Will big law firms and their partners benefit from the new Republican tax plan promoted by President Donald Trump? See, “Trump Proposes the Most Sweeping Tax Overhaul in Decades,” New York Times. Not necessarily, according to tax experts who say some gains may be eroded by loss of crucial deductions.
The one thing tax experts all agree on is that the proposed framework is very short on details and not clear enough to make any conclusions.
In one of its general statements, the framework said it would limit the maximum tax rate applied to the business income of small and family-owned businesses conducted as sole proprietorships, partnerships and S corporations — known as pass through entities — to 25%.
So if a law firm qualified — and that’s a big if — partners who pay 39.6% may pay 25% instead.
But the framework suggests this is only for small businesses, and tax experts say large law firms probably wouldn’t be included in that group.
“It would be hard to imagine that the definition of a small business, when determined, would fit the characteristics of a large firm, but we don’t know at this point,” says David Gaulin, who leads the law firm services practice at PricewaterhouseCoopers.
The proposed tax framework offers no definition of a small business, and even the current Internal Revenue Code uses mixed definitions, according to Columbia Law School tax professor Alex Raskolnikov, noting that one section defines a small business as less than $5 million in receipts while another section defines it as $50 million or less in assets.
Raskolnikov says smaller firms may well benefit, but that also remains to be seen.
Alan Appel, professor of tax law at New York Law School and a senior consultant at Bryan Cave, says he can’t imagine a scenario in which law firm partners are taxed at a lower rate than some employees, such as their associates.
Law firm partners, like others, would benefit from reducing the top taxable individual rate from 39.6% to 35%, but Republicans have also suggested another top tax rate that is not yet defined.
And any benefit gained by the lower tax rate may be reduced by the loss of certain deductions, Gaulin says, such as for state and local taxes. The proposed framework “eliminates most itemized deductions” for taxpayers, except for home mortgage interest and charitable contributions.
It’s All Relative
Considering all the changes that are known now, individual partners’ taxes might not be affected substantially, especially in high tax states.
“It’s likely to be close to a wash in high tax states,” Raskolnikov says, cautioning that many details are not yet known.
The loss of deductions for a New York partner will be more painful, than a Florida partner, he says.
What about the other proposed changes, such as eliminating the alternative minimum tax (AMT) and the estate tax?
Partners who are making millions of dollars, who are at the top of the Am Law 100, are not going to be affected by the repeal of the AMT because they have too much income in the top tax bracket, Raskolnikov says, adding that those who make under $1 million may suffer from the repeal of the AMT.
Some law firm partners may benefit from the end of the estate tax, but that’s likely a relatively small crowd within the Am Law 100.
“The elimination of the estate tax will only benefit the wealthiest partners who have the biggest estates,” Gaulin says.
What’s not discussed is if there are any other revenue raisers for the government under contemplation, he adds.
For instance, there is no mention, at least not yet, of requiring professional service firms to move from a cash to an accrual method of accounting, which has been proposed in recent years and would be painful to law firms.
A bill previously put forward by former Rep. Dave Camp (R-MI) would require partnerships with annual revenue of $10 million or more to change to the accrual method of accounting, in which partners are taxed on earned income. See, “Tax Reform Measure Could Impact Law Firm Accounting Methods,” NYLJ.
Most law firms now use the cash method, where partners pay taxes on earnings they actually collect. If passed, such a law would have a major effect on many large and midsize law firms, immediately increasing how much partners have to pay in taxes.
Of course, even if lawyers wouldn’t benefit right away from the new tax framework, they may benefit if it spurs on economic activity for their clients, such as mergers and acquisitions, investments and the development of new products and services. Whether that would happen is the subject of heated debate.
Another big question is how much support the plan will receive from Republicans in Congress from high tax states. It’s not safe to assume those state and local tax deductions are gone, tax experts say.
“It’s very much in the air what they’re going to end up doing,” Raskolnikov says.
The views expressed in the article are those of the authors and not necessarily the views of their clients or other attorneys in their firm.