Celebrating 10 years! 2007-2017

new solo - best business entity?

So my friend is thinking of starting his own law firm dealin cheapbrass08/08/17
All these entities really do is protect you if someone happe saulgoodmanwannabe08/08/17
No entity will protect an attorney from claims for malpracti jeffm08/08/17
Jeffm is correct. The rules of professional responsibility a thirdtierlaw08/08/17
Yep. Some states also require that you use a PLLC (professio onehell08/08/17
Isn't the main reason for lawyers to form entities for tax p ipesq08/08/17
No. There are no tax benefits to forming an entity. jeffm08/08/17
At some point there can be a tax benefit. I'm thinking in pa onehell08/08/17
This is a matter that is not well-settled. Sure, Exxon can jeffm08/08/17
The IRS has taken the position that as long as the schmuck p onehell08/08/17
Yeah, "reasonable," means what? My guess is that whatever y jeffm08/08/17
Yes indeed. Potentially, it is more iffy with sole practitio onehell08/08/17
I think if you incorporate, you have to pay federal unemploy fettywap08/08/17
No. If you create anything, it would be an LLC or PLLC. Unle onehell08/08/17
I said unemployment tax. A sole proprietor is not required t fettywap08/08/17
The maximum amount of FUTA businesses pay in most states typ caj11108/08/17
Creating an entity costs $800 per year in California, plus y guyingorillasuit08/08/17
LLC isthisit08/08/17
sole proprietorship. get malpractice and business insurance blakesq08/09/17
Why are people saying an LLC protects you from slip and fall tacocheese08/09/17
cheapbrass (Aug 8, 2017 - 11:38 am)

So my friend is thinking of starting his own law firm dealing with mostly real estate closings. what is the best business entity for a solo with no staff? PC? LLC? S-corp? etc? Any opinions?

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saulgoodmanwannabe (Aug 8, 2017 - 12:32 pm)

All these entities really do is protect you if someone happens to slip on the floor at the law office or if you partner with someone and they screw up, you won't be personally liable. I'm in Ohio and registered an LLC for myself just to make it look more "official". Ohio is only $99 to register though and probably not worth it in other states where it can br as high as $1000.

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jeffm (Aug 8, 2017 - 12:04 pm)

No entity will protect an attorney from claims for malpractice. It is highly doubtful any lender will loan the entity money without a personal guaranty. An entity is likely not going to help much.

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thirdtierlaw (Aug 8, 2017 - 12:33 pm)

Jeffm is correct. The rules of professional responsibility and state statutes do not allow attorneys to shelter themselves from malpractice suits. An LLC will likely be the most flexible if he/she is ever thinking of adding a partner. The LLC will at least shield your friend if someone trips and falls going up the stairs to the office or another stupid incident occurs. An S-corp seems like a lot of hassle for no gain.

Though I'm not a transactional attorney and others may know more than I do.

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onehell (Aug 8, 2017 - 12:47 pm)

Yep. Some states also require that you use a PLLC (professional limited liability company) to note this distinction, which is exactly that: The professional is always personally liable for malpractice regardless of entity.

That said, there are some reasons to have an LLC/PLLC over a sole proprietorship, even though it is unlikely to provide liability protection (that being a malpractice policy is for).

The reason for this is that if you go sole proprietor, you're still probably going to want to get an EIN for identity theft prevention reasons (without an EIN you have to give your social security number to business clients who are going to 1099 you) and you may need to at least register a trade name/DBA so that you have something to show the banks so that they will open your trust and operating accounts in the name of your business. By the time you register a trade name and file online for an EIN, you've done about the same amount of work and paid similar fees as it takes to create a PLLC, so might as well just make a PLLC. You'll need it anyway if you ever do hire employees or take on a partner. Also, if you ever do reach the point in revenue where you could pay yourself a "reasonable salary" and treat the rest as a distribution, the PLLC can elect to be taxed as an S-corp and you can thus avoid self-employment tax.

And besides, who knows? With an entity you just might run into a stupid office landlord or something who is willing to contract with that entity and either forgets or doesn't think to get a personal guarantee. Stranger things have happened. I've seen it happen in small towns.

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ipesq (Aug 8, 2017 - 12:38 pm)

Isn't the main reason for lawyers to form entities for tax purposes?

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jeffm (Aug 8, 2017 - 12:44 pm)

No. There are no tax benefits to forming an entity.

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onehell (Aug 8, 2017 - 12:48 pm)

At some point there can be a tax benefit. I'm thinking in particular of S-corps and the way they can be used to avoid self-employment tax, though you have to reach a certain amount of revenue before that becomes worthwhile. (LLCs can elect to be taxed as S-corps if this point is reached).

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jeffm (Aug 8, 2017 - 12:59 pm)

This is a matter that is not well-settled. Sure, Exxon can pay dividends to its shareholders, but when you're just a working schmuck, there is probably a fair chance that if you are audited, the IRS will contend you are diverting ordinary income to dividends by artificially keeping your income low in order to accumulate profits for distribution. The IRS is powerful; I wouldn't risk it.

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onehell (Aug 8, 2017 - 1:01 pm)

The IRS has taken the position that as long as the schmuck pays himself a "reasonable salary" (to which payroll taxes apply) before taking the rest as distribution, the scheme is permissible.

I agree with you that it sounds kinda scammy, and certainly there's some vagueness to what a "reasonable salary" is, but once you reach a certain revenue point most CPAs will advise you to do it, in my experience.

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jeffm (Aug 8, 2017 - 1:05 pm)

Yeah, "reasonable," means what? My guess is that whatever you are capable of earning is reasonable. There is no capital involved; there is no subcontracting; there is basically nothing "entrepreneurial" about it other than having yourself work for as much as you can earn. It seems counter-intuitive to make a profit on yourself.

No doubt opinions will vary, and there are legitimate arguments on each side.

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onehell (Aug 8, 2017 - 1:07 pm)

Yes indeed. Potentially, it is more iffy with sole practitioner attorneys, because the ethical rules already require them to set reasonable fees that are always tied to the actual work they perform, so it's kinda weird to act like some of it is a passive distribution. After all, how could any income of a sole practitioner with no employees be passive income when every dime is generated from hourly billings for hours that you personally spent? But IRS doesn't appear to have singled out attorneys or other professionals, applying only this test of whether you paid yourself a reasonable salary before taking the rest as distributions.

Point being, I totally agree with you that it sounds and feels weird and that interpretations could change. But it does seem to be a pretty standard practice. And if you have partners or associates and are taking a piece of their billables, certainly that would be passive income.

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fettywap (Aug 8, 2017 - 1:25 pm)

I think if you incorporate, you have to pay federal unemployment tax on yourself. If you're a sole proprietor, you don't have to pay federal unemployment tax. Who wants to pay another tax?

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onehell (Aug 8, 2017 - 2:05 pm)

No. If you create anything, it would be an LLC or PLLC. Unless it elects otherwise, a single-member LLC or PLLC is taxed like a sole proprietorship, meaning it's treated the same as if it didn't exist. The income passes through to the LLCs sole member. You then deduct your business expenses on Schedule C and pay self-employment taxes (in addition to regular income taxes) on the net, which is the same thing you would do if there was no entity at all. Self-employment tax basically makes up for payroll taxes that would normally be paid by the employer if you had an employer, so it feels like there's a penalty for being self-employed, but it is what it is. (Incidentally, schedule C deductions are why a lot of small business owners lease their cars, though they can get in trouble for this if they deduct more of the lease payment than they can legitimately attribute to business-related use).

Like jeffm said, the general rule is that the entity simply doesn't have any tax implications. A single member LLC is, for all intents and purposes, disregarded by the IRS unless you elect otherwise.

Why might you elect otherwise? Well as described above, some LLCs do elect to be taxed as S corps, in which case they pay payroll taxes on a portion of the earnings (which must be a "reasonable salary") and take the rest as distributions (on which they pay neither self-employment nor payroll tax, but only ordinary income tax) but unless someone is using this tactic, there would be no reason for the entity to make any difference at all. And certainly, there would be no reason for anyone to incorporate as a C-corp because that would result in corporate income taxes which would mean double taxation. A law firm can't have non-attorney owners and therefore effectively can't raise capital by selling stock, which means there's no reason to "incorporate." The options are to either form a passthru entity or operate as a sole proprietor.

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fettywap (Aug 8, 2017 - 3:00 pm)

I said unemployment tax. A sole proprietor is not required to pay federal unemployment tax. FUTA is paid on IRS form 940.

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caj111 (Aug 8, 2017 - 3:48 pm)

The maximum amount of FUTA businesses pay in most states typically ends up being $42, or 0.6% of the first $7000 of salary, although it can end up being $ 420 in states without an unemployment tax (6% of $7000).

The amount saved by electing S-Corp status and paying oneself a "reasonable" salary can save you far more in Social Security and Medicare Taxes to well more than cover the extra $42 of FUTA you'd pay on the salary, than you'd have to pay if you continued to file as a sole proprietor, if your business is showing enough of a profit. Electing S-Corp status doesn't always make sense for a business, but the $42 of FUTA is not typically a dealbreaker in choosing to do so.

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guyingorillasuit (Aug 8, 2017 - 4:24 pm)

Creating an entity costs $800 per year in California, plus you need to pay your accountant to prepare another tax return, and they charge more for a business than for your personal return.

If and when you need to hire employees, you should form an entity.

The "reasonable salary" issue, as Jeff described upthread, remains murky in my eyes. What does that mean? Does the IRS have guidelines for a "reasonable salary" for, let's say, a solo construction lawyer 15 years out? Is $80k too little? Is $120k fair?

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isthisit (Aug 8, 2017 - 11:13 pm)

LLC

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blakesq (Aug 9, 2017 - 9:30 am)

sole proprietorship. get malpractice and business insurance (if someone slips and falls in your office, the business insurance will cover it). Once you start making real money ($100K+), then consider other business entities by talking it over with an accountant.

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tacocheese (Aug 9, 2017 - 9:43 am)

Why are people saying an LLC protects you from slip and fall? I guess if your employee causes the hazardous condition? Lawyer is still going to be on the hook for his own negligence, which will likely include premises liability, right? Regardless, you'll presumably have insurance for this.

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