In an earlier post, I introduced the sole proprietorship as an option for establishing a law practice.

If you’ve decided to structure your practice in such a way that you are the sole owner, your next decision is whether to use cash-basis or double-entry accounting to keep track of your revenue and expenses.

What is cash-basis accounting?

The vast majority of solo attorneys use the cash-basis accounting method, which dictates that all income must be recorded only when received, and that expenses are recorded only when paid. This works well for law practices and other service providers because these types of business do not maintain product inventory or significant physical assets. We call this single-entry accounting.

All accounting activity is documented on an income statement. When it is time to file yearly taxes, the attorney simply passes along this information to a professional tax preparer. Before filing, the tax preparer makes the requisite adjustments needed to calculate taxable income.

What is the double-entry accounting method?

Unlike single-entry cash-basis accounting, double-entry accounting necessitates a closer look at accounts on the balance sheet rather than just the income statement.

Suppose you’ve just been paid $1,000 for services rendered to a local real estate agent. This is categorized as Revenue. When you record an increase in revenue, this automatically results in an identical increase in the Operating Account.

If, on the other hand, you’ve just cut a check for the same amount, your balance sheet would show an identical decrease in the value of your assets.

What is constructive receipt?

Less frequently used is the constructive receipt method, which uses disbursements and cash receipts. The gross income does not increase until revenue is received, whether constructively or in actuality. The income must be constructively received within the same taxable year in which it appears as a credit under the taxpayer’s account.

Alternately, the income is earmarked specifically for the taxpayer or made available at the taxpayer’s discretion. Irons cautions that the presence of any restrictions or limitations on the taxpayer’s control may prevent the income from being considered as constructively received.