Lawyers have several options when choosing their new firm’s business structure and should explore the pros and cons of each type before selecting the one that suits their needs best.
Options when setting up a firm include practising as a sole practitioner, establishing an association by sharing costs and resources, creating a virtual law firm, partnering with one or more other lawyers with the option of creating a limited liability practice, or even employing a combination of these structures.
All of these options have their own advantages: A sole proprietorship gives a lawyer complete control over the practice and all of its income and assets. A general partnership allows for a profit-sharing arrangement, in which each partner is jointly liable for the firm’s debts and obligations. An LLP provides the same tax benefits as a general partnership but limits the partners’ individual liability. An association between lawyers provides the opportunity to work together without a partnership agreement, offering services to a larger number of clients while sharing expenses.
Ottawa lawyer Valentin Erikson says he looked very carefully at how best to structure his sole practice before he hung out his shingle in 2016. He concluded that a professional corporation was the best approach for him, largely for tax-planning purposes – including the ability to retain earnings within the professional corporation.
“If you’re considering growing your practice with an intention to eventually sell it, this could be a very good tax-planning strategy,” says Erikson, owner and leading lawyer of Erikson Law Firm Professional Corporation, whose practice focuses on real estate, tax and family law. He adds that the income tax rate for Ontario lawyers is more than 46 per cent, but incorporating a professional corporation can lead to a lower corporate tax rate of only 16 per cent.
For Erikson, other income tax benefits of using a professional corporation include deferring income tax, lowering personal income taxes by income splitting, sale of shares tax-free, and the ability to access tax-effective strategies that are only available to corporations.
Setting up a law practice as a professional corporation is “a slam dunk, absolutely the way to go,” advises chartered professional accountant and tax lawyer David Rotfleisch in Toronto. “Incorporate from the get-go.” Rotfleisch, the founding lawyer of Taxpage, says that one of the most important reasons is that “you have the ability to set up an individual pension plan and contribute far more to the pension plan than you would through an RRSP.”
Since individually employed lawyers don’t have pension plans, they have to think about retirement from the start, Rotfleisch says. “If you incorporate, an individual pension plan provides you with far more contribution room than an RRSP does.” You won’t necessarily have money to put into an individual pension plan when you’re just starting to practise law. But if, “10 years after you’ve incorporated, you’re suddenly doing well and you have money available, you’ve got 10 years’ worth of accumulated pension room that you can now contribute in a large lump sum, which will go a long way to kick-starting your retirement funding.”
According to Rotfleisch, the only downside to incorporating a firm to be cost, including annual maintenance and registering with the Law Society. “It costs a few thousand dollars a year to maintain a corporation,” he says. There’s an increased cost in administration because corporate tax returns also have to be filed. “Whatever stays in the corporation in the way of profits gets taxed at a lower rate and the corporation pays those taxes. So you have two sets of tax returns—the corporate T2 and the personal T1.”
When it comes to those who are already practising in a small or solo firm and want to change to a professional corporation, Rotfleisch says it’s not difficult, although “it does require some tax hoops—you have to do a tax-free rollover to get from the existing structure into the corporation.” But doing so is simply a matter of paperwork and spending some money. “If you’re currently carrying on as a proprietorship or partnership, there’s absolutely no reason not to incorporate, to transfer the business into a corporation.”
Whichever law firm structure you end up choosing, contact your Law Society for up-to-date information on provincial laws and regulations. For example, in Ontario, lawyers must incorporate under the province’s Business Corporations Act and apply to the Law Society for a certificate of authorization.
Rotfleisch advises lawyers to get a good accountant when setting up a firm. “There are so many problems caused by inadequate accounting, either from not having an accountant from the start or from having a bad accountant. Make sure you get a CPA who knows what they’re dealing with, who knows how to deal with lawyers, knows about your filings.” Having seen clients who have had various problems over the years with CRA, including accounts seized, he urges lawyers to stay on top of their filings. “Have a separate credit card for your business expenses. Incorporated or unincorporated, don’t comingle your credit cards. It makes your accounting much easier.”
Open a separate law firm bank account and be on top of your trust accounting, as mandated by the Law Society, says Rotfleisch. “It may be formidable to people who don’t know accounting so get your bookkeeper or accountant from the get-go, make sure that your trust accounts are properly set up, properly maintained. Be scrupulous in making sure trust funds go into trust.”
Despite choosing to incorporate his own law firm, Erikson doesn’t believe that those who are not incorporated are at a disadvantage and he advises other lawyers to choose the best structure for them. “Evaluate yourself, develop a business plan, make sure your finances are in order, network, then decide what structure best suits your law firm.” Then follow through with the plan you put in place. “Don’t be afraid to take risks,” he adds. “Be brave, go for it and everything will be fine.”
Ann Macaulay is a frequent contributor to PracticeLink.