Congressional proposals set to substantially affect law firms and their partnership structures

Kate Harry ShiphamThe future of the legal industry

Two proposals are currently before congress to substantially change how law firms report their taxable income. The effect of these could mean that law firms would have a significant tax liability (paid by partners individually) as law firms shift from the current cash method to the proposal accrual method.

The two proposals behind this shift are the Baucas and Camp proposals, both which propose shifts which will affect law firms in 2014, if enacted. While the proposals are not aimed at law firms, they form part of an affected group:

“A critical consequence of these proposals is the acceleration of taxable income that likely will result when a law firm converts from the cash to accrual method of accounting for tax purposes (hereinafter referred to as the cash method and accrual method respectively). Under the cash method, law firms generally report income when cash is received. But under the accrual method, taxable income may need to be reported much earlier under a host of special rules (described in more detail below.) Most importantly, amounts in accounts receivable (A/R) and work in process will likely shift and become reportable as income for US federal tax purposes.” (PwC, December 2013: read the complete paper here)

The proposed change to an accrual method is set to affect law firm partnerships in many ways, including partners reporting requirements, the law firms’ relationships with their partners, the impact of new and retiring partners into the partnership, whether partnership agreements need amending to comply with the proposals, whether additional borrowing needs to occur, and the various new and intricate rules and processes which will need to be complied with.

Law firms have the opportunity to contribute to this discussion by commenting on the Baucas and Camp proposals (Senator Baucas is looking for feedback by January 17, 2014; the Camp proposal does not have a deadline set for feedback).

We think this will hold significant ramifications for the marketing and business development teams in law firms in the way they craft RFP responses and develop new go-to-market strategies that sync with the law firm’s new business policies. This topic must be watched; the firms whose marketing teams are armed with ideas on tackling this new business model with its clients will undoubtedly be those who weather this huge shift the best; this is not something to wait on the accounting department to rule on. This could mean a fundamental shift in the way US law firms do business and a drastic change for the associated marketplace which, in turn, is an epic marketing challenge.