In a letter dated April 13, 2016, the American Bar Association (ABA) President Paulette Brown addressed the leaders of the House Ways and Means Subcommittee on Tax Policy. In the letter, she voiced opposition to the proposals that would require professional services firms to adopt the accrual basis of accounting as opposed to the more widely used and simpler cash basis method.
The Internal Revenue Code currently allows businesses to utilize the cash basis method of accounting if they meet certain requirements listed in a gross receipts test. If the gross receipts test is not met (generally, if a business has more than $5 million in gross receipts), the business is required to adopt the accrual method of accounting. There is, however, an exemption allowed for certain professional services firms structured as pass-through entities or as personal service corporations. This exemption has traditionally been used by law firms in order to utilize the cash basis method of accounting.
In various hearings, the subcommittee has discussed the aspect of removing the exemption typically used by pass-through entities or personal service corporations, thereby requiring such firms to adopt the accrual basis method of accounting. The removal of this exemption, as outlined in the excerpt of the ABA’s letter, would have far-reaching implications on law firms:
“If law firms and other personal service businesses are required to use the more complex accrual method of accounting, 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.”
ABA Letter to House Ways and Means Subcommittee on Tax Policy: “Today’s Hearing on ‘Fundamental Tax Reform Proposals,’ the Need to Preserve Cash Accounting for Law Firms and Other Personal Service Businesses, and Concerns Over Burdensome Mandatory Accrual Accounting Proposals”
The proposal related to removing the exemption is not a new development with regard to tax policy, as it is has been discussed in Congress at several points in the past. However, with this letter, the ABA joins other professional associations such as the AICPA, AIA, ACEC, and the ADA in voicing their opposition to the proposals surrounding the adoption of accrual basis of accounting for professional services firms.
The complete letter issued by the ABA in response to the Subcommittee on Tax Policy.
Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.
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