HANG YOUR OWN SHINGLE FORMS OF PRACTICE/CHOICE OF ENTITY ALPHABET SOUP PLLC, LLP, S CORP, PS, BS!#? Presenter: Jeff Liang Ling & Liang PLLC http://ling-liang.com January 29, 2:30 pm to 3:30 pm Seattle University School of Law Sullivan Hall Room C-5 NOTICE: All materials in this presentation and provided to you are informational. Any answers to questions will not be considered legal advice or guarantee compliance with Washington Rules of Professional Conduct. Available at: http://bit.ly/1me8kw6 1
Four Fundamental Needs: Risk Taker/Entrepreneurial Practice Law Generate business Manage a law practice BIG PICTURE What are your concerns when you are deciding on the type of entity? OVERVIEW 2
What are your concerns when you are deciding on the type of entity? Differences between the entities Liability protection Malpractice issues Taxes Professional appearance Partnership agreement OVERVIEW Give you a Checklist! Identify issues you should consider before forming a law firm. Have an idea of the type of entity you should select. Tax issues to consider. A to-do list of how to form your firm. Congrats! You have an entity now what? GOALS FOR TODAY 3
Carol Rick Maggie and Glenn MEET OUR VOLUNTEERS CAROL Carol has been licensed for a year. She has two children and has been working as a contract attorney. She also got another job as a contracts manager to provide more stable pay and benefits. Carol is coming to crossroads. Does she continue working as a contract attorney, go full time as a contracts manager, or or hang her own shingle? 4
Rick just graduated from law school and passed the bar. While in law school, he worked for Herschel, a solo practitioner where he focused on criminal, family, and estate planning matters. Rick wants to start his own low bono firm and Herschel has offered to give some work to Rick. RICK Maggie and Glenn met during law school and both are committed to offering low bono services. Maggie wants to focus on small businesses, estate planning, and family law. Glenn wants to focus on criminal law. MAGGIE AND GLENN 5
What are the benefits and costs to forming an entity to practice law? Benefits Costs/Concerns BENEFITS AND COSTS What are the benefits and costs to forming an entity to practice law? Benefits Costs/Concerns Protect personal assets (not against malpractice) Professional appearance/separate Establish brand Formalize a partnership (Maggie and Glenn) Costs (hire accountant?, formation costs) Maintain entity Takes time away from practicing law Anything else? BENEFITS AND COSTS 6
What type of entity do they use? Sole Proprietorship (no entity) General Partnership/Limited Liability Partnership (GP/LLP) Chapter 25.05 RCW BIG LAW! Professional Service Corporation (PC)- Chapter 18.100 RCW Professional Limited Liability Company (PLLC) RCW 25.15.045, 25.15.046, 25.15.048 Not covering B Corp or Social Purpose Corp. ENTITY TYPES SOLE PROPRIETORSHIP (NO ENTITY) 7
SOLE PROPRIETORSHIP (NO ENTITY) Services SOLE PROPRIETORSHIP (NO ENTITY) 8
Services $ $ SOLE PROPRIETORSHIP (NO ENTITY) Services $ $ Sole Proprietorship SOLE PROPRIETORSHIP (NO ENTITY) 9
Services $ $ Sole Proprietorship (but may form GP, LLP, PS, PLLC) SOLE PROPRIETORSHIP (NO ENTITY) What is it? One individual or a married couple in business alone. Benefits? Easy to manage with fewer legal controls. Sole Proprietorship How easy is to form? Easy. You don t have to do anything. But get a tradename (DBA). Concerns? No liability protection. Taxes: No separate tax return File on your IRS Form 1040 (Schedule C) Subject to selfemployment tax SOLE PROPRIETORSHIP (NO ENTITY) 10
Capital Contribution Low Bono Law (GP, LLP) PARTNERSHIP (GP OR LLP BIG LAW) Capital Contribution Low Bono Law (GP, LLP) Services PARTNERSHIP (GP OR LLP BIG LAW) 11
Capital Contribution Low Bono Law (GP, LLP) $ Services PARTNERSHIP (GP OR LLP BIG LAW) Distributions Capital Contribution Low Bono Law (GP, LLP) $ Services PARTNERSHIP (GP OR LLP BIG LAW) 12
Distributions Capital Contribution Low Bono Law (GP, LLP) GP, LLP $ Services GP, LLP PARTNERSHIP (GP OR LLP BIG LAW) Distributions Capital Contribution Low Bono Law (GP, LLP) GP, LLP $ Services GP, LLP PARTNERSHIP (GP OR LLP BIG LAW) 13
What is it? Composed of 2 or more persons Benefits? *Flexible allocation/distribution *Each partner manages General Partnership How easy is to form? *No filing requirement *Partnership Agreement (recommended) Concerns? *Each partner liable *Strict tax requirements Taxes: GP not subject to tax but must file IRS Form 1065 and Schedule K-1 Subject to selfemployment tax PARTNERSHIP (GP OR LLP BIG LAW) What is it? Composed of 2 or more persons. No GP. Benefits? *Flexible allocation/distribution *Liability protection from other partners LLP How easy is to form? *Filing with state *Partnership Agreement (recommended) Concerns? *Strict tax requirements *Can t make S Corporation Election Taxes: LLP not subject to tax but must file IRS Form 1065 and Schedule K-1 Subject to selfemployment tax Use a PLLC! PARTNERSHIP (GP OR LLP BIG LAW) 14
PROFESSIONAL SERVICE CORPORATION (PS) Low Bono Advocate, PS Capital Contribution Affordable Law, PS Low Bono Law, PS PROFESSIONAL SERVICE CORPORATION (PS) 15
Low Bono Advocate, PS Capital Contribution Affordable Law, PS Services Low Bono Law, PS PROFESSIONAL SERVICE CORPORATION (PS) Low Bono Advocate, PS Fees (taxed unless S Corporation Election) Capital Contribution Affordable Law, PS Services Low Bono Law, PS PROFESSIONAL SERVICE CORPORATION (PS) 16
Low Bono Advocate, PS Dividends (taxed) Affordable Law, PS Fees (taxed unless S Corporation Election) Capital Contribution Services Low Bono Law, PS PROFESSIONAL SERVICE CORPORATION (PS) What is it? *Separate legal entity *SHs must be licensed *Officers except Sec. and Treas. licensed Benefits? *Liability protection *Investment vehicle PS How easy is to form? *Filing with state *Bylaws, board meetings, etc. Concerns? *Strict rules to maintain liability protection *Governance! Taxes: Double taxation (unless S Corporation election) Separate tax return (IRS Form 1120) PROFESSIONAL SERVICE CORPORATION (PS) 17
Shareholders Licensed Board Members Licensed Officers (President, Vice-President, Secretary, and Treasurer) Licensed (except Sec. and Treas.) PROFESSIONAL SERVICE CORPORATION (PS) PROFESSIONAL LIMITED LIABILITY COMPANY(PLLC) 18
Low Bono Advocate, PLLC Capital Contribution Affordable Law, PLLC Low Bono Law, PLLC PROFESSIONAL LIMITED LIABILITY COMPANY(PLLC) Low Bono Advocate, PLLC Capital Contribution Affordable Law, PLLC Low Bono Law, PLLC PROFESSIONAL LIMITED LIABILITY COMPANY(PLLC) 19
Low Bono Advocate, PLLC Capital Contribution Affordable Law, PLLC Services Low Bono Law, PLLC PROFESSIONAL LIMITED LIABILITY COMPANY(PLLC) Low Bono Advocate, PLLC Fees (NO entity taxation) Capital Contribution Affordable Law, PLLC Services Low Bono Law, PLLC PROFESSIONAL LIMITED LIABILITY COMPANY(PLLC) 20
Low Bono Advocate, PLLC Distributions (taxed) Fees (NO entity taxation) Capital Contribution Affordable Law, PLLC Services Low Bono Law, PLLC PROFESSIONAL LIMITED LIABILITY COMPANY(PLLC) What is it? How easy is to form? *Separate legal entity *Filing with state that has owners called members. *Bylaws, board *Member-Managed or meetings, etc. Manager-Managed PLLC Benefits? *Liability protection *Flexible management *Easy to add/remove members Concerns? *Tax reporting *Self-employment tax Taxes: PLLC not subject to tax but must file IRS Form 1065 and Schedule K-1 Subject to selfemployment tax However, can make election to be taxed as an S Corporation PROFESSIONAL LIMITED LIABILITY COMPANY(PLLC) 21
PS - Governance PROFESSIONAL LIMITED LIABILITY COMPANY(PLLC) PS - Governance PROFESSIONAL LIMITED LIABILITY COMPANY(PLLC) 22
PS - Governance Member-Managed or Manager-Managed Licensed PROFESSIONAL LIMITED LIABILITY COMPANY(PLLC) Profit and loss taxed to Carol and Rick individually (IRS Form 1040 Schedule C) Must document expenses for tax purposes Example: Carol buys a laptop. She splits the use between work and personal use. Can she deduct the laptop as a business expense? Same result if they each formed a PLLC with only one member TAXES - SOLE PROPRIETORSHIP 23
Low Bono Law, PLLC TAXES GP, LLP, OR PLLC Partnership is not subject to federal tax Must file information return (IRS Form 1065) Must issue Schedule K-1 to partners to report share of profit and loss Must file and pay state and local taxes Partnership is a Pass through entity means all profit and loss pass through to partners Each partner reports his share of income Pay self-employment tax (15.3%) Low Bono Law, PLLC TAXES GP, LLP, OR PLLC Partnership is not subject to federal tax Must file information return (IRS Form 1065) Must issue Schedule K-1 to partners to report share of profit and loss Must file and pay state and local taxes 24
Low Bono Advocate, PS Low Bono Advocate, PS subject to tax (max rate 28% to 39.6%) Must file tax return (IRS Form 1120) Must file and pay state taxes TAXES PS Rick, as shareholder, is subject to a second tax on dividends (i.e., distributions from Low Bono Advocate, PS) Tax on dividends is 15% Double taxation! Low Bono Advocate, PS Low Bono Advocate, PS subject to tax (max rate 28% to 39.6%) Must file tax return (IRS Form 1120) Must file and pay state taxes Note: Same result if Carol or Maggie/Glenn formed a PS TAXES PS 25
How do we get out of the double taxation of a PS or the self-employment tax of a PLLC? TAX ISSUES S CORPORATION ELECTION What is it? *A tax election and not an actual corporate entity. *PLLC or PS can make election *Profit paid as W-2 wages and as a dividend (no self-employment tax) Benefits? *Pass through treatment *No Self-Employment Tax S Corp How do you elect? *IRS Form 2553 (fax it in) *Due < 2 months and 15 days after tax year (i.e., 2/15) or during preceding tax year (late election also possible) Concerns? *Will need to establish payroll *May need accounting support to determine reasonable compensation S CORPORATION ELECTION 26
Low Bono Advocate, PS or PLLC TAXES S CORPORATION Entity not subject to tax Entity must file information return (IRS Form 1120-S) Limits: i) < 100 SHs/Owners; ii) All must be U.S. citizens or green card holders; and iii) same ownership rights (not equal owners but same voting rights) Low Bono Advocate, PS or PLLC TAXES S CORPORATION Paid a reasonable wage which is subject to lower employment tax (W-2 wages 12.3%) Receives a dividend of pro rata share of profits (which is not subject to selfemployment tax). Entity not subject to tax Entity must file information return (IRS Form 1120-S) Limits: i) < 100 SHs/Owners; ii) All must be U.S. citizens or green card holders; and iii) same ownership rights (not equal owners but same voting rights) 27
Low Bono Advocate, PLLC Net Profit $60,000 Self-Employment Tax (15.3%) $9,180 Without S Corporation Election TAXES S CORPORATION With S Corporation Election Net profit $60,000 60% Treated as Reasonable $36,000 subject to W-2 tax of 12.4% Compensation 40% Treated as a Dividend $24,000 (no self-employment tax) Employment Tax (12.4%) $4,464 The table is a simplified example of how an S Corporation Election works. Check with your accountant to address reasonable compensation issues and compliance. PROTECT THE LIABILITY SHIELD 28
Lawsuit someone slips and falls at your office Banks or business debts Other creditors business utilities, phone, etc. PROTECT THE LIABILITY SHIELD Lawsuit someone slips and falls at your office Banks or business debts Other creditors business utilities, phone, etc. PROTECT THE LIABILITY SHIELD 29
PROTECT THE LIABILITY SHIELD Lawsuit someone slips and falls at your office Banks or business debts Other creditors business utilities, phone, etc. Employment Taxes, Malpractice Claims, and Sales Taxes PROTECT THE LIABILITY SHIELD Lawsuit someone slips and falls at your office Banks or business debts Other creditors business utilities, phone, etc. Employment Taxes, Malpractice Claims, and Sales Taxes 30
What will weaken the shield? PROTECT THE LIABILITY SHIELD What will weaken the shield? No separate bank account PROTECT THE LIABILITY SHIELD 31
What will weaken the shield? No separate bank account Consistent use of business funds for personal use PROTECT THE LIABILITY SHIELD What will weaken the shield? No separate bank account Consistent use of business funds for personal use Signing contracts or leases in your individual name PROTECT THE LIABILITY SHIELD 32
What will weaken the shield? No separate bank account Consistent use of business funds for personal use Signing contracts or leases in your individual name Leaving the business with no assets PROTECT THE LIABILITY SHIELD PROTECT THE LIABILITY SHIELD What will weaken the shield? No separate bank account Consistent use of business funds for personal use Signing contracts or leases in your individual name Leaving the business with no assets Failing to observe formalities (meetings, board) esp. for PS. 33
Sole Proprietorship and General Partnership No filing required EIN State Business License (DBA) City Business License Bank Account General Partnership Partnership Agreement (recommended) Establishes rules and terms between the partners Decision making Distribution of profits and loss Leaving the partnership Adding new partners States required tax language CHECKLIST Limited Liability Partnership State Filing EIN State Business License (DBA) City Business License Bank Account Partnership Agreement (recommended) Establishes rules and terms between the partners Decision making Distribution of profits and loss Leaving the partnership Adding new partners States required tax language CHECKLIST 34
Professional Limited Liability Company State Filing EIN State Business License (DBA) City Business License Bank Account S Corp Election? Operating Agreement (recommended) Establishes rules and terms between the members Decision making and management Distribution of profits and loss Leaving the LLC Adding new members States required tax language CHECKLIST Professional Service Corporation State Filing (Articles) EIN State Business License City Business License Bank Account S Corp Election? Bylaws SH Consent Board Consent Subscription Agreement Buy Sell Agreement CHECKLIST 35
1) What entity or entities would you advise Rick, Carol, and Maggie/Glenn to use for their law firms? 2) Should an S Corporation Election be made? CLOSING Jeff Liang (jeff@ling-liang.com) Ling & Liang, PLLC 671 S. Jackson St. Suite 201 Seattle, WA 98104 (206) 462-2884 36