2021 Year End Tax Planning for Law Firms and Attorneys

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2021 WithumSmith+Brown, PC
2021 Year End Tax
Planning for Law Firms
and Attorneys

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50 minute session
10 minutes Q&A (or however long it takes) session at the end
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Housekeeping

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Presenters
Daniel Mayo , JD, LLM
Principal, National Lead,
Federal Tax Policy
Jonathan Weinberg, JD, LLM
Senior Manager, Professional
Services, State and Local Tax
Services
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Federal Update

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Individual Provisions
• 5% surcharge for AGI over $10 million, and 3% surcharge over $25 million
• Top ordinary income tax rate would be 48.8% (37% + 3.8% NII + 5% surcharge + 3% surcharge)
• Expansion of SALT limit to $72,500 from 2021 to 2031
• Elimination of 75% and 100% exclusion percentages for Qualified Small Business Stock for taxpayers
with AGI over $400,000, retroactive to sales after 9/13/2021 (subject to binding contract exception)
• Addition of digital assets (i.e., cryptocurrency) to wash sale and constructive sale rules
• Addition of commodities and currencies to wash sale rule
• NIIT expected to include income from active trade or business for taxpayers with TI over $400,000
• Permanent extension (and elimination of thresholds) of EBL limits for non-corporate taxpayers

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Retirement Provisions
 Limitation on further contributions to IRAs/Roth IRAs for individual taxpayers with AGI ≥
$400K where the account balance would exceed or further exceed $10 million (effective
starting in 2029)
 Increase to RMDs for these large accounts, starting in 2029
 Elimination of back-door Roth conversions with after-tax funds after 2021
 Elimination of regular Roth conversions for IRAs and employer sponsored plans for
taxpayers with taxable income over $400K, starting in 2032
 15% prohibited transactions tax applies if an IRA holds a FSC or a DISC

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Business Provisions
 15% minimum corporate tax on large corporations with 3-year average annual income over
$1 billion
 1% excise tax on stock repurchases of publicly-traded, U.S. companies
 Plaintiff’s attorneys can deduct out-of-pocket litigation costs relating to contingency-fee
cases in the year incurred rather than in the year the litigation concludes
 International tax reform, including interest expense disallowance and changes to FDII, GILTI,
BEAT, CFC, and FTC rules

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Eliminated Provisions
• No increase in top individual tax rate to 39.6%
• No increase in top corporate tax rate to 26.5%; no graduated tax rates
• No retroactive increase in top long-term capital gain/QDI rate to 25%
• No carried interest provisions
• No limitation on §199A QBI deduction
• No 2-year period for tax-free S corporation-to-partnership conversions
• No mark to market tax on unrealized capital gains
• No elimination of step-up in basis and no change to estate and gift tax lifetime exemption

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Year-End Planning

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General Year-End Tax Planning Ideas
General rule is to defer income and accelerate expenses – but consider rate surcharges for HNW
individuals
• How to Defer Income?
• Like-kind exchanges of real estate
• Invest capital gain in opportunity zones
• Rollover of QSBS gain
• Installment sales defers gain until payments are received
• Contribute to a 401(k) or SEP, and catch-up amount if 50 or older
• Contribute to an HSA (individual limit is $3,600, family limit is $7,200)
• If 55 or older, the catch-up contribution amount is $1,000

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How to Accelerate Expenses?
• Prepayments of rent, taxes, etc.
• Purchase equipment for §179 expense or bonus depreciation
• Pay in 2021 mortgage interest due in January 2022
• Pay passthrough entity tax before the end of the year to avoid SALT cap
• Pay in 2021 estimated state income tax payments due in early 2022
• But remember state taxes in excess of $10K are subject to the annual SALT cap

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• How to Accelerate Expenses? (cont’d)
• Bunch itemized deductions so itemizing is preferable to the standard deduction (single $12,550/MFJ $25,100)
o Date and mail checks in 2021
o Use credit cards to make payments – promising to pay does not make expenses deductible, but paying with
borrowed funds works
o Contribute to a donor advised fund now, and allocate funds to charities later
o Double up on charitable contributions and pay every other year
o Accelerate medical expenses into 2021 so they exceed 7.5% of AGI
• Reevaluate reasonable compensation in S corporations (i.e., employment tax planning)
• Reevaluate officer compensation in C corporations (i.e., to reduce double taxation)

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Ideas to Accelerate Income
• Accelerate business income
• Elect out of bonus depreciation
• Trigger gain now instead of later (sales, exchanges, distributions from C corporation, etc.)
• Change accounting methods
• Don’t let the tax tail wag the planning dog – think in terms of accelerating something you would otherwise do, rather than doing something you would
not otherwise do
• Accelerate personal income
• Trigger long-term capital gain in 2021 rather than in 2022 or later
• Actual sales or constructive sales – e.g., short against the box; wash sale rules do not apply to gain
• IRA conversions (i.e., convert pre-tax retirement accounts to Roth (after-tax) accounts)
• Take a required minimum distribution (RMD) from an IRA/retirement plan
• Exercise stock options or make a §83(b) election on deferred compensation subject to restrictions

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Basis/At-Risk/Passive Losses
• Taxpayers who experienced losses in 2021 may not be able to deduct them due to
basis/at-risk/passive loss limitations
• Consider year-end strategies for increasing basis to take losses
• Contributing funds or loaning money directly to S corporation
• Filing PPP2 loan forgiveness application to try and receive decision before year
end

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Estate and Gift Year-End Tax Planning

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Current Estate and Gift Tax Law
• The 2017 TCJA doubled the Basis Exclusion Amount and GST exemption from 2018 – 2025 ($10 million in
2011 dollars)
• In 2021, the current Estate, Gift and GST Exemption is $11.7 million per individual ($23.4 million for married
couples)
• In 2026, the Estate, Gift and GST Exemption is set to go back to pre-TCJA law ($5 million in 2011 dollars)
• The Proposed Legislation is to accelerate the sunset to January 1, 2022 where the Estate, Gift and GST
Exemption would be projected to be $6 million

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Current Estate and Estate Tax Law
• The Proposed Legislation does not change:
• Estate and Gift Tax Rate of 40%
• Annual exclusion of $15,000 per donee ($30,000 for a married couple)
• Step-Up in Basis in Assets held at Death, Carryover in Basis for Gifts of Assets
• Portability of a Deceased Spouse’s Unused Exemption
• Annual Withdrawal Right (Crummey Powers) from Existing Non-Grantor Trusts

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Use the Gift and GST Exemption Now
• IRS issued final regulations in November 2019 which would not cause recapture of gifts made in excess of the
lifetime exemption at the time of an individual’s passing
• Example: An individual makes a gift of $11.7 million in 2021 and passes away in 2022 when the exemption is $6
million, the individual’s estate is not subject to estate tax on the $5.7 million excess gift
• Donors cannot use part of the $11.7 million exemption now and preserve the balance for later use
• Example: An individual makes a gift of $6 million in 2021 and passes away in 2022 when the exemption is $6
million, the individual’s estate has no remaining exemption
• If married, have one spouse make a large gift to utilize their $11.7 million exemption to get “at least one bite of the
apple”

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Use the Gift and GST Exemption Now
• Make large gifts to family members or trusts for their benefit in excess above the potential
exemption of $6 million in 2022
• Establish a Spousal Lifetime Access Trust (SLAT) before the enactment of the proposed
legislation
• Be careful of Reciprocal Trust Doctrine if Creating two SLATS for each spouse

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BE IN A POSITION OF SM
Pass Through Entity Tax
Considerations for Law
Firm Partners

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 Traditional prohibitions on practicing law in corporate form mean that
the overwhelming majority of law firms are structured as Pass-Through
Entities (e.g., LLP, LLC, S-Corp)
 Pass-Through Entities (“PTEs”) are not subject to federal income tax. Instead, the PTE’s owners
(e.g., members, partners, shareholders) pay the income tax on the firm’s profit and their
respective distributive shares
 Most states traditionally conform to the federal treatment of PTEs. As such, the owners also pay
the state income tax component on the partnership’s profit. As such, many partners’ state
income tax liability is far in excess of the $10K cap imposed by the TCJA.
Why should law firm partners care about
PTETs

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 What precipitated the PTE Workaround?
 TCJA SALT Limitation
 Failure of Other Workarounds (e.g., Charitable Deduction & Payroll Tax)
 Initial State Adopters (e.g., CT, NJ, etc.)
 IRS Notice 2020-75
The Rapidly Changing Landscape of State
and Local Pass-Through Entity (PTE) Taxes

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 SALT Limitation: Before passage of the TCJA, individuals who itemized deductions could deduct
their state tax payments in full as Itemized Deductions, on their federal Form 1040, U.S. Individual
Income Tax Return. The TCJA put into place a $10,000 state and local tax deduction limitation.
 SALT Workaround: In theory, the premise of the pass-through entity tax is straight-forward. By
imposing an income tax directly on the pass-through entity, which is not limited in the amount of state
taxes that it can deduct for federal purposes, a state's tax on pass-through entity income now
becomes a full deduction for the pass-through entity for federal income tax purposes.
Pass-Through Entity Taxes as a Growing
Trend for the States

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Pass-Through Entity Taxes (Summer 2020)

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Pass-Through Entity Taxes (April 2021)

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Pass-Through Entity Taxes (June 2021)

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Pass-Through Entity Taxes (August 2021)

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Pass-Through Entity Taxes (October 2021)

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Poll Question

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 IRS Workaround Repeal: As 2020-75 was released under the Trump administration, it is possible the draft
regulation could be rescinded by the Biden administration.
 Nonresident Owners; Resident Credits: The resident state of a non-resident member may not allow a resident
credit on their individual returns for taxes paid at the entity level.
 May Require Significant State Presence: As the PTE will only pay tax on state connected income, the benefit
may be limited to the extent of presence in the state.
 Duplicate Estimate Payment Requirements: State legislation may not not alter existing non-resident withholding
requirements for those PTEs that elect to pay the PTE. Therefore, overlapping payment requirements may be
necessary if individual non-resident taxpayers are subject to both regimes.
 Other Risks
PTE Tax Risks and Considerations

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 There are many features / characteristics of each states’ PTE tax. As
such, it’s vital these considerations are analyzed.
 Election (Mandatory/Elective/Revocable)
 Eligibility
 State Taxable Base
 Owner Income Offset
PTE’s Primary Features

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Mandatory
California
Arkansas
Alabama
Colorado
Illinois
District of
Columbia
Georgia
Idaho
Connecticut
Louisiana
New Jersey
Minnesota
Maryland
New York
New York City Oklahoma
Rhode Island
South Carolina
Wisconsin
Arizona
Elective
Massachusetts
Oregon

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PTE Tax Rate
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
SC AZ CO OK IL AL MA GA AR RI LA ID CT WI DC MD NYC CA MN OR NJ NY

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Owner Income Tax Offset

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 Monitor states for legislation / guidance.
 Model out potential PTE savings in consideration of making the election.
 Consider any potential restructuring to potentially maximize benefits and
minimize risks.
PTE Action Items

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BE IN A POSITION OF SM
State Tax Implications of
a Mobile Workforce

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Poll Question

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 As Covid-19 continues to disrupt the global economy and transform workforces,
a renewed focus has put telecommuting at the forefront as businesses grapple
with the state tax implications
 Central issues put into focus:
• Income and Sales Tax Nexus
• Income Tax Apportionment
• State Payroll Withholding
Telecommuting

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 Due to licensing issues, the practice of law traditionally required its
lawyers to be tied to a specific office.
 It was expected that everyone reported to the office during specified hours – working from home
was the exception rather than the rule
 Due to COVID19, everyone was required to work remotely, and many
law firm partners and employees used this opportunity to start working
very far from the traditional office
 Some of these remote work arrangements are ending, some are becoming permanent. These
changes to how work is done have substantial effects on both law firms, lawyers, and employees
Remote Work for Law Firms as a Result of
COVID 19

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 Nexus is defined as contact with a state that is sufficient to establish a
connection allowing the state to impose a tax.
 Requires the seller to possibly register, collect, and remit sales tax on sales made within the state.
 Requires a business to possibly file an income, gross receipts, and/or net worth tax return.
 Types of nexus include:
 Physical Nexus
 Economic Nexus
• Factor Presence
• “Doing Business”
Telecommuting Impact on Nexus

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 Covid-19 has created nexus concerns for businesses due to telecommuting employees.
 A handful of states have issued guidance that employees temporarily working remotely during an
emergency declaration does not create nexus.
 Those same employees may create nexus if they continue to work remotely after the emergency
declarations are suspended.
 The nexus waivers would only apply to employees that did not work remotely prior to the declarations.
 If the business otherwise has economic nexus in a state and isn’t protected by P.L. 86-272, the business
would otherwise have nexus regardless of state waivers.
 It is important for businesses to consider its policies in respect to remote employees.
Telecommuting Impact on Nexus

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 For income tax apportionment, in some states, the consequence of an
employee working from a different state as a result of the pandemic
could affect sales sourcing and the payroll factor of state apportionment.
Telecommuting Impact on Apportionment

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 How do you determine how much income is taxable in one state versus another?
 When a taxpayer conducts business in multiple states, total taxable income must be divided among the
states.
 Historically, states often leveraged a model apportionment formula based on
guidance from UDIPTA, which the formula equally weights payroll, property, and
sales factors.
 However, many states have deviated from this, and use various weighting methods, such as double-
weighted sales, triple-weighted sales, single-sales or other varying methods.
 Further, states use different sourcing statutes, and such provisions along with case law may present
planning opportunities.
Telecommuting Impact on Apportionment

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Poll Question

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Payroll Property
Sales
Factor
Components
TPP
Services/Intangible
s
Market-Based
Cost of
Performance
Activity Types
Destination
Sourcing
Methods
Factors Summary

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 Payroll tax withholding involves deducting income and payroll taxes
from employees’ compensation before payment to employees.
 Employees may adjust income tax withheld from compensation by providing their employers with an employee
withholding certificate. The most common state tax withheld from compensation is income tax.
 Locations complicate withholding requirements.
 The state where an employee principally lives generally has primary taxation authority of the individual’s income.
However, for state taxes, withholding from employment income is typically based on where employees actually work.
 If an employee principally lives in one state but principally works in another, the employee is generally subject to
withholding rules of the principal work state. However, the employee could take a credit for taxes paid to the principal
work state against tax liability otherwise owed to the home state.
 Complications could arise when there are reciprocal agreements between the two states for withholding.
Telecommuting Impact on Payroll Tax

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 Remote workers generally owe taxes to the state from which they work, regardless
of the employer’s location.
 However, some jurisdictions use “Convenience of the Employer test”, which the compensation is sourced to the employer’s located where
the employee “is assigned” unless the arrangement is for the employer’s necessity, not the employee's convenience.
 If an employee had principally worked in a state other than their home state but is working from their home state
due to the pandemic, there is no change to withholding from employment income if the states have a reciprocal
agreement allowing the home state to have tax authority regarding withholding.
 If there is no reciprocal agreement, the home state’s withholding requirements typically apply instead of the former primary work state.
 If an employee is working in a state other than their principal state of residence or their principal work state, and
they reach that state’s threshold number of work days if such a threshold has been adopted for withholding, the
state’s withholding requirements are generally activated.
State Withholding for Remote Workers

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Questions?

2021 Year End Tax Planning for Law Firms and Attorneys

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