April 01, 2016

ABA president reiterates opposition to accrual accounting

ABA President Paulette Brown reiterated ABA opposition April 13 to any proposals in Congress that would require many law firms and other personal service businesses to change to the complex accrual method of accounting from the simple cash method they are currently using.

In separate letters to the Senate Finance Committee, the House Ways and Means Committee, and the House Ways and Means Subcommittee on Tax Policy, Brown emphasized that the mandatory accrual accounting proposals from the last Congress and similar proposals now under consideration would cause substantial financial hardship by requiring firms and businesses to pay tax on “phantom” income they have not yet received and may never receive. The House and Senate committees are in the process of developing new tax reform legislation, and the letter to the Subcommittee on Tax Policy was submitted for the record of an April 13 subcommittee hearing on fundamental tax reform proposals.

Brown explained that under current law businesses are permitted to use the simple, straightforward cash method of accounting (in which income is not recognized until cash or other payment is actually received) if they are individuals or pass-through entities or their average annual gross receipts for a three-year period are $5 million or less. In addition, all personal service businesses, including law firms, are exempt from the revenue cap and can use the cash method of accounting regardless of their annual revenues, unless they have inventory. The proposals would raise the gross receipts cap to $10 million while eliminating the existing exemption.

If law firms and other personal service businesses are required to use the more complex accrual method of accounting, she said, they would be forced to calculate and then pay taxes on multiple types of accrued income and would need to keep much more detailed work and billing records and hire additional accounting and support staff.

In addition to requiring law firms and personal service businesses to pay tax on phantom income, the proposals would adversely affect clients by forcing law firms to collect their fees immediately after the legal services are provided. Many clients could find it more difficult to afford legal counsel as law firms would no longer be able to represent as many accident victims, start-up companies, and other clients on an alternative or flexible fee basis. Many law firms also would have to reduce the amount of pro bono legal services they provide to their poorest clients.

Brown also pointed out that the proposals would discourage small business growth by making it more difficult for professional service providers to join with other providers to create or expand a firm, even if it made sense and would benefit their clients, as these actions could trigger the costly accrual accounting requirement. 

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