may affect your firm.

Consult a tax advisor and review the implications before taking any action. Tax planning for year-end 2019 should include discussion of salaries, timing and distribution of income.

Track meals and entertainment expenses carefully

In the past, business-related entertainment was 50% deductible as a business expense. Now, while you can still deduct 50% of meals for meetings that occur in a business context, you can no longer deduct entertainment expenses at all. This means that tickets to a sporting event or performance, admission to venues or club memberships are not deductible at all. Even if those tickets, admission costs or memberships include meals, they are not deductible. You can, however, deduct 50% of meals that occur in these settings in a business context if the meals are charged entirely separately.

As you get set for 2020, ask your advisors about automated solutions that make expense management and other bookkeeping tasks manageable.

Net interest expense deduction rules are changing; plan ahead

Law firms whose capital strategy relies on borrowing should consider other options.

As of 2018, for net interest expense that exceeds 30% of adjusted taxable income (ATI), deductibility has been limited. Through 2021, ATI is computed without accounting for depreciation, amortization or depletion, but beginning in 2022 those items are included. This could decrease your ATI, and thus limit your interest expense deductibility further.

Start thinking about your strategy now – 2021 will be here before you know it.

Parking and commuter subsidies are limited and it’s complex

Remember, deductions related to employer-provided parking for employees are limited, even in cases where the company owns the parking lot. The methods for determining nondeductible parking expenses are complex, and potentially onerous; if you didn’t go through this process for your 2018 taxes, be prepared to work with your tax professional on it this year.

You may want to consider ways to minimize the deduction disallowance, as well as your overall parking expenses during 2020.

Contact your Kaufman Rossin tax professional to learn more about what you can do now to plan for the coming tax season and coming year.