Choice of Entity

The selection of the form of entity under which to practice law is different depending on whether the lawyer is a solo practitioner or in partnership with other lawyers.

In California, a solo lawyer can practice as sole proprietorship (i.e., no entity), or a corporation, while groups of two or more lawyers can form a partnership (preferably the limited liability partnership (LLP)) or a professional corporation. Lawyers cannot form limited liability companies by virtue of the prohibition now codified in Section 17375 of the Corporations Code.

Solo Practitioners

For solo practitioners, the choice is between ‘sole proprietorship’ and corporation. A solo attorney cannot form an LLP because by definition a partnership must have at least two partners. The liability profile of a solo attorney varies significantly depending on whether the attorney employs associate attorneys.

If the lawyer is truly “solo”, i.e., does not employ any associates, the corporate form offers little liability protection, because the lawyer will always be personally liable for his own Errors and Omissions (E&O) and will almost certainly have to personally guarantee major contracts, such as bank loans and leases. However, a corporation may offer liability protection against other types of liability, such as trade debt.

Thus, the true “solo” attorney will not achieve significant liability protection by forming a corporation, making the sole proprietorship a reasonable alternative.

If the solo attorney employs associates, a corporation should be formed to limit the attorney’s liability for E&O of associates. However, the protection is far from bullet proof – the attorney could still be liable for the E&O of associates on a theory of negligent supervision.

Partnerships

For partnerships, i.e., law firms with more than one owner, the choice is between the LLP and the professional corporation. The LLP is a special form of general partnership available to attorneys, accountants, architects, engineers and land surveyors.

Partners in an LLP are entitled to the same type of limited liability protection enjoyed by corporate shareholders.

A professional corporation is a corporation which meets additional requirements specified in the Moscone-Knox Professional Corporation Act (Section 13400 et seq. of the Corporations Code) and the Business & Professions Code. However, to achieve this protection, the owners of both LLPs and law corporations must maintain malpractice insurance or other forms of security against E&O claims.

The choice between the LLP and the professional corporation (and between C corporations and S corporations) comes down to various tax and other considerations. Once the corporation offered better tax treatment of fringe benefits and qualified plans over other entities, but tax law has evolved to the point where there are few differences.

Both are subject to an $800/ year “minimum franchise tax”, although the corporation may also be subject to California income tax, with the amount varying depending upon whether it is classified as a C corporation or an S corporation for income tax purposes. As a general rule, the LLP provides the best of both worlds, providing the same liability protection as a corporation, but better tax treatment and a legal framework better suited to the law firm dynamic. The employment status of partners is an important practical consideration. The owners of a law corporation are classified as employees for payroll tax and other tax purposes, whereas partners in an LLP are classified as self-employed persons. Among other things, this means that the firm will not be responsible for income tax withholding or payroll tax on the partner’s compensation. Instead, the LLP partner will be responsible for paying his/her own self-employment tax and making quarterly estimated tax payments against his/her income tax liability.


George S. Cabot practices with PremierCounsel LLP in San Francisco and Lafayette after having practiced with Morgan Miller Blair in Walnut Creek for over 17 years. George has practiced transactional business law for over 25 years and is recognized by the State Bar of California Board of Legal Specialization as a Certified Specialist in Taxation.

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