No IRS, Law Firms Shouldn't Have to Use Accrual Accounting - Strategist
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No IRS, Law Firms Shouldn't Have to Use Accrual Accounting

Relax folks: unless you are really successful, this proposed tax "reform" won't affect you.

Section 3301 of the Tax Reform Act of 2014 [PDF], as it is currently drafted, applies to personal services businesses with ten million dollars or more in annual gross receipts -- a figure most solos and small firms can only dream of. But if you're an attorney to the stars, or a small firm that does big business, or if inflation gets really bad, a mandated switch to accrual accounting, instead of cash accounting, will be a major pain in your behind.

Besides, even if you're solo now, who's to say that you won't team up, or make it big, at some point in the next few years?

Accrual Versus Cash Accounting

We know: you're a lawyer, not a C.P.A. We'll try to make it simple.

Accrual accounting is what big companies use. It recognizes economic events as they occur, rather than when cash actually changes hands. For a law firm, this would be like adding billable hours to the books immediately, even though clients sometimes pay late or not at all. This, of course, has to be fixed at a later time when the client goes AWOL and the bill is never paid.

In short, it's a heck of a lot more complicated (and expensive to implement) than cash accounting, which is exactly what you'd expect: income goes on the rolls as it is actually received.

The current state of the law is this: All personal services businesses (including law firms) are allowed to use cash accounting, as are all businesses that have less than $5 million in gross annual receipts. The proposed law would remove the personal services exemption and make accrual accounting mandatory for all businesses with more than $10 million in receipts.

The ABA Hates it Too

American Bar Association President-Elect William Hubbard released a statement speaking out against the proposal [PDF] this morning. Among other points, he notes that the switch would be especially hard for lawyers, since they often work on complex business transactions or appeals that last years and often aren't paid until after the case is completed. These firms would have to pay tax obligations as they accrue, rather when they are paid (years later, if ever).

And what the heck do you do when you take a case on a contingency basis? While accrual accounting makes sense for big companies for lots of reasons (for one, it presents a more accurate picture of the company's health), for law firms, this would be an absolute nightmare.

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