The American Bar Association lobbied Congress to accept the Senate version of the new tax bill giving a tax deduction to owners of “pass-through” businesses, including professional service firms. The conferees accepted the Senate approach, but did not eliminate caps that phase out the pass-through deduction for higher-income professional service providers. The ABA had asked conferees to drop the phase-out.
Pass-through businesses include partnerships, Subchapter S corporations and sole proprietorships. Income for such entities pass through to the owners’ individual returns, where it is currently taxed at ordinary income tax rates. Under the new bill, pass-through owners can take a 20 percent deduction for qualified business income they receive from the entity. Qualified business income is passive income calculated according to a formula.
The tax deduction is phased out for owners of professional services businesses whose taxable income exceeds $315,000 for married individuals filing jointly or $157,500 for individuals. High-income law firm partners will still benefit because the tax bill lowers the top individual income tax rate from 39.6 percent to 37 percent. The bill also increases income thresholds for the higher tax brackets.
The ABA position also prevailed regarding these provisions in the consensus bill:
- The student loan tax deduction is preserved.
- Some contingency-fee lawyers can still deduct upfront litigation-related expenses. Lawyers within the jurisdiction of the San Francisco-based 9th U.S. Circuit Court of Appeals may deduct such expenses. Outside of the Ninth Circuit Court, these expenses paid on behalf of your client are not deductible as ordinary and necessary business expenses.
- There is no requirement for law firms or other professional service businesses to accrual accounting. The accrual method requires law firms to pay taxes on accounts receivable and other income not yet received.
The ABA Section of Taxation asked Congress to preserve the deduction for tax code compliance expenses. But the final tax bill prevents a deduction for costs connected with the determination, collection, or refund of any tax unless the expenses are for the production of income.
You should discuss all taxation matters that may affect your firm with your financial advisor before implementing any changes to leverage provisions of the new bill. Should you need assistance modifying your billing or accounting software configuration to conform to the new law, please don’t hesitate to contact us by email at firstname.lastname@example.org, or by phone at 877-357-0555.