Magazine article The CPA Journal

Market Segment Approach Applied to IRS Audits of Attorneys

Magazine article The CPA Journal

Market Segment Approach Applied to IRS Audits of Attorneys

Article excerpt

In September 1993, the IRS issued as part of its market segmentation specialization program (MSSP) a special audit training guide pertaining to audits of law firm tax returns. One of the issues raised in the guide has resulted in a great deal of press lately. The issue involves law firm deduction of litigation expenses advanced to their clients.

A long line of cases reaching at least back to 1929 have held that such expenses are nondeductible loans to clients and must be capitalized. In the event they are not repaid, these loans become deductible as a business bad debt. Nevertheless, a number of law firms continue to deduct these expenditures currently. The IRS's Training Guide suggests that agents specifically look into this issue when examining law firms' tax returns.

Law firms currently deducting these litigation expenses would he deemed to be using an incorrect method of accounting. If the method is corrected on examination, the resulting denial of current deduction treatment will most likely be made for all open years. The cumulative effect of a change in method would be brought into the earliest open year. Law firms wishing to reduce the harsh impact of these adjustments may wish to consider changing their method of accounting for these expenditures. …

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