Choosing the Correct Entity for Your Practice and the Impact on Personal Liability
by Jonathan A. Karp
(County Bar Update, September 1999, Vol. 19, No. 8)

 

Choosing the Correct Entity for Your Practice and the Impact on Personal Liability

By Jonathan A. Karp, treasurer, Law Office Management Section. Karp is a partner with Reish & Luftman. The opinions expressed are his own.

There are several different types of entities in which lawyers can conduct their practice. Sole practitioners can either operate as a "sole proprietorship" or a professional corporation. Lawyers who have "partners" can operate as a general partnership, a limited liability partnership or a professional corporation.

None of these entities or structures will allow attorneys to escape liability for their own wrongdoing. However, professional corporations and limited liability partnerships will generally permit an attorney to avoid being liable for the wrongful acts, including "malpractice" claims and tort liabilities, of other "partners", and in certain cases employees.

The first question is whether the attorney is the only "owner" of the practice or whether there are partners or co-owners. Certain types of entities are not available to sole practitioners, such as general partnerships or limited liability partnerships.

As a sole practitioner, income and expenses are reported on Schedule C attached to the individual's personal income tax return, and the individual pays tax (income and self-employment tax) on the net income. The individual remains liable for all the debts and obligations of the practice.

General partnerships and limited liability partnerships require that there be more than one owner of the practice. In the case of a general partnership, all of the partners are fully liable for all obligations of the entity, including those founded in tort or contract. In a limited liability partnership, owners are liable only for their own wrongful acts and not liable for the LLP's contractual obligations or wrongful acts of others (unless they have personally guaranteed the contractual obligation or were involved in supervising and directing such individuals in the act that gave rise to tort claim). The liability rules for the shareholder of a professional corporation are generally the same as for LLPs.

General partnerships, limited liability partnerships and corporations must all file their own tax returns, but the income of the general partnership and limited liability partnership passes through to the owners in their respective ownership percentage shares, or as otherwise agreed by the partners. Unless the corporation elects to be treated as a "S Corporation" (in which case the income passes through to the owners in the ratio of their stock ownership), the corporation pays taxes on its net income. Professional corporations are taxed at a flat rate of 35 percent for federal income tax purposes, which leads to year-end tax planning designed to "zero out" the corporations income. This can be difficult since certain expenses paid by the corporation, such as 50 percent of entertainment expenses and the purchase price of more expensive assets (which must be depreciated over a period of years), are not deductible for income tax purposes.

All entities must generally file their income taxes on a calendar year basis. LLPs and corporations are generally subject to a minimum annual tax payable to California of $800. The other entities are not subject to this minimum tax.

Sole proprietorships, partnerships, LLPs and S corporations are not able to deduct medical insurance premiums paid for by the entity for the benefit of the owners, and there are certain restrictions on qualified retirement plans that can be adopted by these entities.

The issues in choosing what type of entity in which to practice are more complex than many attorneys believe, and it is recommended that each attorney considering what form of entity to utilize should consult with both their accountant and an attorney versed in business and corporate law.

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