It is already mid-December and the year is winding down quickly. Now is the time to plan for 2021 tax reporting. Of course, the typical year-end tasks of tax projections and paying estimates are always on the “to do” list, but here are some special 2021 tips – many of them reminders — to help place your firm in the best position for the New Year:
1. Temporary 100% Deduction for Business Meal Expenses – The Consolidated Appropriations Act of 2021 (the “Act”) gave taxpayers a grace period during which restaurant meals would be 100% deductible, rather than 50% deductible. According to IRS Notice 2021-25, interpreting the Act, a qualifying restaurant is one which prepares and sells food or beverages to retail customers for immediate consumption and the food may be either dine-in or take-out.
The exception does not apply to pre-packaged products, such as those sold at grocery or liquor stores. If your firm has not already set up a new general ledger code to track these favorable expenses, we suggest a review of the 2021 meal expense account to reclassify the qualifying expenses to a separate account for a full deduction. Effects of IRS Notice 2021-25: Temporary 100% Deduction Business Meal Expenses
2. Employee Retention Credit – The Infrastructure Investment and Jobs Act (“IIJA”) enacted on November 15, 2021 limits the prior law so that the Employee Retention Credit (ERC) applies only to wages paid before October 1, 2021, unless the employer is a recovery start-up business. Therefore, the maximum 2021 ERC per employee is $21,000 rather than $28,000. The Service issued guidance in Notice 2021-65 for businesses which were counting on the relief in the last quarter of 2021.
If your firm received an advance payment for 2021 fourth quarter wages or if your firm reduced its tax deposits on or before December 20, 2021 for wages paid between October 1, 2021 and January 1, 2022 by the ERC that they expected to claim, please refer immediately to Notice 2021-65 and consult your tax advisor for specific guidance consistent with the new legislation. Infrastructure Bill Repeals the Employee Retention Credit for Q4 of 2021 – Opportunities Remain
Nevertheless, companies may still apply for the ERC as long as the statute of limitations remains open, which is three years from the date of filing the applicable Form 941. Eligible businesses can file a claim for a retroactive ERC refund on previously paid qualified wages for past calendar quarters by filing Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund.
The ERC is taxable in the year to which the payroll relates, so it is important to make this adjustment before the firm’s tax returns are filed. It should be recorded as a reduction to payroll , rather than as an addition to income.
3. Remote Workers – Many employees are still working remotely because of concerns about COVID-19 transmission, coupled with their awareness that working from home (WFH) is more efficient than trekking into the office every day. The decrease in time spent commuting and the enhanced workday flexibility make working remotely very attractive.
The result is that remote workers may be establishing income tax nexus for their firms by virtue of their locations. At the beginning of the pandemic, many states suspended imposition of nexus based exclusively on remote work arrangements – but those grace periods have begun to expire.
Therefore, it is critical first to be aware of those expiration dates and second, for partners and other legal personnel to track their work locations to determine whether these workers have established nexus for the firm. Once nexus has been established, firms will need advisors to guide them through those states’ revenue sourcing rules for tax filing and payment.
Remote work may also reduce a firm’s tax liability in some jurisdictions. For example, New York City’s Unincorporated Business Tax (“UBT”) sources revenue according to where the work is performed. The revenue earned by the attorneys working from their locations outside New York City would not be sourced to New York City and, therefore, excluded from the New York City UBT calculation.
Prospectively, firms should establish human resources polices regarding work arrangements so that they have adequate notice of where and how new and existing employees will be working. For more information, please listen to the Eisner Advisory Group’s on demand webinar: State Ramifications of Remote Workers for Law Firms
4. SALT Cap Workarounds –
In May 2018, Connecticut became the first state to enact a pass-through entity tax (“PTE”) SALT cap workaround, providing owners of pass-through entities a full deduction for state taxes paid by the entity. In November 2020, the Service issued Notice 2020-75, somewhat unexpectedly endorsing such PTE taxes and their goal of circumventing the SALT deduction for partners and shareholders who itemize. Thereafter, multiple states followed Connecticut’s lead and enacted their own versions of the PTE.
The New York State PTET required an election by October 15 for the 2021 tax year, but there are many other states whose eligibility period is still open. Each state has its own election, estimate and calculation system – and potentially its own pitfalls. While a detailed discussion of PTEs is beyond the scope of this article, suffice to say that your firm should consult with its tax advisor to determine whether such an election would be beneficial to your firm and if so, how much to pay before the end of December to preserve the 2021 deduction.
An important caveat is to consider the partners’ resident states. Pass-through entity taxes are most advantageous when the composition of the owner pool is homogeneous and/or the owners are all residents of states which offer a PTE tax option and therefore allow a resident credit for taxes paid at the pass-through entity level. Several states have enacted PTE taxes but have provided only scarce guidance to date, so it is impossible to know exactly how it will apply to your firm. For more information, please watch our on demand Webinars: New York State and other SALT Cap Workarounds for Law Firms and The California Pass-Through Entity Tax Provides Necessary Relief and Reflection.
5. Fixed Asset Purchases – As 2021 draws to a close, consider purchasing fixed assets to take advantage of the available deductions.
IRC Sec. 179 allows a 100% deduction for most fixed asset purchases through 2022 to the extent the business is profitable. IRC Sec. 168(k) (bonus depreciation) also allows a 100% deduction until the end of 2022. Different rules apply to state reporting.
The de minimis safe harbor election pertains to amounts paid for the purchase or production of tangible property. If the firm elects the de minimis safe harbor, it may expense up to $5,000 per invoice or item (if it issues an applicable financial statement) or $2,500 (without an applicable financial statement). Please be sure to discuss the potential tax effects of specific fixed asset purchases with your tax advisor.
6. Basis Considerations –
Paycheck Protection Program (“PPP”) – If your firm’s PPP loan was forgiven during 2021, be aware that the forgiveness does not create taxable income. Instead, report the forgiveness as tax-exempt income and add it to the owners’ basis in the year of forgiveness.
Distributions — Law firms should be tracking the partners’ or shareholders’ tax basis and limiting distributions to the extent of remaining basis. Owner distributions which exceed tax basis may result in taxable income for that partner or shareholder.
7. Forms 1099 – Finally, don’t wait until January 1 to begin gathering information to prepare the Forms 1099 that you will need to issue early in 2022. For a refresher, please visit these links: Eight Tips for Law Firms when Filing 1099s and Four Tax Considerations in Settling a Legal Dispute: Begin with the Eind in Mind.
For general guidance not specific to law firms, please view the on demand webinar: Year-End Tax Strategies for Businesses.