For the newly minted solo practitioner or well-established small firm, whether to incorporate your law practice can be a difficult decision. I have laid out some of the pros and cons below, as well as provide an overview of the steps involved in becoming “Lawyer, Inc.”
The State of California does not allow lawyers to form limited liability companies (LLCs) for the purpose of practicing law. Most lawyers choose to form professional corporations.
-Limited Liability: Providing your law firm with corporate entity status can provide the individuals running the firm with added protection from lawsuits. The employees of the firm (essentially all the lawyers working for the corporation are employees as well as owners) are not personally liable for actions of the law corporation provided the corporation adheres to the rules and regulations for corporate status called the corporate formalities. (Generally speaking, co-mingling funds is the largest offense that allows a litigant to “pierce the corporate veil” and find shareholders liable.)
-Tax Consequences (positive): While not necessary, many law firms chose to incorporate as an S-corp. Electing S-corp status (it is a federal election; the state of California’s Franchise Tax Board will follow the feds unless the firm specifically notifies the FTB to opt out). S-corp status allows for “pass through” taxation to avoid the dreaded “double taxation” problem that may occur when a corporation is taxed at the corporate level and again when it pays out dividends to shareholders.
-Raising Capital: The corporate structure allows for excellent opportunities for a law firm to procure start-up funds. The corporation can sell stock to shareholders – friends, family, business associates – in order to raise capital for business expenses. Further, it may be easier for a law corporation to obtain loans than a sole proprietor or partnership.
-Paperwork Costs: Besides paying any attorney to set-up your corporation, filing fees with the Secretary of State of California are $100. Furthermore, the State Bar also charges a $200 registration fee for law corporations. (These figures may increase over time.)
-Tax Consequences (negative): After the first year, a law corporation is subject to an annual minimum tax of $800 – even if the corporation does not show a profit.
-Ongoing Compliance: While the requirements of board of directors meetings and maintaining corporate minutes are not overly burdensome, they do take time away from producing income or managing the business.
-Lawyer Restrictions: Just like for partnerships, lawyers are not allowed to incorporate with non-lawyers. This means that all of the shareholders of the corporation must be licensed attorneys.
Steps to Reach “Lawyer, Inc.”
Step 1: Picking a name. For some, this will be a very easy step and for others it will be very difficult. A name reservation may need to be made with the state, and checking to see if the proposed name is available may also be a good idea. The state requires that lawyers use “Inc.”, “APC”, or another similar type of ending in the law firm’s name in order to alert the public to its corporate status.
Step 2: Preparing and Filing Articles of Incorporation. This is a very simple, very important document filed with the Secretary of State. It gives the name of the corporation, the agent for service of process, the number of shares authorized, and a few other details. Only one class of stock may be authorized. Professional corporation must include language such as “This corporation is a professional corporation within the meaning of California Corporations Code Section 13400 et seq.”
Step 3. Setting up a Corporate Records book. Many companies sell pre-packaged “kits” that include a binder for storing important corporate documents like bylaws, meeting minutes, and additional stock certificates.
Step 4. Preparing the Bylaws. Bylaws are the rules that the corporation writes for itself. The state bar mandates certain clauses in the bylaws for law corporations regarding the sell and transfer of stock in the corporation. This is because non-lawyers cannot be owners of a corporation that practices law.
Step 5. Appointing Corporate Directors. Hopefully, the lawyers forming the corporation have given thought to who the directors of the corporation will be. For sole practitioners, only one person will act as the President, Treasurer, and Secretary. For a two man firm, the director duties may be split between the lawyers.
Step 6. The First Board Meeting. The minutes of the first board meeting are crucial. At this time, the directors will get together and appoint officers (CEO, CFO, etc), adopt the bylaws, authorize the sale of stock, and complete other administrative tasks.
Step 7. Filing Notice of Stock Transaction Form. A new corporation must file this notice within 15 days after the first sale of the securities. The fees for non-compliance can be significant.
Step 8. Issuing Stock. Generally speaking, stock can be exchanged for anything of value: money, equipment, land, etc. Stock certificates must be filled out, and a log of who owns how much stock must be keep. Attorneys cannot be partners with non-attorneys so a transfer restriction is needed on the stock certificates.
Step 9. Registering with the State Bar. Many states require registration with their state bar. In California, a certified copy of the Articles of Incorporation and copies of the bylaws must be filed along with an application from the State Bar in order to register. Registration must be completed annually, and late fees are substantial.
Step 10. Maintaining the Law Corporation. Regular meetings must be held, financial records must be kept, and on-going “maintenance” of the corporate entity is needed so that the owners can maintain the benefits and protections of the corporate structure.
Information found in this web site is for general informational purposes only and should not be construed as legal advice or legal opinion on specific facts or circumstances nor as a solicitation of legal business.