What the New Tax Law Could Mean for the Legal Field

What the New Tax Law Could Mean for the Legal Field
February 5, 2018 Pearl Insurance

What the New Tax Law Could Mean for the Legal Field

Get your magnifying glass out, because this tax overhaul is complicated.

On January 1, the Trump administration’s new tax plan officially became law. Covering nearly 500 pages, the legislation is a behemoth of complexities and minutiae. And since the final version of the bill went from introduction to signing in a breakneck eight days, unravelling the intended—and unintended—ramifications of this new tax code is tricky.

At the very least, it could spell good news for firms specializing in tax law. As corporate players scramble to decipher the finer details amidst the jargon, many will turn to professionals for help.

But apart from new client potential, what else should law firms keep in mind about this updated tax code?

The Pass-Through Provision Has Expanded

Pass-through status lets business owners have their revenue taxed on their personal filings, meaning they don’t have to pay federal income tax on corporate earnings. The new tax law grants more businesses the opportunity to become a pass-through entity, letting them deduct up to 20% of eligible profits on their returns—a significant savings.

For law firms, the path to qualifying for pass-through benefits was shaky. The original House version of the bill excluded businesses that provide professional services from acquiring pass-through status. But the American Bar Association successfully lobbied Congress to remove this exclusion, and the final version of the bill allows professional service organizations (including law firms) to claim pass-through benefits.

But there’s a catch: If the taxable income for a law firm’s owners or partners is over $315,000 (if married and filing jointly) or over $157,000 (if unmarried), the pass-through deduction benefit is phased out. This means top brass at large firms may not benefit from turning their organization into a pass-through entity, but for small and midsize firms, the option is worth looking into.

Creative Loopholes Will Emerge

Complicated tax bills have a track record of creating unintended loopholes. One of the most prominent examples of this came in 2004, when a manufacturing break was added into the tax code.

The provision laid out the definition of manufacturing as “combining or assembling two or more articles.” Though this language gave manufacturing plants a tax break, the wording was vague enough to invite a bunch of unintended industries to cash in on the lower rates.

Tech companies, movie studios, construction businesses, and even coffee shops claimed to be manufacturers—and many times, they were successful.

One of the most extreme examples came from Dan Maguire, who was the chief financial officer for Wine Country Gift Baskets. He decided that packaging wine and sweets in a basket counted as manufacturing under the legal definition, so he filed for the deduction in 2005 and 2006—scoring $300,000 of refunds in the process.

Once the IRS caught on, they demanded Maguire return the money. He refused, and a lawsuit followed.

But Maguire argued his case, claiming the company’s wine basket creation process was similar to that of a traditional assembly line. Ultimately, a federal judge ruled in Maguire’s favor. Because of this, the deduction has since saved his company over $5 million in taxes—all because he had the gumption to challenge the law’s sloppy wording.

Given how rushed the creation and approval of the 2017 tax bill was—right down to having handwritten adjustments scribbled on an earlier draft mere hours before a floor vote—it’s a safe bet that this legislation left room for unintended exploitations.

Time will tell how creative these loopholes may be, so keep your eyes peeled for developments on how the new tax law’s intent becomes distorted.

The Law Stands on Shifting Sands

Though the new tax code is officially law of the land, it’s facing an uncharacteristically large backlash.

For example, Andrew Cuomo, governor of New York, is planning to sue over this legislation. His ire is directed at a new revision that caps the deduction for state and local taxes at $10,000, which was previously unlimited.

He argues this element of the law disproportionately targets democrat-leaning states that already have higher taxes by limiting the amount of tax relief citizens of these states have access to. In fact, Cuomo estimates that New Yorkers will eventually pay an extra $14 billion in federal taxes because of this change.

However, experts speculate the lawsuit won’t hold up in court—primarily because there are valid arguments for limiting this deduction beyond the perceived punishment of liberal voters. But residents of states affected by this change likely won’t find any solace in that reasoning, which could translate into stronger turnouts at the voting booth.

Affected states are also considering developing new systems to circumvent this $10,000 deduction restriction. One such proposal would allow residents to classify certain types of taxes as charitable contributions, allowing them to offset the extra money they’ll pay from the deduction cap.

All of this adds up to an already unpopular tax bill potentially becoming even less popular as time goes on. When you factor in that individual tax breaks expire after ten years while corporate tax breaks are indefinite, it seems likely that many voters will reach a breaking point.

The next time the Democratic Party controls the government, reforms on the new GOP tax law will almost assuredly be a high priority. Keep this in mind as you decide on your firm’s long-term plan for your new tax savings.

A Mentally Taxing Topic

Most tax codes are cumbersome and confusing, and this one is no different. Be patient, as it may take your firm time to come to grips with the bill’s full impact.

And as you’re internally debating what the new pass-through expansion or emerging loopholes may mean for your firm, keep up-to-date on the political developments surrounding potential adjustments to this legislation. Staying current with the effects this tax law has over the coming years may just be the best way to get ahead.

This article is for informational purposes only.


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