Top 3 Tax Law Changes That Will Impact Attorneys This Tax Season

By 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.

The IRS has updated the inflation-adjusted “luxury automobile” limits on certain deductions taxpayers can take for passenger automobiles — including light trucks and vans — used in their businesses. Revenue Procedure 2019-26 includes different limits for purchased automobiles that are and aren’t eligible for bonus first-year depreciation, as well as for leased automobiles.

The role of the TCJA

The Tax Cuts and Jobs Act (TCJA) amended Internal Revenue Code (IRC) Section 168(k) to extend and modify bonus depreciation for qualified property purchased after September 27, 2017, and before January 1, 2023, including business vehicles. Businesses can expense 100% of the cost of such property (both new and used, subject to certain conditions) in the year the property is placed in service.

The amount of the allowable deduction will begin to phase out in 2023, dropping 20 percentage points each year for four years until it vanishes in 2027, absent congressional action. The applicable percentage for qualified property acquired before September 28, 2017, and placed in service in 2019, is 30%.

But 100% (or 30%) bonus depreciation is available only for heavier business vehicles that aren’t considered passenger automobiles. The maximum bonus depreciation amount for passenger automobiles is much smaller.

IRC Sec. 280F limits the depreciation deduction allowed for luxury passenger automobiles for the year they’re placed into service and each succeeding year. The TCJA amended the provision to increase the Sec. 280F first-year limit for qualified property acquired and placed after September 27, 2017, by $8,000. It increased the limit on first-year depreciation for qualified property acquired before September 28, 2017, and placed in service in 2019, by $4,800. These amounts are the bonus depreciation.

Annual depreciation caps

The new guidance includes three depreciation limit tables for purchased autos placed in service in calendar year 2019. The limits for automobiles acquired before September 28, 2017, that qualify for bonus depreciation are:

• 1st tax year: $14,900
• 2nd tax year: $16,100
• 3rd tax year: $9,700
• Each succeeding year: $5,760

The limits for autos acquired after September 27, 2017, that qualify for bonus depreciation are:

• 1st tax year: $18,100
• 2nd tax year: $16,100
• 3rd tax year: $9,700
• Each succeeding year: $5,760

The limits for autos that don’t qualify for bonus depreciation are:

• 1st tax year: $10,100
• 2nd tax year: $16,100
• 3rd tax year: $9,700
• Each succeeding year: $5,760

Other restrictions

The bonus depreciation deduction isn’t available for automobiles for 2019 if the business:

• Didn’t use the automobile more than 50% for business purposes in 2019,
• Elected out of the deduction for the class of property that includes passenger automobiles (that is, five-year property), or
• Purchased the automobile used and the purchase didn’t meet the applicable acquisition requirements (for example, the business cannot have used the auto at any time before acquisition).

Limits on leased automobiles

The new guidance also includes the so-called “income inclusion” table for passenger automobiles first leased in 2019 with a fair market value (FMV) of more than $50,000. The FMV is the amount that would be paid to buy the car in an arm’s-length transaction, generally the capitalized cost specified in the lease.

Taxpayers that lease a passenger automobile for use in their business can deduct the part of the lease payment that represents business use. Thus, if the car is used solely for business, the full cost of the lease is deductible. (Alternatively, you could just deduct the standard mileage rate — 58 cents for 2019 — for business miles driven.)

But Sec. 280F requires the deduction to be reduced by an amount that’s substantially equivalent to the limits on the depreciation deductions imposed on owners of passenger automobiles. The idea is to balance out the tax benefits of leasing a luxury car vs. purchasing it. That’s where the table comes into play.

Lessees must increase their income each year of the lease to achieve parity with the depreciation limits. The income inclusion amount is determined by applying a formula to an amount obtained from the IRS table. The latter amount depends on the initial FMV of the leased auto and the year of the lease term. Although the $50,000 FMV threshold for 2019 is unchanged from 2018, many of the other values in the new table have changed since then.

For example, let’s say you leased a car with an FMV of $56,500 on January 1, 2019, for three years and placed it in service that same year. You use the car for business purposes only. According to the table, your income inclusion amounts for each year of the lease would be as follows:

• Year 1: $26
• Year 2: $59
• Year 3: $86

The annual income inclusion amount may seem small compared to the depreciation deduction limits, but it represents a permanent tax difference that affects the effective tax rate but not book or taxable income. The depreciation limits, on the other hand, represent a timing difference that affects book and taxable income in the same way but at different times and doesn’t change the effective tax rate. The business will recover the timing difference through depreciation deductions or when it disposes of the auto.

Drive carefully

The new tax rules for vehicles used in business generally are favorable but aren’t easily navigable. We can help steer you toward the best strategy given your current circumstances.

The IRS has updated the inflation-adjusted “luxury automobile” limits on certain deductions taxpayers can take for passenger automobiles — including light trucks and vans — used in their businesses. Revenue Procedure 2019-26 includes different limits for purchased automobiles that are and aren’t eligible for bonus first-year depreciation, as well as for leased automobiles.

The role of the TCJA

The Tax Cuts and Jobs Act (TCJA) amended Internal Revenue Code (IRC) Section 168(k) to extend and modify bonus depreciation for qualified property purchased after September 27, 2017, and before January 1, 2023, including business vehicles. Businesses can expense 100% of the cost of such property (both new and used, subject to certain conditions) in the year the property is placed in service.

The amount of the allowable deduction will begin to phase out in 2023, dropping 20 percentage points each year for four years until it vanishes in 2027, absent congressional action. The applicable percentage for qualified property acquired before September 28, 2017, and placed in service in 2019, is 30%.

But 100% (or 30%) bonus depreciation is available only for heavier business vehicles that aren’t considered passenger automobiles. The maximum bonus depreciation amount for passenger automobiles is much smaller.

IRC Sec. 280F limits the depreciation deduction allowed for luxury passenger automobiles for the year they’re placed into service and each succeeding year. The TCJA amended the provision to increase the Sec. 280F first-year limit for qualified property acquired and placed after September 27, 2017, by $8,000. It increased the limit on first-year depreciation for qualified property acquired before September 28, 2017, and placed in service in 2019, by $4,800. These amounts are the bonus depreciation.

Annual depreciation caps

The new guidance includes three depreciation limit tables for purchased autos placed in service in calendar year 2019. The limits for automobiles acquired before September 28, 2017, that qualify for bonus depreciation are:

• 1st tax year: $14,900
• 2nd tax year: $16,100
• 3rd tax year: $9,700
• Each succeeding year: $5,760

The limits for autos acquired after September 27, 2017, that qualify for bonus depreciation are:

• 1st tax year: $18,100
• 2nd tax year: $16,100
• 3rd tax year: $9,700
• Each succeeding year: $5,760

The limits for autos that don’t qualify for bonus depreciation are:

• 1st tax year: $10,100
• 2nd tax year: $16,100
• 3rd tax year: $9,700
• Each succeeding year: $5,760

Other restrictions

The bonus depreciation deduction isn’t available for automobiles for 2019 if the business:

• Didn’t use the automobile more than 50% for business purposes in 2019,
• Elected out of the deduction for the class of property that includes passenger automobiles (that is, five-year property), or
• Purchased the automobile used and the purchase didn’t meet the applicable acquisition requirements (for example, the business cannot have used the auto at any time before acquisition).

Limits on leased automobiles

The new guidance also includes the so-called “income inclusion” table for passenger automobiles first leased in 2019 with a fair market value (FMV) of more than $50,000. The FMV is the amount that would be paid to buy the car in an arm’s-length transaction, generally the capitalized cost specified in the lease.

Taxpayers that lease a passenger automobile for use in their business can deduct the part of the lease payment that represents business use. Thus, if the car is used solely for business, the full cost of the lease is deductible. (Alternatively, you could just deduct the standard mileage rate — 58 cents for 2019 — for business miles driven.)

But Sec. 280F requires the deduction to be reduced by an amount that’s substantially equivalent to the limits on the depreciation deductions imposed on owners of passenger automobiles. The idea is to balance out the tax benefits of leasing a luxury car vs. purchasing it. That’s where the table comes into play.

Lessees must increase their income each year of the lease to achieve parity with the depreciation limits. The income inclusion amount is determined by applying a formula to an amount obtained from the IRS table. The latter amount depends on the initial FMV of the leased auto and the year of the lease term. Although the $50,000 FMV threshold for 2019 is unchanged from 2018, many of the other values in the new table have changed since then.

For example, let’s say you leased a car with an FMV of $56,500 on January 1, 2019, for three years and placed it in service that same year. You use the car for business purposes only. According to the table, your income inclusion amounts for each year of the lease would be as follows:

• Year 1: $26
• Year 2: $59
• Year 3: $86

The annual income inclusion amount may seem small compared to the depreciation deduction limits, but it represents a permanent tax difference that affects the effective tax rate but not book or taxable income. The depreciation limits, on the other hand, represent a timing difference that affects book and taxable income in the same way but at different times and doesn’t change the effective tax rate. The business will recover the timing difference through depreciation deductions or when it disposes of the auto.

Drive carefully

The new tax rules for vehicles used in business generally are favorable but aren’t easily navigable. We can help steer you toward the best strategy given your current circumstances.