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How Does The Legal Structure Of Your Business Affect Tax Filing?

How does the legal structure of your business affect tax filing?

Deciding to flex your entrepreneurial muscles and start your own law firm is an exciting step in your legal career. Running your own firm means that you’re doing a lot more than practicing law. You’re also running a business. You’ll have to make big decisions about things like your location, your brand, your area of focus, and of course, how you plan to legally structure your practice for tax filing purposes. In order to help you make the right decision for your small or solo law firm, let’s explore some of your choices.

Sole Proprietorship

A sole proprietorship is a popular choice for many solo law firms. In this business structure, you’re the sole owner and operator of your practice. This also means you’re the one liable for your business’ obligations, such as any debts or losses incurred while you’re in business. You’ll be required to obtain the appropriate licenses and permits, but you won’t have to file any forms with the state. The income from your sole proprietorship will be reported on your personal income tax return.

Advantages of a sole proprietorship include:

  • Low tax rates
  • Inexpensive and easy to get up and running
  • Taxes are simplified
  • You’re in control

Disadvantages of a sole proprietorship include:

  • You’re personally responsible for any legal trouble you might encounter
  • You pay self-employment taxes
  • Raising capital can be difficult

Partnership

If you’re hoping to start a firm with another lawyer or business associate, then a partnership might be the right path for you. A partnership has two or more people who split the business responsibilities. In this structure, partners basically share everything equally, including profits, liability, and management. Partnerships file tax returns on the income of their business, and they also file taxes personally on their portion of the income or any losses. If you’re not too keen on sharing liability, you can see if a limited liability partnership is available in your state.

Advantages of a partnership include:

  • Inexpensive and easy to get up and running
  • Room for growth
  • Incentives for incoming employees to reach partnership level

Disadvantages of a partnership include:

  • Personally liable for the acts of others
  • Lack of control over business decisions
  • Potential for conflicts between partners

Limited Liability Company (LLC)

A limited liability company (LLC) is often seen as a blend of a corporation, a partnership, and a sole proprietorship. That means that you can still structure your business as an LLC if you’re running a solo law firm. Structuring your law firm as an LLC protects you personally from any losses or wrongful acts made by the company. The LLC itself doesn’t pay taxes — the owners of the LLC claim profits and losses on their personal taxes. LLC’s must file organization papers with the state and create an agreement on how the business will operate as well as the rights and responsibilities of the members and managers.

Advantages of a limited liability company include:

  • Members and managers have more protection
  • Any surplus earnings are not taxed
  • Not many restrictions on profit sharing

Disadvantages of a limited liability company include:

  • If a member decides to leave, the LLC is at risk of dissolving in some states
  • May be subject to self-employment tax
  • Some states put restrictions on certain professions operating as an LLC

Corporations

Corporations are single legal entities with limited liability and are typically owned by a group of people. A corporation has to deal with more red tape and formalities than other business structures. For instance, all paperwork must be filed with the state and you must create bylaws that will dictate the way a corporation will operate. You also have to create a board, have board meetings, and issue funds to the corporation’s stock. Corporations can be filed as a C Corp, which are separate legal entities owned by shareholders. They can also be filed as an S Corp, which allows profits and losses to be passed through personal tax returns and requires shareholders to pay taxes on distributed dividends.

Advantages of corporations include:

  • No personal liability
  • Easy to raise funds
  • Tax-deductions

Disadvantages of corporations include:

  • Lack of control, since the corporation is run by a board
  • Double-taxation
  • Complicated to get up and running

Now that you know a little bit more about the different legal structures of businesses, which one is right for you?

For more information about how to structure your new small or solo law firm, contact the tax pros at JETRO today!

For more details on this along with additional training and tax strategies to ensure you are paying the least amount in taxes as legally possible, check out our Tax Minimization Program!

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.

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