Year-End Tax Planning and PPP Considerations for Law Firms

Despite the ways your law firm’s business operations may have changed as a result of the far-reaching impact of the COVID-19 crisis and other global and regional uncertainty, your tax planning and strategy is not likely to change much this year. However, that doesn’t mean you should forego year-end tax planning.

It’s a good idea to speak with your tax advisor before December 31st, in case there are moves you should be making now to minimize your law firm’s 2020 tax bill. Read on for a few key considerations for tax year 2020 planning.

Pandemic-relief credits you may not have taken advantage of

Here are a few credits you may be able to claim before the end of the year:

• If you didn’t receive a Paycheck Protection Program (PPP) loan, consider whether you qualify for the employee retention credit under the Coronavirus Aid, Relief and Economic Security (CARES) Act. This is a payroll tax credit of up to $5,000 per employee for employers that had to suspend operations due to COVID-19-related government orders or experienced a significant decline in gross receipts.
• If your business employs fewer than 500 people, you may be able to claim a payroll tax credit for employees who took mandated paid medical leave to quarantine or care for family members due to COVID-19. This payroll credit applies to your gross income for this year.
• The CARES Act allows employers to defer deposit and payment of their share of Social Security taxes due for the tax periods running from March 27, 2020, through December 31, 2020, with no penalties. Even if you haven’t taken advantage of this provision yet, you may still be able to do so. In some cases, you may even be able to re-categorize previous deposits to defer additional Social Security taxes. You will need to report these deferrals on your employment tax return and, of course, you will need to pay the taxes within appropriate deadlines.

PPP loan considerations

Under current guidance, PPP loans that are forgiven will not count as taxable income. However, businesses also cannot deduct any expenses paid with those funds. This is consistent with other IRS rules related to non-taxable income.

The more important year-end planning consideration for PPP loans is forgiveness. While this is not necessarily related to tax planning, if you received a PPP loan, applying for loan forgiveness may be your most important year-end task.

Talk with your tax and financial advisors about the best PPP loan forgiveness strategy for your business. Some businesses should apply for loan forgiveness as soon as they’ve spent the funds. Others may benefit from waiting for more clarification on forgiveness, either from their lender, from the U.S. Small Business Association (SBA) or from Congress. The SBA maintains a current FAQ on PPP loan forgiveness.

Tax impact of employees working from home in another state

To adapt to the new normal of the COVID-19 pandemic, many law firms expanded remote working options, which may have included employees who worked from home in other states for part of the year. If this is the case for your firm, keep in mind that situation could create nexus or change the way your tax liability is apportioned in states outside of your headquarters. Because of this, you may have new states in which to file taxes, and you may not have paid required estimated state taxes in some states. Speak with your tax advisor about any potential state tax implications for your law firm.

Qualified improvement property is now eligible for 100% bonus depreciation

Most non-structural improvements you make to the interior of your law firm office are considered qualified improvement property (QIP). The CARES Act fixed a Congressional oversight and QIP is now back to being classified as having a 15-year depreciation (rather than a 39-year period). In addition to the shorter cost-recovery period, this also allows new QIP to be eligible for 100% bonus depreciation under provisions introduced in the Tax Cuts and Jobs Act (TCJA).

These changes apply retroactively to property acquired and placed in service after December 31, 2017. Therefore, in addition to addressing this for your 2020 taxes, you may also want to amend your 2018 and 2019 taxes (if you haven’t already) or file Form 3115 Application for Accounting Method Change to claim the extra depreciation.

Lease and loan modifications

If you use debt financing in your practice and obtained relief from lenders this year, it may have accounting, financial and tax implications. Seemingly minor changes to loan covenants, agreed-upon payment delays, term expansions, agreements to set aside or ignore certain covenant provisions – any one of these may affect taxes or accounting under Generally Accepted Accounting Principles (GAAP). This includes traditional loans, lines of credit and other financing.

In addition, if you renegotiated the lease on your office space, this may not affect your taxes, but you should still share the details with your tax advisor, along with any information about rent modifications that could affect your year-end accounting and financial reports.

CARES Act changes to interest expense deductions

Beginning tax year 2018, the IRS had limited the deductibility of net interest expense that exceeds 30% of adjusted taxable income (ATI). However, this limitation was increased to 50% of the taxpayer’s adjusted taxable income for both 2019 and 2020. This CARES Act provision also allows the use of 2019’s adjusted taxable income to calculate the limitation for 2020.

For tax year 2021, the 30% limit returns. In addition, through 2021, ATI is computed without accounting for depreciation, amortization or depletion, but beginning in tax year 2022, those items are included. This change could decrease your ATI, and thus limit your interest expense deductibility further.

Bottom line: If your capital strategy incorporates borrowing, you may want to consider other options. Speak with your tax advisor to learn more.

Implications of the 20% qualified business income deduction

While this isn’t new for 2020, it’s still worth visiting whether you qualify for the qualified business income (QBI). Because many law firms are structured as pass-through entities, their owners may be able to take advantage of this tax regulation – depending on income level.

Owners of qualifying pass-through entities will receive a 20% deduction on “qualified business income” (QBI), effectively reducing their maximum effective tax rate. But this deduction is limited for attorneys who make over $163,300 for single filers or $326,600 for those filing jointly. For those with more than $210,700 for individuals and $421,400 for joint filers, the deduction starts to phase out entirely.

If your law firm is a pass-through entity and saw higher tax rates during 2019 as a result of this tax change, you may want to consider changing your business tax structure from a pass-through to a subchapter C corporation. Consult your tax advisor and attorney to discuss the implications before taking any action. Your tax planning conversations for year-end 2020 should also include discussion of salaries, timing and distribution of income to maximize tax benefits.

Other 2020 tax-planning considerations

• The excess business losses limitation is temporarily waived for individuals and households. For tax years 2018, 2019 and 2020, the CARES Act repealed limits imposed by the TCJA on deducting aggregate trade or business losses. It also changed how the overall limitation will be calculated starting in 2021. Knowing this will go into effect next year, you may wish to consider using your losses for this year, or retroactively for the two previous years.
• Parking and commuter subsidies continue to be limited. Calculating these deductions is complex, and potentially onerous. You may want to consider ways to minimize the deduction disallowance, as well as your overall parking expenses during the coming year. And, if you’re paying for parking you don’t anticipate needing because employees are telecommuting and/or in-person meetings are on hold, consider whether you can give up some of that space to reduce your expenses.

Contact your Kaufman Rossin tax and financial advisors before year-end, so you can prepare your law firm for 2020 taxes and plan for 2021.