Choosing a legal structure and entity type for your law firm seems like an easy decision. But is it? Consider the following scenarios:
New lawyer establishes law practice with the goal of becoming an associate
If this is you, being a straight-up sole proprietor may be the best choice, assuming you have no employees.
A sole proprietorship is the simplest and most common structure chosen to start a business:
- No formal action is required to start your business
- It’s inexpensive
- No papers to file
- Nothing to dissolve
- Simple tax preparation
When you’re ready to make the move from running your own practice to becoming an associate, the transition couldn’t be any easier.
On the downside, sole proprietorship means you have unlimited contractual liability and potentially higher taxes.
But how significant is the liability exposure?
Lenders, property managers, and others with whom you do business will typically require a personal guarantee for loans, leases, or other business transactions. A personal guarantee means YOU are on the hook, even if you form a professional corporation or single-member limited liability company. As a result, contractual liability protection doesn’t count for much in evaluating whether to form an entity.
The real choice between sole proprietorship and forming a PC or single-member LLC comes down to taxes and the trade-off between potentially saving money (with entity formation) and simplicity (going with the sole proprietorship model). Talk to a CPA so you can make an informed decision.
What if I’m planning to practice business law or intellectual property?
Why would your area of practice make a difference? And didn’t we just say entity choice is driven by risk aversion – wreaking whatever benefit you can from contractual liability protection – and saving money – courtesy of a lower tax burden? So what difference could practicing business and IP law possibly make?
If your goal is to help clients form entities and protect intellectual property, it could look a little odd that you haven’t followed the usual formalities in establishing your own business.
Fair or not, client perception counts. So does marketing. And part of marketing is how you brand your law firm. Appending a PC or LLC designation to your business name may actually be an important part of how you choose to present yourself to potential clients.
If you plan to have employees …
This is an entirely different ballgame. Without a doubt, form an entity. If you are a solo, choose a PC or single-member limited liability company (LLC).
Both entity types offer liability protection for non-professional torts committed by your employees. The contractual liability protection discussed above will also kick in. Talk to a CPA, but the likelihood is that forming an entity will also result in a noticeable tax savings.
If you plan to practice with others …
This is another occasion when forming an entity is a no brainer. Do it for the avoidance of liability discussed in the preceding paragraph and for the limitation on vicarious liability. The ideal structure may be to form a sole owner PC or single-member LLC that belongs to the firm’s entity. This may allow you, as the individual lawyer, to completely escape personal vicarious liability.
Multi-tier entities are complex, administratively messy, and no longer have the tax benefits they once enjoyed. BUT avoiding vicarious liability is a big plus. To learn more about this strategy, read Choice of Entity for a Legal Practice and Lawyers as PCs, LLCs, & LLPs in Oregon, referenced below.
Being fully informed in the premises
This post skates over some pretty significant content that deserves more in-depth thought. Do your homework. Recommended reading includes:
- Sole Proprietorship as a business structure choice, courtesy of the Small Business Administration. While you’re on the SBA site, poke around. There is a ton of great content here. And don’t forget about the help and resources available from the Small Business Development Center.
- Law Firm Choice of Entity, from the ABA Young Lawyers Division.
- Choice of Entity for a Legal Practice in Oregon, available on the PLF website. Select Practice Management > Forms > Entity Formation for Lawyers.
- Lawyers as PCs, LLCs, & LLPs in Oregon, available on the PLF website. Select Practice Management > Forms > Entity Formation for Lawyers.
- Tax Considerations for Choice of Business Entity, Chapter 3 of the OSB CLE Seminar Handbook Broadbrush Taxation: Tax Law for the Nonspecialist (2015). Available in BarBooks behind the member login on the OSB website.
Talk with a CPA. I can’t say this enough. This is one of the best investments you can make in getting your practice up and running. A CPA can help you determine whether forming an entity will result in tax savings. He or she can also help you select an entity type – which is highly driven by tax considerations.
You’ll also learn about property tax, business income tax, business licensing, and other obligations you may not be familiar with – all of which are determined by where your business is located.
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