In 1993, the IRS issued a market segment specialization program aimed at lawyers. This program provides a road map for IRS agents to use in selecting lawyers' tax returns for examination and making adjustments to their tax liability. Because the IRS is targeting legal practices, lawyers need to be aware of the tax traps that await them. Almost every legal practice uses the cash receipts and disbursements method of accounting. Although the Treasury has long accepted the cash receipts method for most types of service businesses, several issues are specific to the practice of law.
Many lawyers request and receive retainers from clients in advance of performing legal services.
Generally a retainer will be taxable upon receipt. One area of particular interest to lawyers is the income tax implication of client trust accounts. Most state bar associations require client funds that are received or held by a lawyer for the benefit of clients to be held in a client trust fund, although the lawyer exercises control over the fund. In many cases, a separate trust fund may be established for a client. The interest earned on the separate trust fund belongs to the client and he will be taxed on the interest.