Tax Reform Proposal Targeting Law Firms Gains Steam
The newest tax reform plan unveiled Wednesday on Capitol Hill retains a provision that could cause financial hardship for law firms and hit partners with years of outsized tax bills.
Rep. Dave Camp (R-Mich.), chairman of the House Ways and Means Committee, introduced a new draft of The Tax Reform Act of 2014 that he said was intended to simplify the tax code for families and lower tax rates for corporations.
But the draft bill would target law firms’ earnings for the revenue needed to help make those changes possible. Under Camp’s plan, professional service firms including law firms would have to fundamentally change they way they report and pay their taxes, and law partners would bear the burden.
Camp’s legislation would give law firms and partners more breathing room that a previous version would have—eight years, instead of four— to implement the changes. “That’s a pretty gracious period,” said David Gaulin of PricewaterhouseCoopers' law firm services practice.
The provision’s inclusion in the draft, however, brings the reporting change one step closer to introduction in the House, according to lawyers monitoring the reform efforts. The plan could guide tax reform efforts even beyond 2014, when Camp most likely will no longer be chairman of the committee.
“As concepts get repeated and repeated, they tend to get locked in in the minds of Congress,” said Evan Migdail, a DLA Piper partner in Washington who focuses on tax, trade and government ethics. “If you’re waiting until you’re sure something is going to get enacted before you speak up, you’re making a mistake.”
The American Bar Association has criticized the provision, which was also included in a draft bill last year by former Sen. Max Baucus (D-Mont.). Baucus left as chairman of the Senate Finance Committee to become ambassador to China, but the new chairman, Sen. Ron Wyden (D-Ore.), has said he will continue to pursue the measure.
Under the proposals, firms with gross receipts of greater than $10 million could no longer use the cash method of determining taxable income, but instead would use the much more complex accrual method. The change would increase government revenues by $23.6 billion during the next 10 years, according to an analysis by the Joint Committee on Taxation.
Firms would have to report income earlier—even before clients actually pay their bills—and likely would "generate an unexpected, front-loaded income tax liability that must be paid by law firm partners over a proposed four-year period," according to a PricewaterhouseCoopers analysis of the Baucus draft bill, published in December.
Law firms are starting to look at potential complications to cash flow, partnership agreements and lateral hiring, Gaulin said. An ABA Board of Governors report warned that partners could be taxed on income in one year "even though they may not be around when the clients pay their bills (if the bills are ever paid)." And lawyers would be less likely to create or expand a firm, the report said—even if it made economic sense and would benefit their clients—if it meant exceeding $10 million in receipts.