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The New Tax Act and its Implications to You and Your Law Firm

In his economic overview (mobile users, click here) of the new tax provisions that Congress agreed on before the clock struck 12:00, Patrick J. O’Keefe, CohnReznick’s Director of Economic Research, says that the “American Tax Relief Act of 2012 (ATRA) adds some level of certainty to the tax code. Many of ATRA’s policy changes permanently extend what had been temporary exemptions or fixes. Some of these changes accompany tax increases while others provide systemic relief. There is a real benefit from the longer-term stability implicit in these ‘permanent’ fixes: By giving businesses and households added confidence, it should bolster their willingness to invest and spend.”

As an attorney or a law firm managing partner, you are likely wondering how the recently enacted ATRA provisions will specifically affect you. In fact, ATRA will have a significant impact on attorneys and law firms, not only for purposes of tax planning but for business planning and strategy as well. You will be interested in learning about the opportunities and challenges that lie ahead – including the impact of ATRA’s new tax rates, estate and gift tax provisions, the state of the Alternative Minimum Tax, and ATRA’s extension of 50 percent bonus depreciation.
Individual Income Tax Provisions Affecting Highly Compensated Lawyers

  • The Act increases the top marginal tax rate on ordinary income from 35% to 39.6%. This rate applies to single filers with taxable income in excess of $400,000 and married joint filers with taxable income in excess of $450,000.
  • The Act also increases the tax rate on long-term capital gains and qualified dividends from 15% to 20% for income over $400,000 for single filers and $450,000 for married joint filers.
  • The personal exemption phase-out and itemized deduction limitation thresholds have been extended to $250,000 for single filers and $300,000 for married joint filers.
  • Alternative minimum tax (AMT) exemption amounts have been increased to $50,600 for single filers and $78,750 for married joint filers. These exemptions have been “patched” permanently as well, meaning that the exemptions will be adjusted for inflation beginning in 2013.
  • A number of nonrefundable personal credits, such as the adoption expense credit and credits for qualified tuition expenses, can now be used to offset both regular income tax and AMT.
  • The Affordable Care Act imposes a 3.8% Medicare tax which takes effect in 2013 and is imposed on the lesser of “net investment income” or  adjusted gross income in excess of $200,000 for singles and $250,000 for joint filers. Net investment income includes interest, dividends, and stock market gains less investment deductions such as investment interest expense and other deductible investment expenses. The term net investment income also includes income and disposition gains from a trade or business activity which constitutes a passive activity for the taxpayer. Thus, if Smith and Jones are the owners of Smith & Jones Widgets LLC, and Smith is active in the business, but Jones is passive, then Jones’ income from the business would be subject to the Medicare tax, but Smith’s income from the activity would not be subject to the 3.8% Medicare tax.

Impact: Many lawyers have taxable income in excess of $250,000 and substantial investment income, and will thus be impacted by the increased income tax, capital gains and qualified dividend tax rates. Careful planning throughout 2013 will be necessary to mitigate this impact.

Business Tax Provisions Affecting Law Firms

  • The $500,000 Section 179 small business expense deduction limit has been extended through the end of 2013. The $2,000,000 asset phase-out has also been extended.
  • The Act extended 50% bonus depreciation for property placed in service after December 31, 2011 and before January 1, 2014.
  • The Act renews 15-year depreciation recovery period for qualified leasehold improvements placed in service after December 31, 2011 and before January 1, 2014.
  • The exclusion from an employee’s gross income for up to $5,250 of employer-provided education benefits has been permanently extended.
  • The employer-provided child care credit has been extended and made permanent.
  • The amount of employer-provided mass transit pre-tax benefits has been increased from $125 per month to $240 per month, equalizing mass transit benefits and parking benefits through the end of 2013.

Impact: Law firms can benefit from the extensions of bonus depreciation, Section 179 expense deduction and qualified leasehold improvement deductions. These provisions allow a large tax benefit for significant capital expenditures and may have significant impact on a firm’s tax position. Please click here (mobile users, click here) for CohnReznick’s analysis of the ATRA provisions impacting  depreciation.

Estate and Gift Tax Provisions Affecting Lawyers

  • The rates for estate and gift tax increased, going from 35% to 40%.
  • The lifetime estate and gift tax exemption has been permanently retained at $5,000,000, indexed to inflation.
  • The Act makes the “reunification” of the estate tax and the gift tax exclusion permanent.
  • Additionally, the Act permanently extends the portability of the unused exclusion amount between spouses, effective January 1, 2013.

Impact: With the uncertainty that has surrounded the estate and gift tax laws settled, high net-worth individuals, including attorneys, should consider their long-term estate and lifetime gift plans to generate maximum tax benefit and minimum tax burden.

Payroll Tax Provisions Affecting Law Firms

  • The Social Security “payroll tax holiday” for the employee portion of the Social Security withholding tax has expired. The employee portion has gone from 4.2% in 2012 to 6.2% in 2013.
  • The employer portion of the Social Security tax remains 6.2%, with a Social Security wage base limitation of $113,700 for 2013.
  • The Medicare payroll tax rate remains 1.45% for employees and employers.
  • The Affordable Care Act imposes an additional 0.9% Medicare withholding tax on the wages of single filers earning more than $200,000 and married joint filers earning more than $250,000. There is no employer portion for the additional Medicare tax.

Impact: Law firms, as employers, will need to ensure that wage withholding reflects the new employee portions and wage base limitations for these payroll taxes. Additionally, law firms with employees earning more than $200,000/$250,000 must withhold and collect the additional employee Medicare tax.

For more information, please visit CohnReznick’s Law Firm Industry website and contact Richard Puzo, Partner and Law Firm Industry Group Leader, at 973-364-6675.

Circular 230 Notice: In compliance with U.S. Treasury Regulations, the information included herein (or in any attachment) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of i) avoiding penalties the IRS and others may impose on the taxpayer or ii) promoting, marketing, or recommending to another party any tax related matters.


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