On December 22, 2017, President Trump signed sweeping tax reform legislation known as the Tax Cuts and Jobs Act of 2017 (P.L. 115-97), which includes several key tax provisions on which the ABA successfully lobbied. The new tax law includes ABA-supported language allowing the owners of law firm pass-through businesses to deduct 20% of their “qualified business income” up to certain income thresholds; retaining the existing deduction for student loan interest that benefits lawyers with law school debt; and preserving the current deduction for upfront litigation expenses incurred by attorneys with contingency fees in the 9th Circuit. Perhaps most importantly, however, the new tax law does not include ABA-opposed mandatory accrual accounting proposals that would have required many law firms to pay taxes on their work in progress, accounts receivable, and other “phantom income” long before it is received from clients.
For over four years, the ABA worked closely with 34 state, local, and specialty bars, dozens of law firms, and its other coalition allies to protect the legal profession from several mandatory accrual accounting proposals that would have imposed substantial new financial burdens and potential hardships on many law firms and other types of personal service businesses throughout the country. Section 3301 of H.R. 1, the “Tax Reform Act of 2014” introduced by then House Ways & Means Committee Chairman Dave Camp (R-MI) during the 113th Congress, and Section 51 of a similar Senate draft bill prepared by then Senate Finance Committee Chairman Max Baucus (D-MT), would have forced all such businesses with annual gross receipts over $10 million to use the accrual method of accounting rather than the traditional cash receipts and disbursements method. If the propsoals had become law, many law firms, accounting firms, medical firms, and other personal service providers would have been forced to pay taxes on income long before it is actually received.
Current law allows individuals and most partnerships, S corporations, 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 cash accounting regardless of their annual revenue unless they have inventory. Most other businesses are required to use the more complex accrual method of accounting, in which income is recognized when the right to receive it arises, not when the income is actually received.
Mandatory accrual accounting proposals like Section 3301 of the previous House bill and Section 51 of the previous Senate bill would have dramatically changed current law by raising the gross receipts cap to $10 million while eliminating the existing exemption for law firms, other personal service businesses, and other pass-through entities. If enacted, these far-reaching proposals would have created unnecessary new complexity in the tax law; increased compliance costs; and caused 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.