Industry Focus and 2019 Year-End Tax Planning for Professional Services Firms

The professional services industry is a wide-ranging, highly fragmented segment of the global economy, and it is currently responsible for about 9.4 million jobs in the U.S. alone. It’s a unique industry in that profits are derived from employees’ skills and service offerings; while this makes working in professional services exciting and fulfilling, it also presents certain challenges when it comes to tax and strategic planning. 

Naden/Lean works with law, technology, and other professional services organizations on year-round tax planning and business advisory issues. Especially being in the industry ourselves, we have the benefit of seeing first-hand how rewarding careers in this field are. We also have a good vantage point on professional services firm operations and how to help partners and shareholders succeed when it comes to the business side of the firm. 

Professional Services Trends and 2020 Outlook

Strategic planning for the next year can likely include increases in client demand. The U.S. economy is still strong, which helps to drive the market for consulting services that professional services firms provide. Small and medium size businesses (SMEs) are looking to professional services firms more than ever to fill crucial needs and think of services providers as subject matter experts. 

Business challenges remain consistent with 2018 and include:

  • Optimizing business and organizational models and project quality
  • Improving pricing
  • Effective resource management
  • Monitoring KPIs

According to The State of Professional Services 2019, published by Technology Services Industry Association, key performance metrics for professional services are a mixed bag.

Whether your business is law, engineering, marketing, or another division of professional services, your firm’s ability to differentiate itself as an advisor to business owners will help to ensure that the firm can respond well in a rapidly changing marketplace. At the heart of this change is that service providers are transforming from contractor to advisor. No matter the discipline, professional service providers are starting to change billing techniques and incorporate more virtual solutions. 

With regard to billing techniques, the billable hour as the primary means of charging for projects is falling by the wayside in favor of more value-added models. Examples of different billing arrangements are billing based on relative value — for example, charging more for in-demand services and less for compliance services — and bundled pricing. Professional services firms are notoriously tight lipped when it comes to how much they charge, but business owners’ preference for transparency is driving the need for easy-to-understand, all-inclusive fees, like B2C and product companies.  

Virtual solutions are ranging from remote offices for employees who may be located anywhere in the country (or world). A growing number of professional services firms don’t even have a physical office anymore, and one that do are starting to leverage more work-from-home and job-sharing roles. These moves save on overhead and increase flexibility and employee satisfaction. There is also a huge opportunity for virtual client solutions for firms that haven’t capitalized on it yet. Law firms, for example, can use virtual storage solutions for clients’ case files, especially discovery; engineering and architectural firms can offer clients the ability to view project updates and specs in real-time. These value-adds can then be billed to clients. 

Another trend for professional services firms that isn’t going away is social media. Most firms have at least one social media account; more should be looking to social media as a source of brand awareness and an opportunity to connect with clients, prospects, and the community. If a social media strategy isn’t yet part of your firm’s plans, it should be – along with an inbound content marketing plan to drive more people to the website.

The benefit of a great service provider is that they can leverage business owners’ time and resources. It’s costly to employ full-time legal, technology, or  marketing staff, and hardly any (if any) SMEs have the need for in-house expertise in other specialized areas like architecture. As long as professional services firms can continue to offer value and meet business owners where they are — as in, offering innovative solutions to modern challenges — then the market outlook for 2020 looks bright. 

In light of year-end tax planning, professional services firm executives should be reflecting on their organizations’ future and how certain tax considerations now can affect cash flow and profitability in 2020. 

Tax Planning Strategies for Professional Service Firms 

Professional services firm executives have been dealing with the impact of the Tax Cuts and Jobs Act (TCJA)  since it was passed two years ago. In some cases, there are still parts of the tax code that need clarified and the IRS can be slow to issue updated guidelines.

As a result of TCJA, the professional services industry has had to deal with the following changes: 

  • A new 21 percent corporate tax rate for firms structured as a C-Corporation
  • Section 199A, or 20% pass through entity deduction for partnerships and sole proprietors
  • New tax credits, like the Family and Medical Leave credit
  • Changes in allowable tax deductions for meals and entertainment, business interest expense, and fringe benefits 
  • Disallowed business losses, except for C-Corporations

Click here to view and download an infographic with major changes to business taxes in 2019. 

To prepare for year-end tax planning, there are several things professional services firm executives can do to maximize tax savings and minimize headaches in 2020. Beyond traditional year-end planning moves, considerations in 2019 include: 

Ensure meals and entertainment are properly coded and accounted for 

Professional services firms have routinely built into their budgets allowances for client development events like golf outings, sporting events, concerts, and other entertainment expenses that are no longer deductible under TCJA. Also recall that meals provided on-site are now 50% deductible (compared to 100%), and meal expenses while traveling remain at 50%. While these changes have been in effect all year, it’s important to make sure that the appropriate accounting policies and expense codes have been updated and used properly, especially when entertaining clients at events — it’s necessary to separate the expense into the cost of the ticket, for example, and any food that was purchased. 

Implementing policies for paid FMLA leave

Businesses that provide paid FMLA leave are eligible for a temporary tax credit for providing paid family leave to employees. To qualify for the credit, firms must first have a policy in place that provides at least two weeks of paid family and medical leave annually to full-time employees, and prorated for part-time employees. Paid leave can’t be less than half of an employee’s wages. A policy needs to be in place before a credit can be claimed. This credit expires at the end of 2019 and is not expected to be renewed. More information can be found here. 

Review whether making large purchases or business investments makes sense

TCJA expanded bonus depreciation as 100 percent for tax years beginning after September 27, 2017 through December 31, 2022. Even if a big purchase right now isn’t part of the plan, it should be within the next two years while 100 percent bonus depreciation is in effect.  

The updated depreciation table for common business assets can be found here, and a review of general changes to business deductions can be found here

Determine whether the R&D tax credit applies to any projects in 2019

The expanded research and development tax credit is especially useful for technology firms, but it’s not limited to tech-driven organizations. Business activities like … qualify, and new rules that allow the R&D tax credit to be applied to payroll or AMT mean that smaller organizations can benefit, too.

Check on any improvement projects or purchases related to disability inclusion in 2019

Because of its limitations, the Disabled Access Credit won’t be permissible for many professional services organizations. But those that are smaller or just starting out may benefit from the tax credit, which allows organizations with 30 or fewer employees and $1 million or less in revenue the previous year to claim up to $5,000 for cost-related disabled access improvements. Click here to read more about the credit and what qualifies

Look at new hires in 2019 for the potential to claim the Work Opportunity Tax Credit

Professional services firms that hired disabled individuals, veterans, ex-felons, or individuals receiving SNAP or SSI might be able to claim the Work Opportunity Tax Credit. The credit expires after December 31, 2019 and as of this writing is not being renewed. Click here for more information.

Calculate parters’ share of the Section 199A pass-through deduction 

Perhaps the biggest impact to professional services firms when it comes to year-end tax planning is determining whether any amount of the Section 199A pass-through deduction applies to partners. The deduction applies to partnerships, LLCs, S-Corps, and sole proprietors whose business income flows through to their personal tax returns, and the maximum allowable deduction is 20% against qualified business income. 

As service providers know by now, there are limitations for organizations that provide services and whose business and profits are based on the skill and reputation of the individual(s) — like practically every law, marketing, engineering, architectural, tech, and financial firm out there. For professional services organizations, the pass-thru deduction starts to phase out in 2019 at $157,500 for single filers or $315,000 for married filing jointly, and is unavailable for tax filers with income at or above $207,500 for single filers or $415,000 for married filing jointly. 

The deduction can be complicated to calculate, especially in income ranges where only a partial deduction is available and there are different income types to consider. Make sure to involve your CPA if there are income shifting strategies that can be implemented before the end of the year so that a full or partial deduction can be claimed. 

What’s Next for Professional Services Firms 

The business model of professional service organizations is unique. Cash flow and profits are top concerns for most executives, which is why proactive tax planning is critical. Especially after the Tax Cuts and Jobs Act changed so many credits and deductions, firm partners and shareholders should double check that accounting and tax policies are up to date. 

Beyond tax planning, strategic planning that involves more value-based solutions for clients and incorporating virtual business practices will help professional services firms stay competitive in 2020. 

The team at Naden/Lean is happy to elaborate on any of these or other tax planning considerations. Contact us today to talk about how some of these strategies could be implemented before the end of 2019.