April 18, 2014 President’s Message
ACBA opposes Tax Reform Act
by Nancy L. Heilman
The ACBA Board of Governors passed a resolution in March to oppose tax reform measures that would cause an undue financial burden on law firms.
The resolution states that the board “opposes any proposed legislation, regulations, or other governmental measures that would require law firms and other personal service businesses that now compute taxable income on the cash receipts and disbursements method of accounting to convert to the accrual method of accounting, thereby accelerating their tax payments.”
On behalf of the ACBA, I sent letters enclosing this resolution opposing the passage of the Tax Reform Act 2013, subsequently cast as the Tax Reform Act of 2014, to U.S. Senators Robert Casey and Patrick Toomey and to House of Representative members Mike Doyle, Tim Murphy and Keith Rothfus.
The ACBA took this action in response to an American Bar Association Legislative Action Alert, in which the ABA reported that under Section 212 of the discussion draft of the Tax Reform Act, Congress is poised to reconsider tax reform legislation that would impose substantial new financial burdens and potential hardships on many law firms and other types of personal service businesses by fundamentally changing the manner in which they must pay their taxes.
Recently, House Ways and Means Committee Chairman Dave Camp (R-MI) released Section 3301 of the draft Tax Reform Act of 2014, which is nearly identical to the former Section 212; and the Senate released Section 51 of a similar draft bill prepared by former Senate Finance Committee Chairman Max Baucus (D-MT). Both drafts would require all such businesses with annual gross receipts over $10 million to use the accrual method of accounting, rather than the traditional cash receipts and disbursement method.
As a result, many law, accounting, and medical provider firms, and other personal service providers would be forced to pay taxes on income long before it actually is received (even perhaps never received).
Under current law, individuals and most partnerships and other pass-through entities, as well as other types of businesses with annual gross receipts of $5 million or less, are permitted to use the simple cash method of accounting, in which income is not recognized until cash or other payment is received. In addition, law firms and various other types of personal service businesses are allowed to use the cash method of accounting regardless of their annual revenue unless they have inventory. Most other businesses are required to use the more complicated accrual method of accounting, in which income is recognized when the right to receive the income arises, not when the income is actually received.
Sections 3301 and 51 would dramatically change current law by raising the gross receipts cap to $10 million, while eliminating the existing exemption for law firms and other personal service businesses, partnerships and S corporations, and farmers.
In its Legislative Action Alert, the ABA called upon state and local bar associations to join in contacting U.S. senators and representatives to oppose key provisions of the draft tax reform bills. On Jan. 13, the ABA sent letters to the House Ways and Means and Senate Finance Committees opposing Sections 3301 and 51 in respective draft bills. The ABA expressed a number of concerns about provisions that would create complexity in the tax law, increase compliance costs, and cause hardship to affected law firms by requiring them to advance tax payments against income not yet received and income that might never be received.
Law firms, among other personal service businesses, favor the cash method of accounting because it generally correlates with the manner in which these businesses operate – that is, on a cash basis. Along with the increased complexity associated with the accrual method of accounting, enactment of the proposed bills will, among other things, raise compliance costs for businesses while increasing the risk of noncompliance with the Tax Code. Financial hardship would result from clients’ delayed payment for legal services until long after the work is performed.
The traditional cash method of accounting produces a sound and fair result because it properly recognizes that the cash a business actually receives, rather than the firm’s accounts receivable, properly reflects its true income and ability to pay taxes on that income. Requiring law firms to pay taxes on income long before it is received, using scarce capital or borrowing money, would impose a serious financial burden and hardship on many of these firms. Moreover, economic distortions are likely to occur in law firms that are organized as partnerships or in firms in which the partners change yearly because of retirements, promotions to partnership, and lawyers switching firms.
Those firms operating on the cash method can ensure that the partners are taxed on the income actually received that year, but if they are forced to use the accrual method, partners will be taxed on income their firms accrue on paper in the current year even though the partners may not be around when, and if, the clients pay their bills.
This far-reaching proposed legislation would create unnecessary complexity in the tax law and increased compliance costs by disallowing the use of the simple, straightforward cash method of accounting. In addition, the proposal would impose significant new financial burdens and hardships on millions of personal service businesses throughout the country, including many law firms and their personal service business clients by requiring them to pay tax on income they have not yet received and may never receive.
And let’s not forget the slippery slope: as under current law allowing the cash method of accounting for individuals and partnerships with annual receipts of up to $5 million, once in the door with a $10 million threshold, who is to say law firms with receipts of $5 million will not fall prey to legislative amendment, further inflicting hardship on even smaller firms, partnerships, and solo practices.
The ACBA Governors urge members and law firm managing partners to write to U.S. senators and House of Representative members to voice their concerns about the proposed Tax Reform Act of 2014. The ACBA will continue to promote the defeat of these draft bills, but members need to join in writing to lawmakers.
Sample letters, along with the addresses of local representatives, are available from the ABA website at: www.acba.org/acba/Members/Committees-Sections/PoliticalActionComm.asp.