Understanding Pass-Through Entities
In Part I: What to expect from the New Tax Laws we briefly discussed law firm structure and why the corporate tax rate slash would not affect most small law firms, now it is time to dive deep and understand what the new flow-through tax rate is and how it applies to law firms across the country.
Small law firms are typically set up as sole proprietorships, partnerships, and S Corporations. These are known as pass-through entities meaning that business income passes through to individual tax returns. These pass-through entities do not pay taxes themselves. Instead, profits are passed through to owners and taxed at individual tax rates. According to the Tax Foundation, the majority of pass-through business income is taxed at top individual tax rates. Pass-through entities are not considered regular corporations, and thus do not fall under the corporate rate reduction. Law firms considering the move to a regular corporation should take caution, C-corporation earnings are subject to double taxation and accumulated earnings tax on profits. You will also want to note the additional costs of maintaining your newly incorporated C-Corporation and the fact that you will have to pay dividends to shareholders.
Lower individual tax rates
One piece of the pie that we didn’t discuss is the Tax Cuts and Jobs Act new lower individual tax rates. The individual tax rate brackets were reduced from 10%, 15%, 25%, 28%, 33%, 35% and 39.6% to 10%, 12%, 22%, 24%, 32%, 35% and 37%. The 2.6% reduction at the top may be the most helpful result of the Act for attorneys.
Business Tax Deductions and Credits
The Act also cut some business tax deductions and credits. As we previously discussed, the deduction for business entertainment expenses, except for meals was eliminated. Deductions for local lobbying expenses and the payment of employee parking, mass transit or commuting expenses was also eliminated. The domestic production activities deduction was removed, and in 2026, the deduction for meals provided to employees for the convenience of the employer will be eliminated. Limits will go into effect for businesses carrying a net operating loss. In the past, law firms and other businesses with a net operating loss could carry back the loss for prior years and get a refund in most cases. Net operating losses may only be deducted in current and future years under the new law.
It is strongly recommended that you consult a knowledgeable tax attorney before filing individual or law firm taxes. Amicus Media Group and Amicus Capital Group are dedicated to providing you more information on the Tax Cuts and Jobs Act and other legislation. This article does not contain legal or financial advice. Author and publisher disclaim any and all warranties, liabilities, losses, costs, claims, demands, suits, or actions of any type or nature whatsoever, arising from or any way related to this blog, the use of this blog, and/or any claim that a particular technique or device described in this blog.