Top 5 Year-End Tax Planning Strategies for Professional Service Firms

Firms that operate in the Professional Services industry, such as Law Firms, Architectural and Engineering Firms and Consulting Companies, have experienced a turbulent year in 2020, like many of us.

For these sectors, the year began on a positive note with impressive growth in the first quarter. But as COVID-19 hit and the national shut-down occurred, the uncertainty left many firms planning for the worst with layoffs, furloughs and other cash conservation plans to limit their losses. With the prospect of several effective vaccines soon to be released to the American public, many parts of the economy, and in particular, many professional service firms, have rebounded and will report profits for tax year 2020. This, combined with the current negative tax impact of receiving PPP (Paycheck Protection Plan) funds, could create some tax headaches at year-end for many firms.

It’s not too late to employ some last-minute tax planning ideas; below are 5 of our top ideas for Firms to consider before December 31st:

1. Defer revenue and accelerate expenses – most Professional Services companies report their revenue and expenses on a cash basis for income tax purposes. Because of the current notion that the expenses relating to the PPP loan would be non-deductible in the year received, if the government ultimately forgives the loan, 2020 could end up being a high-income year for many Professional Service companies. In that case, you may wish to defer revenue during the last part of 2020 and accelerate the payment of certain 2021 expenses before year-end.
2. Section 179 or Bonus Depreciation – consider making new technology or other fixed asset purchases before year-end in order to be eligible for a tax deduction of up to $1.04 million. These assets may also be fully written off in 2020, using 100% bonus depreciation.
3. QBI Deduction – the TCJA provided most pass-through entities (Partnerships, LLC’s and S Corporations) a new deduction of up to 20% of the qualified business income (QBI) earned during the year. The “catch”, however, was that the owners of many Professional Service companies did not qualify for this deduction because their income exceeded the threshold for businesses considered to be “specified service trade or business” (SSTB’s). For example, most Law Firms, Accounting Firms and Consultants are considered SSTB’s. In those instances where income can be reduced to below this threshold and Firms become entitled to the 20% QBI deduction, businesses may elect to accelerate their expenses or perhaps increase discretionary pension plan contributions for their employees to keep the income beneath this threshold.
4. R&D Tax Credits – a recent tax court summary judgment emphasizes that architectural and engineering firms performing research activities under a fixed-price contract may be eligible for the Federal Research and Development Credit. This new guidance has the potential to allow additional companies to qualify for the R&D tax credit for performing research activities under fixed-price contracts. Firms such as these should reevaluate their R&D tax credit eligibility for this valuable tax credit.
5. Retirement Plans – although most Professional Service companies have a retirement plan in place, now is an opportune time to evaluate ways of maximizing the Firm’s contribution to the plan. There may be ways to design your plan to optimize tax deductions for your business without giving up too much benefit for your owners. Furthermore, Firms can fund their defined benefit and profit-sharing plans after year-end until the due date of the tax return, but new plans need to be adopted by 12/31/20. Smaller companies may consider a SEP plan, which can be adopted and funded after year-end until the due date of the tax return.

Because tax law frequently changes, significantly impacting your specific planning possibilities, no action should be taken without the advice of your tax advisor. This is especially true in light of current election outcomes and other changes that COVID-19 has been forcing Federal, State and Local governments to contend with these days. Speak to your tax advisor today before the clock runs out in December.