Lawyers, CPAs weigh changes in wake of tax law
Local law and accounting firms are waiting for guidance from the Internal Revenue Service on a new law that gives tax breaks to some so-called pass-through entities, but that doesn't cover law, accounting and consulting practices.
Passed as part of the federal tax overhaul last year, a provision known as Section 199A allows business owners to deduct up to 20 percent of their business income if it is reported on their personal tax returns.
It was seen as a way to level the playing field given the new law’s cut to the corporate tax rate, which was slashed from 35 percent to 21 percent.
The trouble is that it’s not yet clear exactly what kinds of entities will qualify for the deduction. Accountants, lawyers and financial advisors are not eligible, but architects and engineers were included at the last minute.
“That was a big win for them,” said Tom Moul, director of strategic tax advisory services for Stambaugh Ness, an accounting firm in York. But, he asked, what about engineers or architects who do mostly consulting? Would they qualify or be exempt?
The IRS is expected to issue guidance in June.
In the meantime, firms such as Stambaugh Ness, whose business falls into more than one category, are discussing whether it makes sense to separate portions of their work into a different entity so that some of their income can qualify for the deduction.
“We sell some software, so our impression is that would be eligible for the deduction, but our normal business of consulting would not,” Moul said. As for whether that business will be spun off from the consulting work, Moul said no decisions have been made.
“We certainly have had those discussions and the wheels are in motion already from a planning standpoint,” he said. “But guidance is clearly needed and that has not been issued yet.”
Steve Beachy, director of tax services at Simon Lever in Harrisburg, said about 20 percent to 30 percent of his firm’s clients will benefit from the deduction, while others will not. While their line of business qualifies, their personal income exceeds the limit. Nearly half of his firm’s clients are still waiting to hear how the Internal Revenue Service plans to interpret the law.
“What about a house painter? How do you determine how much of the business he gets is because of the reputation of his company or his skills and personal knowledge?” he said. “It’s going to be a busy fall and a busy tax season, so we’re trying to prepare people.”
Beachy is encouraging clients to err on the conservative side when making their estimated quarterly tax payments and assume that the new law won’t give them any benefit.
“It’s easier to say they have paid in enough with the first three payments and so they don’t need to do the last one instead of telling them they have to bump it up at the end,” he said.
Ron Hershner, managing partner at York law firm Stock & Leader, said to the extent that a firm undertakes multiple business activities under one entity, it may make sense to split the work into different organizations to take advantage of the new deduction.
“If you are an accounting firm that also sells computers, you may want to separate out the computer business so that income is eligible,” he said.
He expects some law firms that own real estate may consider breaking off their real estate business from the law firm so their rental income could be eligible for the deduction.
Because the provision ends in 2026, though, Hershner suggests some firms may not want to change their business structure for eight years only to change it back again.
“Sometimes it’s harder to undo than it is to do,” he said. “You want to think about that long term, too, before you go rushing out to save a few dollars this year.”
Another factor to consider is whether it makes sense for owners in firms covered by the deduction to cut their salaries so more of their income stays eligible. “Right now it says the deduction doesn’t apply to salaries or guaranteed payments made to members,” Hershner said. “But that’s another issue that needs clarification.”
Moul said the corporate tax rate of 21 percent may prompt some firms to consider whether it makes sense for them to remain pass-through entities. “That’s a discussion we’re having with a lot of our clients,” he said.