Representative Dave Camp (R-MI) (Photo: Diego M. Radzinschi / NLJ)
The latest tax reform plan appeared last week on Capitol Hill, and it 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 on Feb. 26. He said he aimed to simplify the tax code for families and lower tax rates for corporations. “The debate about needing to do tax reform is over,” he said. “We’ve already lost a decade, and before we lose a generation we must enact real, meaningful tax reform to get this economy back on track.”
But the draft bill would target earnings by professional services organizations — including law firms — for the revenue needed to make those changes possible. Firms would have to fundamentally change they way they report and pay their taxes, and law partners would bear the burden.
The 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 enactment, according to lawyers monitoring the reform efforts. The plan could guide tax reform efforts in Washington even beyond 2014, when Camp most likely would 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 also was included in draft legislation 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.), said he would 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, published in December.
Law firms are starting to look at potential complications such as changes 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 warned — even if it made economic sense and would benefit their clients — if it meant exceeding $10 million in receipts.
ABA President James Silkenat wrote a cautionary letter to Camp and other lawmakers in January, and released a written statement Wednesday.
“The ABA continues to have serious concerns regarding the accrual accounting provisions in Chairman Camp’s new Tax Reform Act of 2014, and we are hopeful that Congress will eliminate them from any final legislation that might be approved,” he said.
“These harmful provisions would force many law firms and other personal service businesses to adopt new, costly accounting methods and incur substantial financial burdens by requiring them to pay tax on income they have not yet received and may never receive.”
Its progress notwithstanding, the bill faces an uphill battle during 2014. On Feb. 28, Senate Minority Leader Mitch McConnell (R-Ky.) told reporters, “I don’t see how we can” move tax reform given policy differences between the parties. House Speaker John Boehner (R-Ohio) said during a press conference only that Camp’s draft bill would “start a conversation.”
The White House is engaged in conversations about tax reform with lawmakers of both parties, spokesman Josh Earnest told news reporters on Feb. 26. He added that “there’s not a great amount of optimism on Capitol Hill” for the prospects of enacting complicated legislative proposals including tax reform.
“I think it’s fair to say that we are realistic about the prospects for difficult pieces of legislation like this passing this Congress this year,” Earnest said.
Contact Todd Ruger at firstname.lastname@example.org.