Now you need to figure out how to set up your business. And not in the sense of "Where does the office furniture go?" No, now you have to make the big decision on the legal structure of your firm. This is no small matter either. The choice you make will affect many aspects of your business operations, so it is important to thoroughly research your options and make the right choice for your needs and circumstances.
So what are your options?
Types of Legal Structures
1. Sole Proprietorship
The sole proprietorship is perhaps the most straight-forward option. It is a business structure where the business is owned and controlled by one person and that person is liable for any of the business' obligations.
Some aspects of a sole proprietorship include:
- You don't have to file any forms with the state, though you still need to obtain any required licenses and permits.
- Owners are personally liable for any debts incurred by the business.
- Income from the business is reported on your personal income tax return.
According to the Small Business Administration (SBA), some of the advantages of using a sole proprietorship structure are that it is low cost, owners have control, and taxes are simplified, while the disadvantages include unlimited liability and that you have to pay self-employment taxes.
As the owner of a law firm, this may be an easier route to take to get your business off the ground and running. On the other hand, if the business is sued for for any reason, such as a slip and fall in your office or for malpractice, you could be personally on the hook for any damages (in excess of any insurance coverage that you have hopefully purchased).
A partnership consists of two or more people who own and run the business. The partnership may be general or limited, and is generally governed by an agreement that sets forth the partners' responsibilities and obligations. Limited liability partnerships (LLP) may be an option depending on your state. LLPs may be limited to certain professions, as in California, and provide some protection to the partner from personal liability for certain acts of the other partners.
In a partnership:
- Partners are personally liable for the partnership's obligations in a general partnership.
- Partners owe fiduciary duties to each other.
- Taxes are paid through the partner's individual tax returns.
The benefits of a partnership, says the SBA, include low formation costs, profits that flow through to the partners, and incentives for employees to become partners, while the downside includes joint and several liability, profit sharing, and disputes between partners over business decisions.
So if Joe Law Partner commits malpractice (or some other tort related to the partnership), or bails on a contractual obligation, you could be personally liable. One good reason to pursue a limited liability partnership if it is available in your state.
3. Limited Liability Company
A limited liability company (LLC) is a business whose members are protected from personal liability for the acts and debts of the company in the same way as a corporation, but can opt to be taxed as a partnership.
- Members do need to file organization papers with the state.
- An operating agreement governs the rights and responsiblities of the members and how the business will be run.
- The LLC can choose to be taxed as either a partnership or a corporation.
The SBA notes that LLCs provide the benefits of limited liability and less recordkeeping than corporations, but members may have to deal with dissolution if a member leaves or dies, although the operating agreement can be drafted to address this situation.
Some states do not allow certain professions to operate as an LLC, so be sure to check the law of your state.
A corporation is treated as a unique entity with limited liability and perpetual existence that is owned by shareholders.
Of note with regard to corporations:
- You must file paperwork with the state.
- You must prepare bylaws that govern the operation of the corporation.
- The corporation must observe certain corporate formalities.
A corporation is taxed when the corporation earns profits, and the dividends distributed to shareholders are also taxed. If the corporation meets certain requirements, it can elect to be treated as an "S Corporation" such that income and losses pass through to the shareholders.
Some states allow certain professionals to form a Professional Corporation, which allows for limited personal liability for the shareholders.
Keep in Mind...
The type of structure available to you will depend on the law of your state, and as used, must of course conform to any applicable rules of professional responsibility. It is therefore important to research your state law and governing ethical rules before making your final decision. You may also want to consult with an attorney and an accountant to fully understand all of the implications for your firm.