Choice of Entity for New Lawyers

coffee-cup-and-docs-bought-at-ssChoosing 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.

Most importantly

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.

All Rights Reserved 2017 Beverly Michaelis

Mission Impossible? Working as an Independent Contractor in Oregon

For those of you who like to use “independent contractors” (contract lawyers, contract paralegals, freelance legal secretaries) take heed.  Your contractor may well be an employee.

The latest case to interpret ORS 670.600 is Compressed Pattern, LLC v. Employment Department Tax Section.

In Oregon, an independent contractor must be “customarily engaged in an independently established business.”  A person operates “an independently established business” if at least three of the following five requirements are met:

  1. The person maintains a business location
  2. The person bears the risk of loss related to the business or provision of services
  3. The person provides contracted services for two or more different persons within a 12-month period, or the person routinely engages in business advertising, solicitation or other marketing efforts reasonably calculated to obtain new contracts to provide similar services
  4. The person makes a significant investment in the business
  5. The person has the authority to hire other persons to provide or to assist in providing the services and has the authority to fire those persons

In Compressed Pattern, LLC v. Employment Department Tax Section, the Petitioner hired Jason Singer as a “contractor” to provide drafting services.  During the course of their contract arrangement, Singer did projects for Compressed Pattern and others.  (Compressed Pattern was not his sole customer.)  While Singer adhered to deadlines provided by Compressed Pattern, he was otherwise in complete control of the projects assigned to him.  Singer:

  • Set his own hours
  • Invoiced Compressed Pattern for his work
  • Received a 1099 from Compressed Pattern
  • Used his own vehicle for travel
  • Used his own tape measure, pens, pencils, and paper to perform services for Compressed Pattern
  • Obtained a camera to use for photographing the job site
  • Did not use Compressed Pattern’s equipment or supplies
  • Was not provided with office or work space by Compressed Pattern
  • Did not have a Compressed Pattern e-mail address or business card
  • Was not held out to customers or the public as Compressed Pattern’s employee
  • Independently studied for and paid his own examination fees to become licensed as an architect during the time he was working on projects for Compressed Pattern

When the Employment Department Tax Section mailed a Notice of Tax Assessment to Compressed Pattern for the “wages” paid to Singer, Compressed Pattern appealed the determination.  The ALJ found against Compressed Pattern, noting that Singer met only two of the requirements for an “independently established business:”

  • He provided the same services to others, ORS 670.600(3)(c)
  • He had the authority to hire and fire other qualified drafters, ORS 670.600(3)(e)

First Assignment of Error – Singer Failed to Maintain a Business Location

On appeal, Compressed Pattern first challenged the ALJ’s finding that Singer “did not maintain a business location.”  During the course of the project, Singer worked at Compressed Pattern’s building site.  He did drafting and 3D modeling work for Compressed Pattern at the offices of GBD Architects.  GBD Architects previously employed Singer as an intern, but laid him off earlier in the year.  GBD generously permitted Singer to use the company’s offices, computers, and CAD software at no charge.  The Court of Appeals affirmed the ALJ’s finding:  “… a business location must be both ‘maintained’ by the person and separate from the business or work location of the person for whom services are provided…. although Singer worked separately from petitioner’s place of business, Singer did not do anything to maintain a business location; he used, for free, the space and equipment of GBD Architects and did not otherwise do anything to maintain his own business location at their site.”

Lesson 1:  No good deed goes unpunished.  In this instance, GBD Architects was trying to help a former employee by providing office space and equipment at no charge.  Unfortunately, that was a deal-breaker.  Independent contractors must maintain their own place of business and provide services from that business location.  If you hire a freelance legal secretary and he uses his former employer’s office to do your work without paying rent to the former employer, you don’t have a freelancer.  You have an employee.  (Unless the freelancer can meet at least three of the other four criteria for engaging in an independently established business.)

Second Assignment of Error – Singer Did Not Bear the Risk of Loss

In affirming the ALJ applied the correct legal test, the court found:

  • The parties had no written agreement (as to Singer’s pay)
  • There was no indemnification agreement between the parties
  • Singer, as the contractor, did not carry liability insurance or a performance bond
  • Singer billed by the hour, rather than billing Compressed Pattern a fixed-fee – which might have been evidence that he bore some risk of loss if he underbid a job
  • Singer was paid for the exact time spent on Compressed Pattern’s project

The fact that Singer was responsible for correcting defects in his drafting work at no charge was not sufficient, in and of itself, to show that he bore a significant risk of loss.

Lesson 2: Always enter into a written agreement when hiring a contractor. Terms of engagement should always be documented no matter what and your written agreement could influence the outcome in a contractor vs. employee dispute.  Query 1:  If you are a law firm hiring a contract lawyer, would you be in a better position to argue that your contract lawyer “bore the risk of loss” if he or she carried coverage with the Professional Liability Fund?  (My thought:  Yes.)  Query 2:  Should contract work be billed on a fixed-fee basis?  (Since the lack of a fixed-fee arrangement appears to have influenced the outcome here…)

Last Assignment of Error – Singer Did Not Make a Significant Investment in His Business

Although Singer covered the cost of architectural examination fees during the course of his drafting projects, obtaining a license as an architect was not required for any of the work he was hired to do.  The Court was not persuaded that payment of the fees constituted an “investment.”  Furthermore, Singer did not invest in any of the assets necessary to provide drafting services since he used GBD Architect’s CAD software and printers at no charge.

Lesson 3:  Surely a contract lawyer who pays her own bar dues, covers the cost of attending CLEs, obtains her own Professional Liability Fund coverage, and purchases the equipment and supplies needed to do contract work is “making a significant investment in her business.”

All Rights Reserved 2012 Beverly Michaelis

Are Contract Lawyers Automatically Independent Contractors?

Many new lawyers seek out contract lawyering assignments as a means of getting their practice off the ground.  If you are interested in contract lawyering, there are many excellent resources to help you get started.

Begin by checking out the following forms and practice aids available from the Professional Liability Fund at no charge:

  • Contract Lawyers Checklist
  • Contract Project – Letter of Understanding
  • Contract Project Intake Sheet
  • Letter Declining Contract Project
  • Project Assignment

Next, order the following free CLEs:

  • Choice of Entity for Contract Lawyers and Sole/Small Firm Practitioners
  • Practical Contract Lawyering

Both can be found on the PLF Web site.  Select Programs on CD/DVD under the Loss Prevention – CLE heading.

Once you’ve done a bit of homework you will start to get the drift that there is a bit more involved in being a contract lawyer than merely taking an assignment and completing a project.  For example, your classification.  Are you an employee or an independent contractor of the hiring firm?

Some contract lawyers assume they are “independent contractors” because they produce “contract work.”  But a true “independent contractor” must meet the criteria of federal and state agencies for income tax, employment tax, wage and hour, pension, health, Medicare, retirement, disability, workers’ compensation, and unemployment insurance purposes – to name a few.  So how to proceed?

In their article Contract Lawyers: Independent Contractors or Employees? Lisa Brown and Jim Vogele provide some answers.

First, enter into a written agreement with the hiring firm confirming your independent contractor status.  Brown and Vogele suggest including the following provisions:

  • The contract lawyer is responsible for his or her own income tax withholding and Social Security self-employment taxes, professional liability insurance, and excess coverage.
  • The firm will issue a Form 1099 for the services performed by the contract lawyer.
  • An acknowledgement that this is not a joint venture and the parties do not have any shared business interests.
  • The contract lawyer is currently licensed and in good standing with the Oregon State Bar, has current professional liability coverage, and has no pending malpractice claims or ethics complaints.
  • The contract lawyer does not have a conflict with any of the parties involved in the assigned project.
  • The contract lawyer agrees to at all times fulfill his or her professional duties to protect the client’s privileged and confidential information.
  • The contract lawyer will at all times comply with his or her ethical and legal responsibilities as a lawyer licensed to practice law in the state of Oregon.
  • The contract lawyer will return all client documents, including all copies of the documents, when the project is complete.
  • The contract lawyer will not receive any employee benefits or workers’ compensation coverage.

Second, behave like an independent contractor:

  1. Maintain your own office (virtual or brick-and-mortar)
  2. Provide services to a variety of firms
  3. Print and use your own business cards
  4. Keep an e-mail account separate from the hiring firm(s)
  5. Use your own online legal research tools, computer, and copying capability
  6. Get your own taxpayer ID
  7. Work independently, setting your own hours
  8. Exercise control over how your work is performed
  9. Invoice the hiring firm and arrange for payment on a project basis
  10. Obtain a 1099 from the hiring firm at year-end
  11. Fulfill the other hallmarks of working as an independent contractor

Read the complete article on the Professional Liability Fund Web site.