Note: Post substantially revised at 3 pm 12/4/2017 to include additional explanation of proposed legislation
This week, businesses of all sizes – from behemoths like Google and Amazon to tiny mom & pops will have their eyes on tax reform, particularly the provisions on tax rates levied corporations and pass-through income from LLCs. Most solo and small firms are small businesses, frequently organized as some type of limited liability companies (LLC). Because the House version of the tax bill excludes professional service providers from the tax breaks proposed for pass-through income, there’s a lot at risk here for solo and small law firms. Yet the ABA is nowhere to be found. Let me back up a bit and explain.
First, some background on the tax proposal. As a general matter, an LLC structure is ideal for small businesses because of the protection it provides to owners’ personal assets. Because an LLC is a distinct entity, any judgments or business liability is levied on the LLC and not the owner’s personal assets. Unfortunately, for lawyers, an LLC won’t protect against personal liability for malpractice. That said, even solo attorneys engage in ordinary business transactions — leasing space, paying vendors for services or meeting clients at their office (who could have an accident during the visit) — for which an LLC may limit personal exposure.
There are other benefits to LLCs for solo and small firms. Because of prohibitions on outside ownership, there aren’t as many benefits to incorporation as for a traditional small business. Plus, forming and administering a corporation can be cumbersome and costly, and an owner must pay both corporate tax on corporate revenues along with tax on salary and profits earned by the owner. By contrast, with an LLC form, the LLC revenue is “passed through” to members who pay tax on the income as part of their personal return (owners can choose taxation as an s-corporation, but the designations do not change the “pass through” nature of the income or trigger double taxation).
Moving on to tax reform, much of the discussion has centered around the need to cut taxation on corporations – and both bills propose to slash the existing 35% tax rate down to 20%. But as I’ve just discussed, most solos and small firms – and in fact, most small businesses in general – aren’t organized as corporations. As such, the corporate tax cut doesn’t help solo and small law firms very much.
Thus, both the House and Senate tax bills are a welcome effort to extend the tax benefits afforded to corporations to entities organized as LLCs. In the Table below, I’ve summarized the provisions of the legislation with regard to pass through taxation and how they would impact small business owners with pass-through income of $75,000, $165,000 and $200,000:
As I mentioned at the outset, the House bill completely excludes service professionals, including lawyers from coverage. But does that make a difference as a practical matter? Well, yes and no. The House plan would drop the top income tax rate from 39% to 25% for pass-through income, and would also phase in a lower rate of 9% for businesses that earn less than $75,000 in pass-through income. As the table shows, the House reduction would not impact those lawyers with pass-through income in the $75k-$200k range. That’s because under the new tax plan, the applicable tax rate would be 25% or less anyway, irrespective of whether the income comes from a generic small business or a professional services firm.
Still, there are two instances where the tax bill could help lawyers, if they qualified for relief. Under the new legislation, taxpayers with passthrough income of $200,000 or more would be spared a 35% tax rate under the proposed legislation (up from 32%) since the House bill caps the tax rate at 25%. More significantly, the House Bill would phase in a 9% rate for businesses with a passthrough income of $75,000 or less. This would be an enormous benefit to solo and small firms, who according to some sources, earn an average of $50,000/year.
The Senate bill takes a different approach. As shown on the table, the Senate bill does not change the tax brackets for pass-through income but instead, allows the taxpayer to deduct 23% of their pass-through income. The 23% deduction would be apply only to service professionals with taxable incomes under $500,000 if married, and $250,000 if single. (Above those levels, deductions are still allowed, but they are phased out for income above the eligibility caps – it’s not entirely clear). I did some quick calculations and found that the Senate Bill would afford significant tax relief to both married and unmarried taxpayers within the $75,000-$200,000 band either by reducing the amount of taxable income and in some instances, dropping the taxpayer down to a lower tax bracket. The benefits under the Senate bill shown on the table would extend to service professionals because the pass-through incomes fall below the $500,000/$250,000 cutoff.
Now that I’ve gone through the gory details, you may be wondering why I’m upset with the ABA. After all, the Senate Bill will help many solo and small firm lawyers, while the House Bill will have little impact, at least on lawyers with earnings of $200,000 or less. So briefly, here’s a list of my grievances:
- The Senate Bill was released several days after the House Bill. And the reason that the Senate Bill expands tax relief for pass-through professional service entities is due to the lobbying efforts of OTHER professional organizations – not the ABA. For example, after the House bill was passed, the American Institute for Architects sharply criticized the House bill’s exclusion professional service firms as unfair, and quickly mobilized efforts to eliminate the disparate treatment – which ultimately succeeded. By contrast, the ABA said NOTHING about the House Bill – which is particularly shameful because it would have substantially helped the many struggling solos who earning less than $75,000/year. Indeed, the ABA’s silence on this matter is doubly shameful when you consider that many low-earning solos are handling court-appointed indigent criminal defense or low-bono matters.
- Even though the Senate Bill helps professional service firms, lawyers are not yet out of the woods. The House and Senate bills need to be reconciled. It’s entirely possible that one potential compromise might be to retain the Senate’s proposed tax treatment for pass-through entities but to adopt the House’s exclusion on denying this relief to service providers. Heck, it’s entirely possible that a compromise might deny tax relief ONLY to lawyers and not other service providers given that the ABA hasn’t advocated for law firms.
So why has the ABA been silent on legislation that would significantly impact a large percentage of practicing lawyers that the ABA purports to represent? It’s not that hard to figure out: the tax relief would largely benefit solo and small law firms, not biglaw. Although technically, some large firms, like solo and smalls operate as pass through entities, many might not benefit from the relief on pass-through income anyway which was intended to provide a benefit to small businesses which are not organized as corporations.
This tax bill makes clear that despite the ABA’s claim to represent the interests of all lawyers, it only cares about lawyers at biglaw. I’ll admit that there are some situations where the interests of its members directly conflict and preclude the ABA from taking a side. But this case is different – the proposed tax relief doesn’t hurt large firms; rather, they simply don’t benefit from it as solo and small firms would. In short, there’s no explanation as to why the ABA couldn’t have stepped up in the tax debate to protect lawyers from disparate treatment, just as other professional associations have done. Instead, the ABA hasn’t advocated lawyers at all because solo and small lawyers don’t matter.
The ABA’s indifference to solos and smalls isn’t just with regard to tax reform. As I wrote in my ATL Column last week, the ABA’s Initiative on why women leave the law mid-career is more accurately titled “why women leave Big Law midcareer,” focusing on the needs of a narrow one percent of female attorneys and treating solo and small firm women owners as second-class citizens. (As an aside, as my column also observes, what’s even more ironic is that Greenberg Traurig, the firm where ABA President Hilarie Bass, the leader of the women’s initiative spent her career – was sued for gender discrimination back in 2012 and was defended by Bass!).
Solos and smalls – the ABA isn’t working for us. It never has but now the writing is on the wall. It’s time to leave it all behind. In the meantime, I’ll try to put together a letter on behalf of solo and small firm lawyers, urging equal treatment for LLCs owned by lawyers.