Bar Associations

ABA opposes draft tax bills that would force many law firms to pay taxes on phantom income

The ABA is opposing two draft tax bills that would require many law firms to switch accounting methods and pay taxes on phantom income before it is received.

ABA President-Elect William Hubbard submitted written testimony (PDF) opposing draft tax bills that would require all personal services businesses with annual gross receipts over $10 million to use the accrual method of accounting, according to an ABA press release.

“This particular issue has become one of the most important issues to our members—and many state and local bars throughout the country—because of the serious negative effects that the proposed legislation would have on practicing lawyers, their law firms and their clients,” Hubbard wrote.

Under current law, Hubbard said, personal service businesses such as law and accounting firms can use the “simple, straightforward” cash accounting method rather than the accrual method. The cash method of accounting doesn’t recognize income until it is actually received and doesn’t take expenses into account until actually paid.

While law firms that use the cash method simply pay taxes on income actually received, law firms using the accrual method will have to pay taxes on work in progress, accounts receivable and accounts paid. The more complicated accrual record could force law firms to keep more detailed work and billing records, hire additional staff, and borrow money or use scarce capital to pay accelerated tax obligations, he said.

Lawyers working on complex cases or lengthy appeals are often not paid until years after the work was performed, in contrast to professionals such as doctors, dentists and accountants who typically work on a pay-as-you-go basis, Hubbard said. As a result, the proposed bills would create special hardships for those in the legal profession.

Hubbard also said the bill could discourage law-firm mergers or expansions because growth could trigger the need to switch to accrual accounting.

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