“Taxpayers overpay taxes by almost a billion dollars each year to mistakes and missed opportunities” – 2002 Study by US General Accounting Office
When it comes to filing your personal and business taxes, there are many money-saving tips and tricks in the legal sector. But with the anomaly that has been the year 2020, and a new, Democratic administration quickly approaching, the coming tax season will certainly require additional research and planning. In this post, we’ll delve beyond the basics and uncover lesser-known wealth management and tax savings strategies.
Covering the Basics
Everyone knows the more deductions you can claim on your taxes, the better. Here is a quick recap of some of the most common expenses law firms can deduct:
- Meals. When you take a client out to dinner, there’s a deduction for that. In fact, you can deduct 50% of your meals and expenses you accrue during meetings to network with clients. Keep detailed notes of who the meal or outing was with, what was discussed, and receipts for occasions. You’ll be thankful to have all this info handy should the IRS ever want to conduct an audit of your law firm.
- Home office. As the pandemic continues, more of us are working from home than ever. If you run your law firm from home, a percentage of your home expenses can be deducted, including mortgage interest, rent, utilities, etc. Of course, this part of your home should be used regularly and exclusively for your legal practice.
- Professional fees. After hiring an accountant or tax preparer, you can deduct those expenses on your law firm taxes.
- Furniture, computers, and other equipment. Your new office chair with the built-in back massager is totally tax-deductible. If you benefit from these purchases within the taxable year, you can deduct them. Or, you can capitalize on them instead.
Other potential deductions include travel expenses, continuing education, health insurance, internet, email services, professional association dues, and more. Be sure to double-check with your tax professional on what can be counted as a deduction before writing it up.
Take Advantage of Section 179
Section 179 of the IRS tax code allows law firm owners to deduct the full purchase price of qualifying equipment and/or software bought during the tax year, allowing you to reduce your overall taxable income. As of 2019, section 179 increased to $1,000,000. Please note the item must meet three qualifications:
- The property must be tangible.
- The property must have been acquired for business use.
- The property must have been purchased by you, not gifted.
Leverage Your Retirement Plan
Take advantage of savings opportunities with your firm’s retirement plan. Deferring income until later years may translate into tens of thousands of dollars in tax savings. If your company’s plan is not set up to enable Mega Backdoor Roth IRA’s, you need to speak with your CFO right away. With this type of Roth IRA, you can put up to $37,500 away annually.
To do this, your company must allow for “after-tax” contributions. Your plan must also allow for yearly “in-service” distributions to a Roth IRA. Once you save the money, immediately in-service the money into a Roth IRA. Multi-partner firms should also look at variable partner credit, allowing you to save more money for the future.
Make Sure You Are Filing In All Relevant Tax Jurisdictions
Attorneys are often required to file in multiple states and localities. This can quickly become complicated, triggering audits and penalties if not handled correctly. Consult your tax advisor to ensure you satisfy these filing requirements, capture all available deductions, and properly document your filings as a safeguard against audit risk. If you need to file foreign tax returns, make sure your accountant has experience in that area.
Note that the cap on itemized deductions is rising from 21% to 28% under President-elect Joe Biden, as he removes the SALT tax. If you’re planning any large charitable donations or events, they can be written off up to 50% of your adjusted gross income. Lastly, ask your tax advisor about certificated and allocated credits for your state – this could be another avenue to significant tax savings.
Should You Spend More To Reduce Tax Liability?
Businesses often receive this advice from tax professionals: spend more money at the end of the year to get tax deductions. This is not always wise. If it means spending your profit, don’t waste money on things you don’t need simply to avoid taxes. But, if it makes sense to spend money to receive the benefit in that year, such as much-needed equipment upgrades, go for it.
If you did incur a loss for 2020, look into doing a Roth conversion (taxed at 0% or 10-12%) in order to free yourself from that tax liability later on. Under the CARES Act, you can also move losses from 2018, 2019 and 2020 over to 2017, offsetting 2017 net revenue gains. This means you could receive tax dollars back from the IRS for the 2017 tax year.
“Made in America” Tax Break
Biden plans to implement a 10% tax credit for businesses that invest in “revitalizing closed or nearly closed facilities, retooling or expanding facilities, and bringing production or service jobs back to the U.S. and creating U.S. jobs,” according to Bloomberg.
A 10% surtax will also be applied to services and sales to U.S. customers from a U.S. company’s foreign affiliate. The plan includes strong rules against U.S. companies moving their headquarters to other jurisdictions for tax purposes. And lastly, the minimum tax policy applied to foreign profiles of U.S. companies will rise from 10.5% to 21%.
1031 Exchanges & Top Capital Gains Rate
You’ll no longer be able to avoid paying capital gains taxes when you sell an investment property and reinvest the money into a new property of like kind and equal or greater value (1031 exchange). Speaking of capital gains, the highest capital gains rate will rise from 20% to 39.6% under the Biden administration. With all this in mind, you’ll need to quickly make decisions regarding what to do with your key capital, such as stock sales, business sales, and real estate. If you’re a large business with lots of overhead and had a substantial loss for 2020, you could sell some of this capital, appear to the IRS as still netting negative revenue, and therefore pay 0% capital gains on your sales.
If your business took a PPP (Paycheck Protection Program) loan in 2020, you now have 5 years to pay it off instead of 2 years (while still at 1% interest). Like any other loan, you can ask for forgiveness on your PPP and not pay it back, but that money would no longer be tax-deductible. Therefore, we recommend running dual profit and loss statements to not underestimate your true taxable income for 2020.
Like these tips for next year’s tax season? At Broughton Partners, we love to help our law firm partners out in any way we can. While we may not be able to do your taxes for you, we do offer an innovative, turnkey claimant acquisition solution to help keep your business churning. Learn more about our data-driven approach here. Happy holidays and stay healthy!