How QBI Under Tax Reform Impacts Law Firms and Individuals

I recently attended a seminar that my colleagues Carolyn Dolci and Brian Karnofsky led for the New Jersey Association of Legal Administrators on the impact of the Tax Cuts and Jobs Act of 2017 on law firms. One of the key points discussed, in a session led by Allyson Millbrod, was Qualified Business Income (“QBI”). 

Allyson first defined QBI as U.S. effectively connected trade or business income arising from pass-through entities and sole proprietorships, which is eligible for a 20% deduction on an individual's tax return. This deduction creates an effective 29.6% marginal tax rate on this income, putting it on par with the C corporation tax rates under the new law. Allyson also mentioned the pro rata wage and/or percent of asset tests needed to determine the QBI deduction. She also noted the importance of knowing that QBI applies whether a taxpayer is active or passive in the given business; as well as that it does not reduce basis.

Discussion then turned to the taxable income floor and ceiling for individuals who have such income arising from service professions, such as lawyers, medical services, brokerage services and so forth (further defined as any trade or business where the principal skill is the reputation or skill of one or more employees).  This, of course, was the most important aspect of the discussion to the attendees. There was a review of a few fact patterns to see how this new deduction would or would not be advantageous, as well as what is trending in the legal sector to find ways where law firms can leverage the new legislation wherever possible.