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Philadelphia Bar Association Opposes Switch to Accrual Accounting for Law Firms

Charles J. Klitsch, Esq. on 7/27/2015

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At its July meeting, the Philadelphia Bar Association's Board of Governors unanimously passed a Resolution Opposing Federal Legislation to Require Professional Service Firms to Use the Accrual Method of Accounting.

Currently, the vast majority of law firms use the cash method of accounting, a relatively simple method that allows law firms to pay taxes on income when it is actually received. The cash method of accounting suits professional service firms well, as they have no inventory to consider.

Under the accrual method, firms must report income to the Internal Revenue Service in the tax year the service is provided, whether or not the firm has actually received payment from the client. In the 117th Congress, House Resolution 1, known as the Tax Reform Act of 2014, proposed that professional service firms, including law firms, with an income of more than ten million dollars per year would be required to use the accrual method of accounting.

Sponsors of the legislation suggested that this change would generate more tax revenue for the federal government. However, the impact of such a change on the practice of law was not adequately considered.

The Tax Section and the Business Law Section sponsored the resolution. Tax Section Chair Jennifer O'Leary and Business Law Section Chair Graham Laub presented the resolution to the Board. In his remarks, Laub noted, "The accrual method of accounting would be bad for the business of law and bad for clients." He gave the example of the law firm providing services to a small start-up business, with the expectation that legal fees would be paid down the road when the company becomes better established. With the accrual method of accounting, such a fee arrangement would be more difficult for a client to obtain, as the firm would have to pay taxes on the value of the services in the year they were provided, not necessarily the year payment was received.

O'Leary stated, "Using the accrual method would have a very real impact on clients, as costs would have to be passed along to them." O'Leary added that the accrual method will be difficult and confusing to administer. "There is no current body of law in this field," O'Leary explained, that can guide a law firm in determining at what point a service is provided that will trigger the tax obligation.

The Tax Reform Act of 2014 was ultimately defeated. The American Bar Association has learned that the accrual accounting proposal is once again on the table. The Philadelphia Bar Association now joins the American Bar Association and other influential large bar associations in vocal opposition to any proposed legislation that would require law firms and other professional service firms to use the accrual method of accounting.

The resolution states as follows:

PHILADELPHIA BAR ASSOCIATION RESOLUTION OPPOSING FEDERAL LEGISLATION TO REQUIRE PROFESSIONAL SERVICE FIRMS TO USE THE ACCRUAL METHOD OF ACCOUNTING

WHEREAS, current law allows professional service firms, including law firms, to use the cash method of accounting, reporting income as it is received and expenses as they are paid; and

WHEREAS, in the previous session of Congress, House Resolution 1, known as the Tax Reform Act of 2014, was introduced in the United States House of Representatives; and

WHEREAS, House Resolution 1 and a similar draft bill prepared for introduction in the United State Senate would have required professional service firms to change to the accrual method of accounting, meaning that firms must report income in the calendar year in which the services are delivered, regardless of whether the corresponding cash for such services is received that year; and

WHEREAS, changing to the accrual method of accounting would cause substantial hardship to many professional service firms by requiring them to pay tax on income they have not yet received and may never receive; and

WHEREAS, the Congressional Joint Committee on Taxation estimated that these proposed changes would generate $23.6 billion in new taxes over ten years by forcing many thousands of small businesses to pay taxes on phantom income up to a year or more before it is actually received – if it is ever received; and

WHEREAS, changing to the accrual method of accounting would constitute a major, unjustified tax increase on professional service firms and other businesses and hamper economic growth; and

WHEREAS, changing from the simple cash method of accounting to the more complicated accrual method would increase administrative costs for providers of professional services; and

WHEREAS, requiring accrual accounting would lead to unnecessary complexity with regard to professional service firm partner tax liability for work in progress, partner compensation, financing of tax liabilities and allocation of tax liability when a partner changes firms or retires; and

WHEREAS, if professional service firms are forced to pay taxes on accrued income they have not yet received, the resulting financial pressures would require many law firms charging on a traditional hourly fee basis to collect their fees immediately after the legal services are provided to the clients, making flexible fee arrangements less available to individuals and small businesses; and

WHEREAS, the reduced availability of alternative fee arrangements resulting from the economic pressures of accrual accounting would make it far more difficult for many start-up companies, small businesses and individuals to obtain much needed legal representation; and

WHEREAS, the inability of many start-up companies, small businesses and individuals to obtain legal services would be detrimental to economic growth; and

WHEREAS, although the tax reform bills did not pass in the previous session of Congress, the American Bar Association has reported learning in recent meetings with the staffs of the Senate Finance Committee and House Ways and Means Committee, that mandatory accrual accounting proposals remain “on the table” and could be included in the new comprehensive tax reform bills that the committees are now developing.

NOW, THEREFORE, BE IT RESOLVED that the Philadelphia Bar Association opposes any proposed legislation, regulations, or other governmental measures that would require professional 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.

AND BE IT FURTHER RESOLVED that the Chancellor or his or her designee be authorized to communicate the position of the Philadelphia Bar Association to members of the United States Senate and the United States House of Representatives, the President of the United States, the media and the public, and to take such other action in furtherance of this resolution as may be appropriate and necessary.

PHILADELPHIA BAR ASSOCIATION
BOARD OF GOVERNORS
ADOPTED: July 27, 2015

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