What the New Tax Law Means for Law Firms
Just before the end of 2017, President Trump signed into law the Tax Cuts and Jobs Act (TCJA). Many types of businesses stand to benefit from the sweeping legislation, but the boon for law firms is limited. Here’s a quick review of the TCJA and some of its impact on law firms.
The Pass-Through Deduction
The TCJA’s new pass-through deduction generally allows S corporations, limited liability companies, partnerships and sole proprietorships to deduct 20% of their income before calculating their taxes. Sounds great, right?
However, the TCJA considers large law firms to be specific service businesses, for which the deduction begins to phase out when taxable income reaches $157,500 for single filers and $315,000 for joint filers. It phases out entirely when taxable income exceeds $207,500 and $415,000, respectively.
Costs in Contingency-Fee Cases
The House version of the tax law would have prohibited contingency-fee attorneys from deducting case-related expenses before the case was resolved. Fortunately, the final law left it out.
Note, though, that the IRS generally disallows such deductions, deeming such costs loans rather than business expenses. Only attorneys in the Ninth Circuit can take the deduction. That court allows attorneys to deduct the costs if they had a gross fee contract where the attorney receives a percentage of the gross recovery, with costs paid by the attorney taken solely from his or her percentage.
Deductibility of Alimony
Family law lawyers often use the deductibility of alimony payments as a bargaining chip to increase alimony payments by higher-earning spouses. The TCJA repeals the deduction for the paying spouse, which could push the spouse into a higher income bracket, leaving him or her with less cash to pay alimony.
The law also excludes alimony from the recipient’s taxable income, but that spouse would typically pay a lower tax rate than the paying spouse, so the overall tax bite would increase. The changes apply to divorce agreements executed (or, in some cases, modified) after December 31, 2018.
Much More to Consider
We’ve covered just a few highlights of the impact of the TCJA on law firms and their clients. Your firm may be affected in other ways, and your clients will be affected by numerous other provisions. In addition, like any legislation that covers hundreds of pages, much remains to be resolved.
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