Reform Could Require Changes in Your Accounting and Borrowing
By Saul B. Brenner, CPA, J.D., LL.M.
It’s still only a discussion draft issued by the U.S. House Ways and Means Committee1, but it has the potential to change your firm’s method of accounting Ultimately, if enacted, it could also increase your firm’s need to borrow money.
In the proposed legislation, Congress would require partnerships, S corporations, personal service corporations and other pass-through entities with annual gross receipts of over $10 million to use the accrual method of accounting. Most law firms use the simple and straightforward cash method of accounting where partners pay taxes only on income that has been collected and expenses are not taken into account until they are actually paid. Switching to the accrual method could require tax payments on income that has been earned, but is not necessarily in hand.
This proposed legislation raises concerns on many fronts, including income reporting, partnership agreements, borrowing, and receivables. On 1.17.14, it prompted a coalition of six business organizations, among them the American Institute of CPAs, to send a letter opposing this proposal to the Senate Finance Committee. Here are just some of the issues.
Some firms may find themselves in a tight cash squeeze under the accrual method where uncollected income is reported and taxed. As a result, a law firm may not have enough cash to distribute to the partners to fulfill their tax obligations.
It may then become necessary to borrow to make up the shortfall. Alternatively, some partners might need to reach into their personal reserves — which could be a serious problem for younger members of a firm who are just beginning to build wealth.
Tighter tracking of receivables will become a higher priority. This may be a logistical and organizational chore that will eat into time and increase costs. Some firms have billing cycles of as much as 90 days. This cycle will not work well under the accrual method, so many may have to notify clients that a 30 day cycle is the new norm.
Firms, struggling with the need to fulfill their tax obligations with money not yet in the till, may have to renegotiate and restructure their partnership agreements as they relate to retired partners.
Those firms with overseas operations where the accrual method is more common, as it is in the United Kingdom, may have already made adjustments. But, for the vast majority, it is important to monitor activity in the Capital dome and be prepared should this concept or some modified version be enacted.
1 Ways and Means Committee discussion draft, March 12, 2013
Sales and Use Tax - Clearing the Blurry Line
By Jesse Cohen, J.D.
On the same day that Cyber Monday 2013 tallied record high online sales, the U.S. Supreme Court declined to grant a writ certiorari in two New York cases. This action could have substantial sales tax implications on ecommerce transactions and use tax implications for purchases frequently made by law firms.
The Court’s denial left New York’s “click-through” affiliate nexus law intact — with implications for Connecticut, Pennsylvania and many other states that have similar laws. The nexus law compels online businesses that work with affiliates in New York State to collect sales tax on purchases — even if the business has no physical presence in the state.
Purchases from out-of-state or online vendors are not necessarily tax free solely because the vendor is not required to collect New York State or City sales tax. These very same purchases are subject to a compensating use tax, due and payable by the purchaser.
While attorneys’ fee income and other receipts from rendering legal service are exempt from sales tax, New York State and City continue to target professional service organizations, including law firms, for examinations for potential use tax liability. New York’s persistence is driven by the perpetually growing availability of electronic practice management resources and tools from out-of-state and online vendors.
The peculiar rules on software purchases especially complicate a firm’s potential use tax obligation. Generally, purchases of prewritten or “canned” software are subject to sales and use tax, while software that is custom-designed specifically for a firm is not. However, purchases of prewritten software that was subsequently modified to fit the particular specifications of the purchasing firm may be partially taxable if the customization charge (nontaxable) is separately stated. Otherwise the entire charge is subject to sales and use tax. While these concepts may seem black and white, the difficulty lies in defining what is prewritten versus what is custom.
Moreover, as software products continue to evolve into models offered through cloud computing, such as Software as a Service (SaaS) and Platform as a Service (PaaS), the line between what is taxable and what is not blurs further. Some states liken these internet-based mediums to downloading prewritten software (taxable), while other states consider it a nontaxable service because the software is never physically transferred to the user-purchaser. New York has no specific authority on the taxability of SaaS and PaaS resulting in more uncertainty regarding potential exposure to State and City tax examinations.
Once this can is opened, all contents may be under scrutiny. When a law firm is selected for an audit, all purchases may be reviewed by the State or City auditors. This means that many other commonplace items, whose taxability may have been overlooked, become a potential source of use tax liability, for example:
In addition, the statute of limitations may not run on New York’s assessment of use tax. Generally, there is a three-year statute for assessing unpaid use tax from the date a sales and use tax return is filed. However, where no return has been filed — which may be the case where a law firm has no taxable receipts — no assessment limitation period applies. In these instances, the taxing authority may assess unpaid use tax for an unlimited time period — even dating back to the firm’s inception — although taxing authorities at their discretion have generally been agreeable to limit their sales and use tax examinations and any related assessments to a “reasonable” period.
To lessen the potential impact of a tax examination for future periods, law firms may formally register with the New York State Department of Taxation and Finance for sales and use tax purposes. The law firm will be required to file a quarterly sales and use tax return, and pay on a current basis any use tax due. Instead of registering, another option is to pay the tax within 20 days of each purchase. While these methods may require additional tax compliance responsibilities, they will certainly reduce the potential for surprise costs and result in diminishing the time-frame within which New York may seek to examine the firm for use tax liability to a three-year period.
Also, there are certain strategies to initiate prior to the audit to help it proceed expeditiously and to ultimately minimize any assessment. Firms that are selected for an audit, should immediately contact their tax advisors to make preparations. -
Paper Conservation that’s Practical and Painless
The paperless office remains a laudable goal that, for many firms, is still on the far horizon. In the meantime, the legal profession, among many others, continues to consume alarmingly high quantities of paper. Going green need not become an irritable shift in the way you do business. In fact, the most practical solutions are the ones that slip easily into your routine. Here are ten.
1. Copying reports: Print doubled-sided (duplex). A 50-page report suddenly becomes an easier-to-carry 25 pager.
2. Think before you print: You find an article that you want to read later. Instead of printing it out, email it to yourself so you can read it whenever you choose.
3. Correcting errors: You find an error on page 36 of a 100-page document. Instead of reprinting the entire report, correct the error on page 36 and just print out that page.
4. Print only what you need: Do you require the full document or just a few relevant pages? In Excel, when working with large spreadsheets with dozens of columns, print only the area or cells that you really need. With PowerPoints, print handouts, not slides; use greyscale or black & white mode instead of color.
5. Scan more/copy less: Need more be said?
6. Making extra copies: It’s good to have a few extra copies of a document for meetings, but don’t overprint. Five extras may be enough, while ten might be wasteful. Make sure that one person is designated to bring copies to a meeting so that others don’t print their own and add to the waste.
7. Leverage email/portals: Eliminate as much as possible the practice of printing a document just to fax and eventually trash it.
8. Use print to PDF: Saving a PDF is a faster (and better!) option than printing and scanning a document to make a PDF.
9. Choosing paper size: Make sure you use the correct paper tray. Use the Print Preview and Shrink to Print options and try to keep to standard paper sizes— 8.5x11, 8.5x14, and 11x17.
10. Reuse: Before you trash unneeded documents, consider using the reverse side of nonproprietary material for notes.
And, of course, recycle!
These simple steps can eventually become a part of your firm culture — their logic and practicality overriding most resistance. You might also consider letting your clients know about your initiatives. There is little downside to this news and you may generate additional goodwill with some.