Attorneys and Law Firms and Federal Government and Income taxes and Taxes and Government & Economic Development and Government and Law

Law firms fight 'onerous' tax shift for service businesses

April 10, 2014

Lawyers representing Indiana’s legal profession are in Washington, D.C., this week with a message for their congressional delegations—kill a proposal that would change the way many law firms report income-tax obligations.

“It’s a very onerous accounting burden on a firm,” tax attorney Carol Adinamis said of proposals in Congress. Measures that have drawn the ire of the legal community would require law firms and other personal services businesses with annual revenue in excess of $10 million to switch to accrual accounting from the current cash-basis method.

Opponents of the proposal fear it could create financial hardship for some firms, add to accounting expenses and create cash-flow nightmares.

Currently, firms report income-tax liability based on receipts through Dec. 31 of a calendar year. Accrual accounting would require reporting income based on the calendar year in which the right to receive revenue arises, regardless of whether the money was received.

“Firms would be forced to pay taxes on income they have not received and may never receive,” the American Bar Association said in a recent alert to members.

Adinamis, of Adinamis Michael & Saunders P.C. in Indianapolis, also is vice president of the Indiana State Bar Association. Today, an ISBA delegation and state bar groups from around the country are expected to join the American Bar Association on Capitol Hill in lobbying against the measure.

The proposal is contained in the Tax Reform Act of 2013 sponsored by House Ways & Means Chairman Rep. Dave Camp (R-Mich.), and also appears in draft legislation in the Senate. The switch in accounting methods would impact not just law firms, but a host of others including medical-service providers, accounting, engineering, consulting and other professional-services companies with revenue in excess of $10 million.

ISBA President James Dimos already has sent letters to members of the state’s congressional delegation urging them to reject the proposal. Large firms such as Barnes & Thornburg LLP and others also are opposed.
dimos-jim-mug Dimos

“This far-reaching provision would create unnecessary complexity in the tax law and increased compliance costs by disallowing the use of the simple, straightforward cash method of accounting,” Dimos wrote to Indiana’s congressional delegation.

A partner at Frost Brown Todd LLC in Indianapolis, Dimos is also a former member of the ABA’s Board of Governors and House of Delegates.

While the accrual accounting proposal has been widely characterized as targeting large law firms, Dimos told Indiana Lawyer that the $10 million threshold could reach some small- to mid-sized firms with as few as 20 to 30 attorneys.

“At the minimum, it is going to create a whole other layer of accounting responsibilities within a law firm that may very well necessitate adding staff so the firm is in compliance with the tax code,” Dimos said.

Joseph O’Connor is a partner with the 14-lawyer Bloomington general practice firm Bunger & Robertson. “Someday a firm our size could be affected by this,” O’Connor said.

Even a two-person firm might win a big judgment that would subject it to paying tax on the accrual method, said O’Connor, a past ISBA president and Indiana delegate to the ABA who will be among those in the delegation to Washington.

The accrual method also could be painstaking in cases where revenue goes uncollected or awards are reversed years later on appeal, Dimos said, because taxes on that expected income already would have been paid in the year the income right arose.

The impact for firms could be dramatic, according to Dimos. He imagines some firms organized as partnerships might restructure to avoid being subject to accrual accounting if the measure were enacted.

On the flip side, firms that are below the $10 million threshold might restrain growth if they’re concerned about the challenges that accrual accounting might present, Dimos said.

“It’s certainly a disincentive for bringing in new lawyers,” he said of such firms, “which is something the profession doesn’t need right now.” He also imagines some firms might have to resort to unconventional means to pay taxes on receivables.

The ABA and bar groups have been the loudest voices protesting the proposed change in accounting for personal-services companies. Adinamis suggested that may be because law firm accounting is already tricky enough.

“The biggest problem is, they’re going to be asked to pay taxes on money they haven’t received yet,” she said of accrual accounting. Law firms don’t typically hold back a lot of money, she explained, so any additional tax burden is likely to crimp cash flow.

“A lot of times, we don’t get paid for a long time,” said Adinamis, who’s also a certified public accountant. “Ultimately, I think it will affect the clients we serve. I think no doubt attorneys would be wanting their money sooner than later.”

Dimos said the change also would impact attorneys who counsel professional-services companies, particularly those who also provide accounting services.

Indiana University Maurer School of Law Professor Emeritus William D. Popkin is a nationally recognized scholar in tax law and legislation who says this isn’t the first time tax code writers have tried to cast a wider net around law firms and other professional services.

“I don’t think it has a chance of passing based on past experience,” Popkin said. “Any chance of passage would probably have to exempt smaller law firms.”

Popkin said he expects smaller firms to argue accrual accounting would prove too difficult for them to manage. “Larger businesses will probably go along on their coattails and the whole thing will die.”

O’Connor said that there may be an element of public perception at play in the proposal. Because the measure is promoted as tax reform aimed at big law firms, “it’s hard to generate much sympathy for the new method, even though I think it creates all kinds of headache and hardship for everybody involved,” he said.

Dimos isn’t as certain as Popkin that lawmakers will drop the proposal.

“What I do think is going on here is an effort to make the (government’s) books look good in the short term,” Dimos said. “Over the long run it should balance out, but in the short term, you’ll see increased tax revenues to the government.

“That will then be not a result of increased economic activity, but it will be because law firms and other personal-services businesses had to go out and pay taxes sooner, or in some cases had to borrow or go into savings to pay the newly expedited taxes,” he said.

In addition to opposing the proposed accounting change, Dimos and O’Connor said members of the delegation will ask lawmakers to adequately fund the Legal Services Corp. The program that provides civil legal assistance to low-income Americans is requesting a budget of $486 million for fiscal year 2015, the same it received in FY 2014.
 

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