Gavin Howe
Lawyers and law firms have different business structure options to choose from, including a limited liability company (LLC). However, the choice of business structure is dependent on several factors, including the type of firm, size, and financial liability. While an LLC offers the same protection as a corporation with fewer requirements, it is not a viable option for law firms in some states like California. This is because, in California, practicing law is considered a professional service, and per the California Corporations Code, an LLC cannot be used to provide professional services. Therefore, law firms in California must be structured as professional corporations or limited liability partnerships (LLPs).
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What You'll Learn
Law firms can be LLCs in some states
Law firms can be structured as limited liability companies (LLCs) in some states. However, this is not the case in California, where the State Bar does not certify LLCs for the purpose of practicing law. Instead, law firms in California must be structured as professional corporations or registered limited liability partnerships (RLLPs).
LLCs are pass-through entities, meaning that all profits and losses incurred by the business are passed directly to the company's members as income and are subject to income taxes. The LLC itself is not taxed, so profits are only taxed once, unlike in a corporation where they are taxed twice. When a law firm organises as a single-owner LLC or sole proprietorship, the individual owner's company profits are taxed under self-employment taxes.
LLCs offer the same protection as a corporation, but with fewer requirements, such as meetings and other red tape. However, a potential downside of an LLC is that the company might be required to be dissolved upon the loss of an owner. In most cases, if one member of an LLC faces a lawsuit, the other members will be protected from liability, and only that member will be affected. However, in some situations, other members of an LLC can be held liable if one member encounters legal issues.
An alternative structure for law firms is a limited liability partnership (LLP), which offers similar protections to LLCs in legal and financial matters. LLPs have certain tax and filing benefits that make them a popular choice among law firms. For example, under the LLP model, partners can pass their profits or losses to their own individual tax returns, meaning that the firm itself doesn't have to file a tax return. This results in less paperwork than the LLC model, where the firm itself must file taxes.
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California prohibits law firms from being LLCs
In California, practicing law is considered a "professional service," and lawyers are required to have a state license to provide legal services. As such, law firms in California must be structured as professional corporations or registered limited liability partnerships (LLPs). A professional law corporation is the entity of choice for law firms in California. This structure provides liability protection in specific circumstances, such as breach of contract, employee lawsuits, or accidental injuries unrelated to the practice of law. It also offers substantial tax savings compared to other business structures.
To form a professional law corporation in California, law firms must follow specific steps. They must submit an application to register as a Law Corporation, pay the necessary fees, and provide proof of security for claims. The name of the law corporation should also comply with the California Rules of Professional Conduct and the California Business and Professions Code, including wording or abbreviations that denote corporate existence, such as "Professional Corporation" or "Incorporated."
While LLCs offer benefits such as limited liability protection and pass-through taxation, they are not an option for law firms in California due to state regulations. These regulations are in place to uphold professional standards and protect the public from potential harm or malpractice. Therefore, lawyers in California who wish to start their own law firm must form a professional corporation or LLP instead of an LLC.
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Law firms can be LLPs
Law firms can be structured as limited liability partnerships (LLPs). LLPs are a common business structure for law firms, offering a range of benefits.
LLPs provide protection in legal and financial matters. The partners in an LLP benefit from limited liability, meaning their personal liability is limited to their contributions to the partnership. If one partner is sued, the other partners are not responsible for their debts or legal obligations. This structure also allows partners to protect their personal assets while enjoying the benefits of a partnership.
LLPs have operational flexibility, and partners can manage the business as outlined in the partnership agreement. This flexibility includes the ability to add or remove partners as needed, with the approval of existing partners. Additionally, partners can set up the LLP to only pull profits when needed, providing tax benefits. Under the LLP model, partners can pass profits or losses to their individual tax returns, and the firm itself doesn't need to file a tax return.
LLPs also offer the advantage of minimal paperwork compared to other structures like LLCs, which require articles of incorporation, a board of directors, and a registered agent. However, it's important to note that LLPs have more complex formation documents and may require the assistance of a corporate lawyer.
While LLPs provide benefits, there are also some disadvantages to consider. For example, LLPs are governed by state law and typically cannot operate across state lines. Additionally, some states restrict the formation of LLPs to specific professions, including lawyers.
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LLCs offer protection and flexibility
A law firm can be an LLC when the LLC business structure is chosen as the desired entity type. However, it is important to note that the State Bar of California does not certify LLCs for the purpose of practicing law. The only entity choice for law firms in California is a professional corporation.
LLCs also offer flexibility in terms of management. Members (owners) of an LLC can manage the LLC themselves or elect a management group to do so. Additionally, LLCs may offer several classes of membership interest, whereas an S corporation may only have one class of stock.
LLCs also have pass-through taxation, meaning that business income is not taxed at the entity level. Instead, profits and losses are passed through to the owners and reported on their personal income tax returns. This means that profits are only taxed once, not twice as with a corporation. However, members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security.
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PCs are an alternative to LLCs
A law firm can be a limited liability company (LLC) if the desired entity type is chosen. However, in California, law firms cannot be LLCs. Instead, California allows for the use of a professional limited liability partnership (LLP).
Professional corporations (PCs) are an alternative to LLCs for law firms. PCs are a business entity established to provide professional services to others. They are governed by state law, and the laws can vary from state to state, so it is important to know the rules of your jurisdiction when forming one. PCs are more formal entities than other formations and have bylaws that dictate the decision-making process and the scope of activities. They typically require the approval of a board of directors and/or shareholders to make decisions.
One advantage of an LLC is that each owner or member has limited liability, meaning they are not personally liable for the financial obligations of the LLC. PCs also offer limited liability protection, but they have stricter requirements, such as the need for bylaws and approval from a board of directors or shareholders. Additionally, PCs require that each director, shareholder, and officer be licensed to practice law, and they can only provide services in their field.
In terms of taxation, LLCs are not taxed as an entity, so profits are only taxed once as income for the members. In contrast, PCs are taxed as corporations, resulting in profits being taxed twice: first as business earnings and then again as income for shareholders. However, both LLCs and PCs can file as S corporations to avoid double taxation, with profits and losses passing through to the members' or shareholders' personal tax returns.
When choosing between an LLC and a PC, it is important to consider the specific state statutes and the needs of the law firm. While both structures offer limited liability protection and have similarities, there are also differences that may make one more suitable than the other for a particular firm.
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Frequently asked questions
No, California prohibits lawyers from forming a standard California LLC. Law firms in California must be structured as a professional corporation.
LLCs offer the same protection as a corporation but with fewer requirements, such as meetings and other red tape, and different taxation. LLCs are also pass-through entities, meaning profits and losses go directly to members as income and are taxed once, unlike corporations.
The two main alternatives are the Professional Corporation (PC) and the Registered Limited Liability Partnership (RLLP). Both structures can provide liability protection and professional legitimacy.
