As the year draws to a close, it’s time to ask if you’re taking advantage of the many tax breaks you’re entitled to. It’s not too late for lawyers to think about how they can reduce their 2018 income tax. While the Trump tax reform bill did not heavily favor law firms, there are still some steps you can take before December 31 to trim your 2018 tax bill.
1. Take steps to qualify for the 199A 20% pass-through deduction.
The general consensus is that lawyers don’t qualify for this deduction. However, if you’re a partner in a law firm that files as a pass-through entity (partnership, S corporation) and your personal taxable income is less than $415,000 if joint filer ($207,500 for other filers), then you may, in fact, qualify. If joint taxable income is between $315,000 and $415,000 ($157,500 and $207,500 for other filers), you may qualify for a partial deduction. If joint taxable income is under $315,000 ($157,500 for other filers), then the full deduction may be available. If your projected 2018 taxable income is close to these thresholds, look for ways to reduce income to maximize the 199A deduction (retirement plan contribution, yearend business expenses, charitable gifting).
2. Be sure to get reimbursed for unreimbursed out-of-pocket employee business expenses.
The new tax bill eliminated miscellaneous itemized deductions which includes unreimbursed employee business expenses, investment expenses, professional fees, license fees, job search expenses, etc. So if you are an employee of your firm, you may not be able to deduct these expenses starting in 2018. Your best option may be to submit a yearend expense report and get reimbursed for these nondeductible employee-related, out-of-pocket expenses.
3. Set up a qualified retirement plan.
For many retirement plans, as long as the plan is established as of December 31, you have until the extended due date of the firm’s tax return to make the retirement plan contribution. Plans can range from an SEP IRA which allows contributions up to $55,000, to a defined benefit plan which can allow much higher contributions.
By doing so, it may have a dual purpose. It can reduce your current year tax as well as your taxable income, so you may benefit from the 199A 20% pass-through deduction.
4. Take advantage of the new luxury auto limits before year-end.
Before 2018, the luxury auto limits put a cap on annual depreciation if you paid more than $15,800. For example, if you bought a $40,000 car, it would take 19 years to fully depreciate.
With the new 2018 tax reform rules, you are allowed a faster write-off in 2018 and later years. Under the new law, the so-called luxury auto limit is essentially $50,000. This means that any business vehicle costing $50,000 or less can be fully depreciated over six years. As a result, you can realize over 70% of the total vehicle depreciation in the first three years.
On top of this, the new law allows an additional first year bonus depreciation deduction of $8,000 in the first year. With bonus depreciation, you can buy a $58,000 vehicle used 100% for business and take $8,000 first year bonus depreciation on top of the annual depreciation limits.
5. Write off 100% of the cost of large SUVs, crossover vehicles, and pickup trucks used for business.
Before 2018, many business taxpayers purchased business vehicles with gross vehicle weight ratings greater than 6,000 lbs. to avoid the luxury auto limitations. For 2017, the first year Section 179 deduction was limited to $25,000. Under the new tax law, these vehicles can now qualify for immediate 100% write-off of the full business cost using bonus depreciation or Section 179 expensing. As long as you place the vehicle in service this year, you can take the deduction in 2018.
6. Consider tax benefits of employing your child.
Tax reform eliminated the deduction for personal exemptions starting in 2018. So you can no longer take the exemption deduction on your child. However, by employing your child in your business, you can make up for all or more of this lost deduction.
Because of the increase of the standard deduction from $6,350 to $12,000, your child can earn up to $12,000 in W-2 wages and owe no federal income tax. By doing so, the firm can take a tax deduction for wages paid. If you add $5,500 for a deductible traditional IRA contribution, the amount of untaxed income increases to $17,500. Unless your firm is a sole proprietorship or spouse-only partnership, the child’s pay will be subject to social security/Medicare employment taxes.
7. Beware of new meals and entertainment deduction rules.
Most law firms spend a lot of money entertaining clients and prospects. Under the new tax bill, entertainment expenses with clients and prospects are nondeductible. Before this year, they were 50% deductible. This includes golf, theater tickets, or football game with your best clients as well as a year-end client party. However, business meals with clients and prospects are still 50% deductible.
For firm employees, meals for business meetings or the convenience of the firm, overnight business travel, these expenses are 50% deductible. However, employee entertainment such as a yearend holiday party or employee golf outing are 100% deductible.
8. Shift deductible expenses to 2018 and defer income to 2019.
Most law firms are cash basis and claim deductible expenses in the year they’re paid. Therefore, expenses normally incurred in 2019 can be paid and deducted in 2018. This may include employee bonuses, insurance premiums, rent, office supplies, subscriptions, etc. The IRS has permitted the deduction for a business insurance premium that overlaps a portion into the following year. Also, keep in mind that charging expenses on a credit card is the same as paying with cash.
You may be able to shift firm income to 2019 by sending invoices after December 31. However, be aware of constructive receipt rules that state you have income if you have an unrestricted, vested right to receive it. Also review your yearend client trust fund accounts to make sure you are not reporting income on work that has not been earned.
9. Establish a home office for administrative use for additional tax benefits.
If you have an office in your home that qualifies as a “principal place of business,” you can deduct your daily transportation costs between your home and law firm office. To qualify, the home office must be your “principal” office, used regularly and exclusively for business, and is used to perform administrative work.
The home office qualifies as your principal place of business when you use it for your firm’s administrative or management activities. Examples include billing clients, keeping books and records, setting up appointments and writing reports. To meet the regular test, a good rule of thumb is 10 or more hours of work every week. If done properly, you can deduct a portion of the costs of your home plus increase the deduction for business use of your vehicle.
10. Be charitable.
‘Tis the season to give so let Uncle Sam pay for a portion of the donation. If your personal itemized deductions exceed the new standard deduction amounts ($24,000 for joint filers/$12,000 for single filers) and you are in the top marginal tax bracket, the tax savings would be 37 cents for every dollar of donation. Also, depending on your taxable income, charitable gifts may help you qualify for the 199A 20% pass-through deduction.
Even though there’s not a lot of time left in 2018, it’s not too late to take some year-end steps to reduce this year’s tax bill. With all of the new changes, a little planning can go a long way.
David Epperson is a CPA and tax partner with Saville, Dodgen & Company, PLLC. He has over 30 years of experience working with law firms and other professional services organizations. If you have questions about your firm’s 2018 taxes under the new tax bill, please contact David Epperson at davide@savillecpa.com or (214)-922-9727.