American Bar Association President James R. Silkenat recently sent letters to leaders of the House and Senate committees with tax oversight to warn that proposed changes to allowed accounting methods would overburden many law firms and other types of professional service businesses throughout the country.
Section 212 of draft House legislation titled the “Tax Reform Act of 2013” and Section 51 of similar draft Senate legislation would require all law firms and other personal service businesses with annual gross receipts of more than $10 million to use the accrual method of accounting rather than the traditional cash receipts and disbursement method of accounting.
As a result, many law firms, accounting firms, medical firms and other professional service providers would be required to pay taxes on income long before it is actually received.
Under current law, sole proprietors and most partnerships — 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 actually received, and expenses are not taken into account until they are actually paid.
In addition, all personal service businesses — including those engaged in the fields of law — are exempt from the revenue cap and can use the cash method of accounting irrespective of their annual revenues, 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 is present, not when the income is actually received by the business.
The ABA contends that the mandatory accrual accounting provisions in the draft House and Senate bills would create unnecessary complexity in the tax law.
In addition, the ABA says the changes would increase compliance costs and add significant new financial burdens and hardships for many law firms and other personal service businesses by requiring them to pay tax on income not yet received and that may never be received.
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