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Choosing A Business Entity Structure For Your Law Firm
(Current as of August 2020)
One of the most important decisions you’ll make when starting a law firm is the legal structure you’ll operate under. The business entity you choose for your firm can have important implications for personal liability protection, tax treatment, and ongoing business operations.
Commonly Used Law Firm Business Entities
Sole Proprietorship
You don’t need to create a separate legal entity to sell legal services. As a solo practitioner, you’re free to operate your practice as an extension of your own personal affairs, known as a sole proprietorship.
The main advantage of a sole proprietorship is that it’s relatively inexpensive to start and maintain from an administrative perspective. There are few registration or reporting requirements, if any, and your business income and expenses pass through to your personal income tax return (as opposed to requiring a separate tax return for your business).
It’s important to understand, however, that a sole proprietorship won’t afford you any of the liability protection you might receive from operating your firm as a separate legal entity (i.e. LLC, LLP, PC, etc.). You’ll be personally responsible for all business debts and liabilities, and your personal assets may be fully at risk for any business-related claims brought against you.
General Partnership
Two or more partners are also free to begin operating a law practice together without creating a separate legal entity. This business structure is known as a general partnership.
Much like a sole proprietorship (discussed above), a general partnership is relatively inexpensive to start and maintain from an operational standpoint, and any income the partners receive from the business will pass through to their individual personal income tax returns.
But the general partnership structure carries a unique risk of personal liability for each of its individual partners. Specifically, each individual partner is personally responsible for the acts or omissions of all other partners in the firm. So, for example, if one of your partners commits malpractice or sexually harasses an employee, you could be liable for those wrongful acts, even if you personally did nothing wrong.
Limited Liability Company (LLC) or Professional Limited Liability Company (PLLC)
An LLC is a legal entity that is separate and distinct from its owners (also called members). LLCs can have one or more members, and most states will allow you to form an LLC for the purpose of practicing of law.
LLCs offer the same pass-through taxation as a sole proprietorship or general partnership. But the main advantage of an LLC is that it can also provide you with certain personal asset protections. Specifically, because an LLC is recognized as a legal entity that is separate and distinct from its owners, there are certain business debts and liabilities for which only the LLC may be responsible.
Even with an LLC, however, your liability protection is not absolute. While an LLC may protect you from liability for certain business-related claims, you’ll remain responsible for any personal wrongdoing that you commit in the course of conducting business, such as legal malpractice.
Some states prohibit licensed professionals like lawyers from operating through an LLC and require them to form a professional limited liability company (PLLC) instead. A PLLC generally affords the same liability protection and pass-through tax advantages as an LLC, but requires you to provide proof of your professional licensure when you submit your business formation documents. Whether your law firm can operate as an LLC, or must instead form a PLLC, will be specific to your state of formation.
Limited Liability Partnership (LLP)
The LLP is a popular choice for multi-partner law firms. LLPs offer the same pass-through tax benefits as LLCs, and in most states partners in an LLP also enjoy the same liability protections as LLC members. In some states, however, LLP partners remain jointly and severally liable for general business obligations. Some states also require LLPs to carry a statutorily mandated level of liability insurance.
Professional Corporation (PC)
A PC is a type of corporation that is reserved for use by licensed professionals. Like an LLC or LLP, a PC will generally shield your personal assets from business debts and the wrongdoing of any co-owners. Depending on your state, however, PCs can have cumbersome operational requirements (implementing bylaws, designating officers and directors, holding annual shareholder meetings, etc.). Taxation of PCs is also more complex, and in some circumstances, income earned through a PC can be subject to double-taxation (on both the corporate and personal level).
Professional Association (PA)
Some states allow law firms to form as PAs, which differ in form and effect depending on your jurisdiction. In some states, a PA is treated as corporation formed for the purpose of providing professional services, much like a PC. But in other states, a PA is considered its own special type of legal entity, subject to unique rules and regulations.
Choosing The Right Legal Structure For Your Firm
Rules governing business entity formation, operation, liability protection, and taxation are state-specific and may vary depending on your jurisdiction. Be sure to check your state’s rules and regulations to determine which legal structures are permissible for operating a law firm, and which of the various legal structures best suits your needs. Consider consulting with an accountant or another attorney if you’re unsure which legal structure is right for your firm. Additionally, be sure to comply with all applicable registration and ongoing reporting requirements. Failure to do so can result in a loss of limited liability protections.
Swyft Filings and incfile are popular online entity formation services.
Remember: No matter which legal structure you choose for your law firm, you’ll always remain personally liable for your own wrongdoing. For additional personal asset protection, you should strongly consider obtaining legal malpractice insurance.
OTHER ARTICLES ON THE LAW FIRM LAUNCHPAD:
Getting An Employer Identification Number (EIN)
Getting A Business Credit Card
Opening Law Firm Bank Accounts
Buying Legal Malpractice Insurance
Assessing Your Furniture And Office Supply Needs
Setting Up Internet, Phone, and Fax
Assessing Your Computer And Technology Hardware Needs
Assessing Your Software Solutions Needs
Fortifying Your Electronic Data Security
Setting Up Mailing And Shipping Accounts