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November302020
Leveraging 2020 to Prepare for 2021

11.30.20 | Practice Made Perfect

Jonathan San Solo, CPA

2020 will probably be remembered as a year of chaos and disruption, but the hard lessons learned can be leveraged right now to help law firms prepare for a more stable and successful 2021. With changes to working environments, cash flow, and the overall legal environment, the following considerations outline key topics that firms should be discussing and planning for when developing year-end strategies to build a stronger future.

KEY CONSIDERATIONS

Receivables – A healthy accounts receivable (AR) is a key indicator of the firm’s position. While firms may be less inclined to write off uncollectible AR and work in progress (WIP) to save their realization rates, doing so clouds the true viability of AR. A more reliable AR can be leveraged to potentially determine the availability of line of credit funds as banks look at this benchmark in gauging future collections. Additionally, examining AR to identify unusual delays in payment may help indicate a client’s satisfaction with the firm’s services or the health of, which is critical during periods of business interruption, such as the one caused by the COVID-19 pandemic, when firms are looking to retain recurring business. Moreover, client collection and satisfaction can be used as a benchmark when measuring performance, especially in a tighter staffing market and when clients are more fee sensitive.

Collections – As companies try to finish the year off with strong collections, firms should consider their billing structure for the next year, with potential retainers, alternative fee arrangements, or monthly billing as a consideration. Retainers or monthly billings can help cash flow constraints as fixed costs, such as payroll and rent, arise prior to job completion. Moreover, monthly billings for recurring work can provide clients with more manageable expenses as they seek to streamline their own cash flow.

State and Local Tax Planning – The COVID-19 pandemic caused many businesses to close their doors—forcing a significant portion of the workforce to telecommute. Telecommuting employees may work in states and localities where the firm does not traditionally operate. This can create a variety of nexus and apportionment issues and new state tax filing and withholding requirements. To stay ahead of this, firms should know where their employees are working and consult their tax advisors to help reduce the impact that the pandemic may have had on their overall state and local tax liability.

Unincorporated Business Tax (UBT) – Firms operating in New York City (NYC) with staff teleworking outside of the city due to the pandemic could potentially source less revenue within the city, resulting in a NYC UBT savings. For NYC-based law firms, identifying and documenting their employees’ work locations could yield considerable savings with employees that live outside the city. For a deeper dive into the complexities of the UBT click here.

Paycheck Protection Program (PPP) and the Treatment of Forgiveness – There are still questions regarding PPP loan forgiveness. The CARES Act provides that loan forgiveness will not be income taxable. In addition, the IRS issued Rev. Rul. 2020-27, which reinforces Notice 2020-32 and states that business expenses paid from proceeds of forgiven PPP loans will not be deductible if there is a reasonable expectation of loan forgiveness. The reasonable expectation rule applies even if the taxpayer has not yet submitted an application for forgiveness by the end of the taxable year. With only a short time remaining in 2020, firms should consider the lost deductions when projecting the tax effect to the firm and consider the interplay of PPP loan forgiveness with other tax provisions. For more information on the PPP program, please review Berdon’s articles on PPP forgiveness and subsequent update.

Credit Agreements

  1.  Interest Rate – Firms should review the interest rate they have on their credit facilities and consider re-negotiating. With interest rates at historic lows, they may want to consider refinancing or renegotiating a facility at a lower rate.
  2. Covenants – Firms need to take an early look at debt covenants to make sure they will meet them. If not, seek to obtain a waiver. With lower potential fee income, firms need to be cognizant of their required thresholds to ensure covenants are met.
  3. Clean-up Requirement – A credit facility may require a firm to pay down the facility and not borrow any new funds for a certain period of time. Planning cash flow ahead will help meet this requirement.
  4. PPP – Review loan agreements and make sure that a PPP loan does not cause a technical default of your loan agreement by having secured additional debt. Many loan agreements have specific provisions for additional debt and even if most firms use PPP loan proceeds for forgivable uses, they should still ensure that their agreements allow for the PPP loan, and if not, look to amend those agreements.

Budgeting/Forecasting – Many times budgets are set far in advance. Now may be a good time to take a second look at your 2021 budget, keeping in mind specific areas—such as marketing, networking, travel, and other firm events—may have been hindered by the pandemic, which allows for firms to potentially reduce their expenses or reallocate them to areas that present more benefit in the short and long-term, such as investments in technology. What may have been consistent over the last number of years may need to change based on the way people are working and interacting with clients in the current environment and properly allocating funds to support these changes should be considered.

Rent – Consider approaching the landlord about rent abatements and deferrals. Click here to learn more on navigating the available rent concession options. Additionally, firms should continue to plan for their long-term use of space. Should they be looking to move to a hybrid model and include hoteling or the opening of smaller satellite offices? Get an industry leader’s perspective on bold new directions in office space.

Amended Benefit Agreements – Meet with plan administrators and custodians about potential amendments that need to be made to the benefit plan documents as a result of the Setting Every Community Up for Retirement Enhancement (SECURE) and Coronavirus Aid, Relief, and Economic Security (CARES) Acts. These Acts allowed for additional contributions and allowable distributions to be made from certain benefit plans as a result of the pandemic.

Deferred Self-employment Taxes – The CARES Act allows employers to defer the deposit and payment of the employer’s share of Social Security taxes and self-employed individuals to defer payment of certain self-employment taxes, with the deferral ending on December 31, 2020, and 50% of the tax due by December 31, 2021 and the remaining 50% due by December 31, 2022.

Unclaimed Property – With fiscal constraints on many states, state governance will look to add additional revenue as a result of the pandemic. One area is unclaimed property. With firms often having old outstanding checks on their bank reconciliations, states may be more punitive for companies that did not escheat old property.

Technology – As was the case for much of 2020, with a large number of employees working from home and sharing information over unsecured connections, firms must be vigilant in their IT and cyber protection. Suspicious cyber activity in 2020 surpassed any previous year’s benchmarks. As employees continue to work outside of the office, and even potentially move more towards a hoteling model, firms need to ensure that their clients confidential and privileged information is safe. Furthermore, now is a good time for IT and finance departments to examine and scrutinize their internal control processes, ensuring that they have the proper controls in place, especially as workflow and processing may have changed. Additionally, firms should consider how automation can impact their administrative processes to help enhance efficiency and reduce expenses. Firms should also make a push to go truly paperless. Many firms have delayed this conversion, however the firms that best transitioned to working from home in March of 2020 were the ones that were already paperless. Learn about the need for a more vigilant cybersecurity program.

Vendor Files – The end of the year is a good time for firms to review their Accounts Payable (AP) vendor list and strengthen controls around the process of adding new vendors. Controlling the AP vendor file will help firms prevent potential fraud and misappropriation.

With the many surprises that 2020 has thrown at law firms, firms are looking at how to adjust to certain new realities as well as ensuring they have the proper plans in place for the coming year. With all of the uncertainties surrounding the COVID-19 pandemic, firms need to be well prepared. The firms that can best adapt to the uncertainty will be best able to refocus attention on client facing activities and the practice of law.

If you have questions or would like to pursue some or all of these recommendations, contact Jonathan San Solo at 212.331.7617 or JSanSolo@berdonllp.com.

Berdon LLP, New York Accountants

 

 

 

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