Law firms, like any business, can generally choose what type of business entity to operate as, and one of the common choices is a limited liability company (LLC). LLCs offer several benefits that make it popular among entrepreneurs of all kinds.
Here, we’ll discuss those benefits, as well as some special considerations for law firms.
Benefits of an LLC
Personal liability protection
Arguably, the most important benefit of an LLC is the personal liability protection that it offers to its owners, called members. An LLC is a separate and distinct entity from its owners, which means that it has its own assets and debts. It is solely responsible for its own obligations, and members are not personally liable for those obligations.
The personal liability protection does, however, have a few exceptions. If members personally guarantee a business loan for the LLC, they are personally liable for that loan.
Additionally, if a member commits fraud or acts recklessly in the operation of the business, they can be held liable for any damages that occur due to those actions.
LLCs also have the distinction of being able to elect how they will be taxed. By default, if an LLC has only one member, it is considered a disregarded entity by the IRS. The LLC is not taxed, and profits pass through to the sole member to be taxed at their personal tax rate.
If the LLC has more than one member, it is considered a general partnership by the IRS. The LLC is still not taxed, and profits pass through to members, but it does have to file Form 1065, the U.S. Return of Partnership Income. The form, however, is for informational purposes only.
But in both of those scenarios, members must pay self-employment taxes on all profits.
Instead, the LLC can elect S-Corp status, which can provide some self-employment tax savings. An S-Corp still offers pass through taxation but becomes subject to corporate rules. Managing members must be paid a reasonable salary as defined by the IRS before taking any additional distributions from the profits of the LLC. However, those after-salary distributions are NOT subject to self-employment taxes.
While it seems like a no brainer to elect S-Corp status because of those savings, S-Corp requirements mean additional administrative expenses. For S-Corp status to be financially beneficial, the self-employment tax savings must exceed the additional admin expenses, which generally occurs when the LLC reaches a certain level of profit.
The tax status decision is best made with the help of a tax advisor.
LLCs that have not elected S-Corp status can essentially be managed any way they choose. This differs from a corporation or S-Corp, which come with many management requirements. They must elect a board of directors, which must meet regularly, usually annually. A corporation must also appoint officers to manage the corporation and who will be overseen by the board of directors.
LLCs have no such requirements.
In some states, law firms must form a professional limited liability company (PLLC) instead of an LLC.
A PLLC is just like an LLC in most ways. It offers personal liability protection for its owners and pass through taxation.
A PLLC, however, is for businesses that require professional licensing, such as a law firm. To form a PLLC for a law firm, you must have approval of certain state authorities and have the proper state licensing to practice law.
The other key difference between an LLC and a PLLC is that the personal liability protection offered does not apply to claims of malpractice by a member. That member is still personally liable for such claims, although the other members are not.
How to Form an LLC
To form your LLC you have to follow a few steps.
Select a Registered Agent
In all states, an LLC must appoint a registered agent, which is a person or company authorized to accept official correspondence on behalf of the LLC. A member of the LLC can be the registered agent, but that person will then be required to be personally available at their registered address during business hours.
You can instead choose to use a registered agent service, which generally costs between $100 and $300 annually. The service will notify you of the correspondence and make it available to you by email or on an online dashboard.
Submit Documents to the Secretary of State
Then you’ll simply need to file a document with the Secretary of State, which is usually called the articles of organization. This filing comes with a fee that varies by state. For example, to register an LLC in North Carolina, the fee is $125.
If you’re forming a PLLC, you’ll have to follow your state’s procedures to get approval from the proper state authorities. For example, in North Carolina, before you form your PLLC with the state, you must submit an application for a certificate of registration for a PLLC to the North Carolina State Bar.
Create an Operating Agreement
An operating agreement is not required in most states, but it’s very important to draft this document. It will specify the ownership percentages of the law firm, the management structure, how profits are allocated and distributed, voting rights of members, and how disputes are resolved.
As an attorney, you know that without such an agreement, state laws surrounding LLCs will apply, and such laws do not cover every potential situation. This could mean messy legal trouble if members of the LLC are ever in a dispute.
An LLC is a great option for law firms, offering personal liability protection, and tax and management flexibility. Whether you form an LLC or a PLLC, be sure to follow all the steps so that you can get your law firm up and running without delays or issues.