ABA opposes proposals that would require many law firms to switch to accrual accounting
Many law firms would be forced to pay taxes on “phantom” income they haven’t received and may never receive under tax reform legislation being considered by Congress, the ABA says in a letter to lawmakers.
ABA President Paulette Brown says in the letter (PDF) that the ABA strongly opposes proposals to require law firms and other personal service businesses with annual gross receipts over $10 million to use the accrual method of accounting.
Brown sent the letter to the Senate Finance Committee letter, the House Ways and Means Committee letter and the House Ways and Means Tax Policy Subcommittee, according to an ABA press release.
Currently law firms and personal service businesses are generally allowed to use the cash method of accounting, in which income is not recognized until cash or other payment is actually received.
“If law firms and other personal service businesses are required to use the more complex accrual method of accounting,” Brown’s letter says, “they would be forced to calculate and then pay taxes on multiple types of accrued income, including work in progress, other unbilled work, and accounts receivable (where the work has been performed and billed but payment has not yet been received). To meet these requirements, law firms and other affected businesses would need to keep much more detailed work and billing records and hire additional accounting and support staff. This would substantially raise compliance costs for many law firms and other personal service businesses while greatly increasing the risk of noncompliance with the tax code.”
Many lawyers are not paid by clients until long after the work is done, Brown says. If they are forced to pay taxes on the money before collecting it, law firms would have to borrow or use their scarce capital to cover the cost. Firms facing financial pressures may seek to collect immediately after completing legal work. Firms may also opt to reduce their representation of accident victims, start-ups and other clients served on an alternative of flexible fee basis, the letter says.
The proposal would also discourage law firm mergers that would produce gross receipts in excess of $10 million, the letter says.
Related articles:
ABA Journal: “Building Momentum: Opponents of requiring accrual method of accounting for law firms gain support”
ABA Journal: “ABA opposes burdensome accounting method affecting law firms”
