Five key take-aways to help your law firm navigate 2019’s new tax regulations

Karen LoDico Tax Partner, PwC US February 21, 2020

The 2019 tax year is shaping up to be just as challenging as 2018, if not more so. A steady stream of guidance from the IRS is providing more clarity around the new forms and reporting requirements in some areas, such as the Schedule K-1s, but business tax filers will likely continue to contend with open questions elsewhere, such as how to depreciate for Qualified Improvement Property (QIP) for 2019, possibly in advance of technical corrections to the rule.

Given these complexities, PwC tax partner Karen LoDico sees five important considerations to help your law firm prepare for this new tax season.

For more on the tax landscape for law practices, access the 2019 Law Firm Services Year-End Tax Planning Webcast.

1. Tax basis capital reporting requirement

The 2019 draft Schedule K-1 included a number of changes in reporting requirements, including requiring firms to report partner capital on a tax basis. Having never needed to report tax basis capital for their partners, this is a new challenge for the majority of law firm partnerships. Released after the webcast, the IRS issued Notice 2019-66, which provides reporting relief for 2019, confirming that the requirement will be effective for the 2020 tax year. (Note: The 2018 requirement to report negative tax basis capital accounts per partner is still required in 2019.)

While firms don’t need to scramble to determine tax basis partner capital for the 2019 K-1s, they should evaluate how to approach this requirement for 2020. Securing sufficient time for determining a starting point is important, particularly if firms need to reconstruct tax basis partner capital over an extended period of time.

2. Technical Corrections to the Tax Cuts and Jobs Act

Unfortunately, the end-of-year tax deal passed by Congress did not include technical corrections to the Tax Cuts and Jobs Act of 2017. Further complicating matters, the overall legislative environment typical of an election year is not likely to yield to the enactment of much tax legislation before the last quarter of 2020, including technical corrections, such as 15-year life for Qualified Improvement Property. Assuming the technical corrections are not enacted prior to K-1s distribution (or return filing by corporate law firms), firms should decide how to depreciate their QIP for 2019 and 2020. Based on the polling results during the webcast from the 101 law firm respondents, generally ranging in the role of CFO to tax director/manager, we expect about two-thirds of law firms to follow the current 39-year life law. The remaining third, will likely place in service as 15-year property, with or without disclosure.

3. Meals, entertainment, and transportation benefit disallowances

As of January 1, 2018, law firms saw a significant spike in the disallowed portion of meals and entertainment, as well as transportation and commuter fringe benefits disallowances. Proposed regulations are imminently anticipated under section 274, which should include further guidance in determining the parking portion of disallowed expenses among other provisions.

4. Foreign branch reporting

According to our 2018 compliance season, many law firms experienced a significant increase in the number of Forms 8858 filed as a result of the new requirement for foreign branches to file. In many cases, law firms were more than doubling the number of forms required to be filed. 

In December of 2019, Treasury released the final foreign tax credit regulations under section 904. They incorporate the earlier proposed regulations with a few relevant variations:

  • The final regulations included the same branch carryover exception election as the proposed regulations: reallocating pre-2018 foreign tax attributes carrying forward to 2018 from general to the foreign branch category based upon a detailed "reconstruction option." Favorably though, the final regulations offered a simplified safe harbor option. Individual law firm partners making this election would save time and require less prior-year detail from the law firm to do so.
  • The final regulations assigned a lower threshold for whether a permanent establishment constitutes a foreign branch. They indicate that a permanent establishment generally meets the trade or business standard of the foreign branch definition. Thus, firms should revisit whether foreign branch reporting of any permanent establishment is required.
5. State and local tax perspective

The trend of states adopting market-based sourcing provisions has increased law firm state filings. We expect this to continue rising through 2019. Firms should consider the recent Wayfair decision in assessing their income tax filing perspective. There may also be additional state deduction opportunities, and firms should continue evaluating federal conformity amongst the states. This is particularly important with respect to the meals and entertainment, as well as transportation and commuter fringe benefits federal disallowances. Firms should also continue to monitor state activity with respect to either enacting or proposing entity level taxes for pass through entities to determine potential impact.

Let us help

Our Law Firm Services practice brings a singular, specialized focus on law firms. Our global network is able to provide the guidance and in-country knowledge you need to transact business and handle global, national and local tax issues.

We are able to provide timely and insightful answers to your questions, and have a long and proven record as a trusted advisor to clients, which include the majority of the AmLaw 100. Please reach out if you need more guidance on interpreting 2019 tax regulations for your firm.