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ABA supports law firms' use of cash accounting, warns of proposed tax on phantom income

ABA supports law firms' use of cash accounting, warns of proposed tax on phantom income

By John Glynn

WASHINGTON, July 10, 2014 — American Bar Association President-Elect William Hubbard submitted a statement to a key House Small Business subcommittee Thursday pointing out the advantages of the simple cash method of accounting used by most law firms and expressing serious concerns over legislation that would force many firms to switch to accrual accounting and pay taxes on phantom income they have not yet received and might never receive.

Section 3301 of the draft “Tax Reform Act of 2014” recently released by House Ways & Means Committee Chairman Dave Camp (R-MI) and Section 51 of a similar draft bill prepared by former Senate Finance Committee Chairman Max Baucus (D-MT) would require all personal services 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.

The ABA believes these provisions would:

  • Create unnecessary complexity in the tax law and increase compliance costs.

  • Impose new financial burdens on many law firms and other personal service businesses by requiring them to pay taxes on income they have not yet received and might never receive.

  • Cause the legal profession to suffer even greater financial hardships than other professions because many lawyers and law firms are not paid by their clients until long after the work is performed.

  • Lead to economic distortions that would adversely affect all law firms and other personal service businesses that currently use the cash method of accounting.

  • Discourage individual professional service providers from joining with other providers to create or expand a firm because it could trigger the costly accrual accounting requirement.

The existing cash method of accounting produces a sound and fair result because it properly recognizes that the cash a business actually receives in return for the services it provides —not the business’ accounts receivable—is the proper reflection of its true income and its ability to pay taxes on that income. While accounts receivable clearly are important to determining the financial condition of a business and assessing its future prospects, they do not accurately reflect its current spendable income or its present ability to pay taxes on that income.

Although the ABA supports simplification of the tax laws, it opposes the accrual accounting provisions in the draft House Ways & Means Committee bill.

With nearly 400,000 members, the American Bar Association is one of the largest voluntary professional membership organizations in the world. As the national voice of the legal profession, the ABA works to improve the administration of justice, promotes programs that assist lawyers and judges in their work, accredits law schools, provides continuing legal education, and works to build public understanding around the world of the importance of the rule of law. View our privacy statement on line. Follow the latest ABA news at www.ambar.org/news and on Twitter @ABANews.

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