Tax reform includes numerous implications for professional services firms. Here’s an overview of several provisions that executives should consider when planning for 2018 and beyond. (Unless otherwise noted, the provisions will be effective in tax years beginning after Dec. 31, 2017. Expiration dates are noted for provisions enacted on a temporary basis.)
Qualified Business Income Deduction
Taxpayers who have domestic “qualified business income” (QBI) (Trade or business income excluding reasonable compensation to a shareholder, guaranteed payments to partners, and capital gains and losses) from a partnership, S corporation, or sole proprietorship can deduct up to 20 percent of the net income from those trades or businesses. However, that tentative deduction is subject to several limitations, including:
- A taxpayer who owns all or part of a professional services firm, such as a law, accounting, or consulting firm, will not be eligible for the deduction if the taxpayer’s individual taxable income exceeds certain income levels. The deduction begins to phase out at $157,500 (for single filers) or $315,000 (for joint filers) and is completely phased out at $207,500 (single filers) or $415,000 (joint filers).
- Another limitation based on the W-2 wages or depreciable property costs of the business phases in within the same taxable income ranges described above. More specifically, the deduction cannot exceed 50 percent of W-2 wages or 25 percent of W-2 wages and 2.5 percent of the original cost of depreciable property.
Professional services firm owners aren't eligible for the QBID deduction if their taxable income exceeds certain thresholds.
With the corporate tax rate now lowered to 21 percent and income from service fields excluded from the 20 percent qualified business income deduction for pass-through entities, professional services firms should examine their choice of entity to see if a corporate structure might be more beneficial to them. Key considerations in this area include:
- Dividends from C corporations will still be subject to additional 20 percent dividend rate.
- Dividends will be subject to additional 3.8 percent of net investment income tax.
Business-related meals and entertainment
Costs for business-related entertainment expenses are no longer deductible, and some rules relating to the deductibility of meals have changed:
- Employers can deduct 50 percent of the cost of meals provided on or near the employer’s premises for the convenience of the employer. (These costs were previously fully deductible.)
- After 2025, the cost of meals provided on or near the employer’s premises for the convenience of the employer will no longer be deductible.
- Meal expenses incurred while traveling on business are still 50 percent deductible.
- Key action steps to take as a result of these changes include:
- Evaluate the impact of the revised meals and entertainment on future purchasing decisions.
- Create or update accounting policies for tracking meals and entertainment costs to reflect, at a minimum:
- Nondeductible entertainment
- 50 percent deductible meals
- 100 percent deductible meals and entertainment
- Track and report meals separately from entertainment expenses. For example, taking a customer to a sporting event will have two components:
- Entertainment — the cost of the venue ticket
- Meals — the cost of food and beverages purchased at the event.
Professional service firms should create or update accounting policies to track meals and entertainment costs to reflect the changes in the new law.
Employee fringe benefits
The new law changed the treatment of transportation fringe benefits provided to employees by an employer. This means:
- The cost of commuting benefits provided by an employer to an employee, such as a car service, are no longer deductible, with the exception of transportation necessary for the employee’s safety.
- The cost of providing transportation fringe benefits such as parking allowances, mass transit passes and van pools are no longer deductible. Those benefits are still tax-free to employees, though, to the extent the monthly benefit is no greater than the employee’s allowable monthly transportation fringe benefit limit ($260 per month in 2018). If the monthly benefit allowable limit, that excess is taxable to the employee and deductible to the employer as a benefit (as was the case prior to tax reform).
Employee achievement awards
Payments up to $1,600 for service, safety, or suggestions in certain circumstances are still deductible to the employer and excluded from employee income. The amount must be paid in the form of tangible personal property. That can include selecting personal property from a catalog, but cannot include cash, gift certificates, stocks and securities, event tickets, meals, vacations, lodging or similar items.
Gifts less than $25 are still deductible. Any gift over $25 is not deductible.
Employer credit for paid family and medical leave
Employers may claim a business credit for 12.5 percent of wages paid to a qualifying employee during a period of family and medical leave if the employee’s pay rate under the program is 50 percent of normal wages. The credit increases by 0.25 percentage points (but not above 25 percent) for each percentage point by which the rate of payment exceeds 50 percent.
To qualify, the employer’s family and medical leave program must:
- Allow all qualifying full-time employees at least two weeks annual paid family and medical leave.
- Allow part-time employees a commensurate amount of leave on a pro rata basis.
The credit will no longer be available for wages paid in tax years beginning after Dec. 31, 2019.
Affected businesses should consider these tax reform implications for professional services firms and their owners early in 2018, as many of these benefits are available starting this tax year. Many provisions will require additional guidance from the Treasury and the IRS in the form of regulations, revenue rulings, and revenue procedures. For more information on how these provisions may affect your business, please give us a call.