Congress is poised to consider tax reform legislation that would impose substantial new financial burdens and potential hardships on many law firms and other types of personal service businesses throughout the country by fundamentally changing the manner in which they must pay their taxes. Section 3301 of the draft “Tax Reform Act of 2014” prepared by House Ways & Means Committee Chairman Dave Camp (R-MI) and Section 51 of a similar Senate draft bill developed by former Senate Finance Committee Chairman Max Baucus (D-MT) would require all such businesses with annual gross receipts over $10 million to use the accrual method of accounting rather than the traditional cash receipts and disbursement method. As a result, many law firms, accounting firms, medical firms, and other personal service providers would be forced to pay taxes on income long before it is actually received.
Current law allows individuals and most partnerships and other pass-through entities—as well as other types of businesses with annual gross receipts of $5 million or less—to use the simple cash method of accounting for tax purposes, in which income is not recognized until cash or other payment is actually received. In addition, all law firms, accounting firms, and various other types of personal service businesses are allowed to use the cash method of accounting regardless of their annual revenue unless they have inventory. Most other businesses are required to use the more complicated accrual method of accounting, in which income is recognized when the right to receive the income arises, not when the income is actually received.
Section 3301 of the draft House bill and Section 51 of the draft Senate bill would dramatically change current law by raising the gross receipts cap to $10 million while eliminating the existing exemption for law firms and other personal service businesses, and for other partnerships and S corporations. Therefore, these provisions would create unnecessary complexity in the tax law; increase compliance costs; and cause substantial hardship to many law firms and other personal service businesses by requiring them to pay tax on income they have not yet received and may never receive.