Professional services firms are unique businesses. Whereas a manufacturer or retailer sells goods and products, professional services sells knowledge, expertise, and the trust of its people. Ownership structures can vary, too – while many are partnerships, some are C-Corps, S-Corps, LLCs, and sole proprietors. As such, they often have unique tax implications.
Naden/Lean routinely advises other professional services firms, especially law, engineering, and IT firms. Usually around this time of year, we work with the partners and shareholders on their firms’ tax planning. This year we are sharing some of our year-end planning advice with our blog readers who may have ownership interests in similar businesses, so they can better know how to prepare for the new tax changes contained in 2017’s Tax Cuts and Jobs Act.
Read on for our top four considerations for professional services firms’ year-end tax planning.
20 Percent Qualified Business Income Deduction
Most professional services firms have partners or shareholders with pass-through income. If this is you, then you may already be looking forward to the qualified business income deduction. Eligible taxpayers who receive compensation from a partnership, S-Corp, or sole proprietorship can deduct up to 20 percent of the net income from that business.
As partners or owners of professional services firms, the deduction is limited for taxpayers whose incomes exceed $157,500 (or $315,000 for married filing joint). The QBID deduction completely phases out at $207,500 (or $415,000 for married filing joint).
Another limitation for professional services firms concerns depreciable property costs. is that the 20 percent deduction cannot exceed 50 percent of W-2 wages, or 25 percent of wages and 2.5 percent of the original depreciable property cost.
Meals and Entertainment Deduction
Another big tax planning area concerns the meals and entertainment deduction. As part of the new tax law, business-related entertainment expenses are no longer deductible, and the business meals deduction is for the owner(s) only. Unless the current rules are rolled back, it is now necessary to track expenses for employee meals, business meals, and entertainment expenses. Business meals that are brought on-site at your firm are deductible by 50 percent; meals for client purposes and travel are still 50 percent deductible; and employee expenses, like a year-end office party, are 100 percent deductible.
Therefore, if in the past you relied on also deducting entertainment expenses, like taking clients to a baseball game or golf outing, additional tax planning may be needed to offset the value of those deductions. We still recommend tracking entertainment expenses, though. Also be aware that beginning in 2026, business meals – those that are brought on-site – will no longer be deductible at all. In the meantime, make sure to update your firm’s accounting methods to accurately track and record these new categories of meals and entertainment.
Even though most small and mid-size professional services firms are not structured as C-Corporations, under the new tax law it might make sense to reevaluate the business structure. The new corporate tax rate is reduced to 21 percent. There are pros and cons to consider. Partners and shareholders would lose the 20 percent business income deduction, but depending on their adjusted gross income, they may not receive the full benefit anyway, if at all. C-Corporations’ dividends are still taxed at an additional 20 percent, plus 3.8 percent net investment income tax. Another point to consider regarding entity structuring is how soon the partner(s) plan to sell or exit the business. There tend to be more favorable tax treatments in the sale of a business that is not structured as a C-Corporation. Yet, the tax benefits could be worth it in the right situation.
Finally, some employee perks are either losing or gaining when it comes to tax treatments. Employee awards up to $1,600 that reward service, safety, or other circumstances can be fully deductible if certain guidelines are met. The award cannot be made in cash, gift certificates/cards, stocks and securities, event tickets, meals, vacations, or lodging. The award amount must be given in personal property, such as from a catalog.
Another employee benefit, transportation costs, are no longer deductible unless the transportation is necessary for the employee’s safety. These benefits, which range from parking allowances, public transportation passes, and car pooling are still tax-exempt for employees as long as the monthly benefit is less than the employee’s monthly transportation fringe benefit amount.
Last but not least, the employer credit of 12.5 percent of employee wages for periods of paid family and medical leave is expiring after December 31, 2019. Until then, you can still receive the business credit if all qualifying, full-time employees are given two weeks of annual, paid family and medical leave, and part-time employees are given a commensurate amount of leave in accordance with their hours worked.
If you’re a partner, shareholder, or owner in a professional services firm and need advice on year-end planning for the business or your pass-through income, contact us today.