As Congress focuses on developing major tax reform legislation this year, ABA President Linda A. Klein reiterated ABA opposition April 21 to any proposals that would accelerate the tax liability of law firms and other personal service businesses by requiring them to switch from the simple cash method of accounting they are currently using to the more complex accrual method.
In separate letters to the Senate Finance Committee and the House Ways and Means Committee, Klein emphasized that the mandatory accrual accounting proposals ─ including House and Senate proposals affecting firms with annual gross receipts over $10 million that were first proposed during the 113th Congress ─ would create unnecessary new complexity in the tax law and increase compliance costs. In addition, she said, by requiring these businesses to pay their taxes on accrued income up front instead of when the income is actually received, the proposals would cause substantial financial hardship to many lawyers, law firms and other personal service businesses, and would be a job killer.
Klein explained that current law permits businesses to use the 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 such as partnerships or Subchapter S corporations or their average annual gross receipts for a three-year period are $5 million or less. In addition, all law firms and other personal service businesses are exempt from the revenue cap and can use the cash method of accounting regardless of their annual revenues, unless they have inventory.
The mandatory accrual accounting proposals would raise the gross receipts cap to $10 million while eliminating the existing exemption for law firms and other personal service business, other sole proprietorships and pass-through entities, and farmers. Although the proposals would allow certain small business taxpayers with annual gross receipts in the $5 million to $10 million range to switch to cash accounting – an idea to which the ABA is not opposed – Klein maintained that the proposals would significantly complicate tax compliance for a far greater number of small businesses.
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 up front 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. Many firms also would be required to borrow money or use their scarce capital merely to pay their taxes, Klein added.
In addition to requiring law firms and personal service businesses to pay tax on phantom income, the proposals would adversely affect clients by forcing many law firms to collect their fees in advance or immediately after the legal services are provided to the client. As a result, 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 as they now do. Many law firms also would have to reduce the amount of pro bono legal services they provide to their poorest clients, she warned.
Klein also pointed out that the proposals would discourage professional service providers from joining with other providers to create or expand a firm, even if it made economic sense and would benefit their clients, because such expansion could trigger the costly accrual accounting requirement.
In her letters, Klein also emphasized that the mandatory accrual accounting proposals are strongly opposed by more than 30 state, local and specialty bars throughout the country.