By Shawn Hardister, CPA, CFP®, Tax Partner at Moore Colson CPAs and Advisors.
2018 was an eventful year with changes in tax law for attorneys and their firms. As a partner in a law firm, there are three key changes that will have the greatest impact on your tax liability for 2018:
Impact #1: Business meals and entertainment
As you may have heard, entertainment expenses are now non-deductible, as opposed to prior law that allowed a 50% deduction. Many CPAs were concerned until recently that this prohibition would include business meals; however, the IRS has since clarified that business meals are still 50% deductible, including meals in conjunction with entertainment if billed separately (and not inflated to circumvent the entertainment restriction). Note, however, that whereas overtime meals for associates and staff “for the convenience of the employer” were 100% deductible under prior law, these now are only 50% deductible as well.
Many firms sponsor events such as golf tournaments and other events. This begs the question: How are these events treated?
This is how the IRS defines entertainment:
any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation, and similar trips, including such activity relating solely to the taxpayer or the taxpayer’s family.
Under this definition, it is clear that participation in these events by firm personnel or clients is to be treated as non-deductible entertainment; however, it is possible that deductions could still be allowed for sponsorship of the event for promotional purposes if this does not include additional rights to tickets or participation in the event. If tickets are desired, they should be purchased separately, as this would limit the non-deductible expense to the cost of participation in the event.
Impact #2: Personal deductions
The new tax law has limited state and local tax (SALT) itemized deductions to $10,000 for Married Filing Jointly (MFJ) taxpayers – and to $5,000 for other taxpayers – and has eliminated miscellaneous itemized deductions such as tax preparation fees, investment expenses, and unreimbursed employee business deductions (which impact owners of firms organized as S-corporations). S-corporation shareholders should consider having all personally-paid business expenses reimbursed and deducted at the S-corporation level. Partners in partnerships can still deduct these unreimbursed partnership expenses at the individual return level.
There is good news. As a result of the limitation of SALT deductions and elimination of miscellaneous deductions – and due to a greatly increased exemption amount, Alternative Minimum Taxes, or AMT, will likely be a non-factor going forward for most taxpayers. Also, Congress eliminated the “Pease adjustment” which reduced eligible itemized deductions in the past.
Impact #3: 20% Qualified Business Income deduction
When Congress passed a reduction in the C-corporation tax rate to a flat 21% (prior law was graduated rates up to 35%), they also wanted to allow owners of pass-through businesses the ability to benefit from lower tax rates on business income. This was achieved through the 20% of QBI (Qualified Business Income) deduction, whereby a partner in a partnership or an S-corporation shareholder could take a 20% deduction against the lesser of income passed through on a K-1 (excluding guaranteed payments) or the owner’s taxable income. Note that there is a requirement that guaranteed payments and salary be “reasonable” for the services provided to the firm by the owner. However, Congress specifically prohibited law firm partners from taking this deduction, unless they have limited taxable income.
There is still an opportunity here however. If an attorney’s income falls within or below a certain range, he or she may nonetheless take the 20% of QBI deduction. The deduction phases out between $315,000 and $415,000 for MFJ taxpayers, and between $157,500 and $207,500 for other taxpayers. Below the lower limits of these ranges, the full deduction is available. Strategies that lower taxable income, such as contributions to defined contribution and defined benefit retirement plans, or charitable contributions utilizing donor-advised funds or conservation easements, for example, are helpful in lowering taxable income for those who are in reach of these limits.
These changes make tax projections and strategies more important than ever. With so many changes taking place at once, and since every taxpayer’s situation is unique, it is important to meet with your CPA and “run the numbers” to identify the best strategy for you and your business.
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Shawn Hardister, CPA, CFP®, is a Tax and Financial Planning Partner at Moore Colson. He regularly assists closely-held companies and their owners realize financial success. He specializes in professional services firms, particularly law firms and physician practices.