Choosing the right business structure is a crucial decision for solo attorneys in California. The choice of business entity determines tax consequences in how the legal practice is taxed, the extent of personal liability protection and personal asset protection available to the attorney, and the administrative requirements the attorney will need to manage in operating the legal practice.

A future article titled “What are the Business Structure Options for Two or More Attorneys in California?” will discuss the additional options available when two or more attorneys start practicing law together, however, for attorneys practicing law solo in California, the options are limited to sole proprietorships and California Professional Law Corporations.

This article provides an overview of the various business structure options available to attorneys in solo practice in California, helping these attorneys to make an informed choice that aligns with their professional goals and liability concerns in the most tax efficient format possible.

Executive Summary: Putting the Conclusion First for Busy Attorneys

Summary of Practicing Law as a Sole Proprietor

The primary benefit of a sole proprietorship for attorneys is its simplicity. There are few legal formalities to establish a sole proprietorship and tax reporting is equally straightforward. However, a sole proprietorship is not a separate legal entity, which means that attorney sole proprietors are personally liable for all debts, liabilities, obligations, and legal judgments (including liability for malpractice claims) against their legal practice. The lack of a separate legal entity also means there is no distinction between personal and professional business assets for attorney sole proprietors, so the debts, liabilities, and legal judgments for which the attorney sole proprietor is liable are satisfied from the personal assets of the attorney.

Summary of Practicing Law with a California Professional Law Corporation

While inherently more complex than attorney sole proprietorships, the complexity of a California Professional Law Corporation may be reduced by working with the experienced corporate attorneys at San Diego Corporate Law. As a separate legal entity, California Professional Law Corporations significantly reduce liability risks and are more tax efficient for most attorneys. For attorneys in high-liability practices, this reduction in risk can be substantial. The separate legal entity status of California Professional Law Corporations also means there is a distinction between personal and professional business assets for the attorney, meaning the debts, liabilities, and legal judgments against the legal practice are not generally satisfied from the personal assets of the attorney.

Choosing Between a Sole Proprietorship and a California Professional Law Corporation

For most attorneys, the California Professional Law Corporation is the right chose because the tax benefits coupled with limited liability protection and ability to separate personal assets from professional business assets far outweighs the increased administrative complexity compared to practicing law as a sole proprietorship.

Contact San Diego Corporate Law for Assistance Selecting and Forming the Best Business Structure for Your Law Practice

Take the next step toward securing the ideal business structure for your legal practice, whether that is a California Professional Law Corporation or another business structure. Contact the experienced corporate attorneys at San Diego Corporate Law today to schedule a consultation and receive personalized, expert guidance tailored to your needs. Our team is here to help you make informed decisions with confidence.

Practicing Law as a Sole Proprietor

Practicing law as a sole proprietor is the simplest and most straightforward business structure for solo law practice in California. It requires minimal paperwork to set up compared to other business entity options and offers flexibility in managing the legal practice. However, along with these advantages come distinct disadvantages that attorneys must consider carefully before considering sole proprietorship as the business structure for their legal practice.

Administrative Requirements of Practicing Law as a Sole Proprietor

One of the primary benefits of a sole proprietorship for practicing law is the simplicity of establishing a sole proprietorship and the continued simplicity of operating as a sole proprietor.

Sole proprietorships require minimal effort to establish, with few legal formalities involved. Typically, the initial steps of setting up a sole proprietorship include obtaining a local business license or business tax certificate to operate legally in the municipal jurisdiction in which the practice will operate and, if applicable, registering a fictitious business name (often referred to as a d/b/a).

Unlike other business structures, there is no need to file complex paperwork or create a formal business entity, which saves both time and money, but as discussed below, there are tradeoffs in exchange for this simplicity.

Taxation of Attorney Sole Proprietors

Tax considerations are a critical aspect to be examined when planning to practice law as a sole proprietor. Sole proprietors are subject to business income taxation, self-employment taxation, and additional Medicare taxes. Understanding how these taxes apply to legal practices is essential for attorneys when choosing a business structure in which to operate their legal practice.

Business Income Taxation When Practicing Law as a Sole Proprietor

For attorney sole proprietors, business income taxation is both simple and straightforward compared to that of other business entities. Sole proprietors report their business income and expenses on Schedule C (Profit or Loss from Business) to their personal income tax return, using Internal Revenue Service Form 1040. This allows attorneys to consolidate both personal and business income on a single tax form.

Self-Employment Tax When Practicing Law as a Sole Proprietor

While simple and straightforward, taxation of attorney sole proprietors is not tax efficient. One significant consideration for attorney sole proprietors is self-employment tax. Since a sole proprietor does not receive a salary from their business, they are responsible for paying self-employment taxes to cover Social Security and Medicare contributions. This self-employment tax is reported on Schedule SE, with the current rate at the time of this writing totaling 15.3% of net profit in addition to federal and state income taxes (however, a sole proprietor can deduct half of the self-employment tax paid as an adjustment on their tax return, which provides some financial relief).

Additional Medicare Tax When Practicing Law as a Sole Proprietor

High-earning attorney sole proprietors may also be subject to the Additional Medicare Tax. This tax applies to individuals whose income exceeds certain thresholds, which are determined based on filing status. For attorney sole proprietors filing as single, the threshold is $200,000, while it is $250,000 for attorney sole proprietors filing a joint tax return with a spouse. The Additional Medicare Tax rate is 0.9% and applies only to the earnings above the specified threshold. Sole proprietors must calculate and report this tax on Form 8959, ensuring compliance with Internal Revenue Service requirements. It is important for high-earning attorneys to account for this additional tax in their financial planning to avoid unexpected liabilities.

Conclusions About Taxation of Attorney Sole Proprietors

Understanding the tax implications of a sole proprietorship is integral when deciding which of the available business entities will be the most tax efficient, and understanding self-employment and the Additional Medicare Tax liabilities is the first step in planning and efficiently managing future tax liabilities.

Personal Liability Protection and Personal Asset Protection When Practicing Law as a Sole Proprietor

Practicing law as a sole proprietor, while simple, also comes with challenges regarding personal liability protection and asset protection because a sole proprietorship is not a separate legal entity, and thus does not offer a legal distinction between the attorney and the legal practice.

Personal Liability for Attorneys When Practicing Law as a Sole Proprietor

One of the primary risks faced by attorney sole proprietors is personal liability. The lack of distinction between the attorney and the legal practice means that the attorney sole proprietor is personally liable for all debts, liabilities, obligations, and legal judgments incurred by the legal practice personally, including claims for professional negligence, better known as malpractice, for errors and omissions.

Personal Asset Protection for Attorneys When Practicing Law as Sole Proprietors

The lack of distinction between the attorney and the legal practice that makes personal liability a primary risk to attorney sole proprietors also means that all assets of the attorney, be they strictly personal assets or assets used in the legal practice, are subject to claims by creditors and legal claimants against the personal assets of the attorney (such as homes, bank accounts, investments, and other property).

Conclusions About Personal Liability and Asset Protection for Attorney Sole Proprietors

The exposure to personal liability for debts, liabilities, obligations, and legal judgments (including those for professional negligence) coupled with the inability to separate personal assets from professional business assets underscores the importance for attorneys choosing a business structure for their legal practice to understand liability risks and take proactive measures to safeguard their personal wealth and future earnings from such claims.

Conclusions About Practicing Law as a Sole Proprietor

When deciding whether to practice law as a sole proprietor, it is essential to weigh the benefits and drawbacks of this business structure. While attorney sole proprietorships offer simplicity to attorneys, attorney sole proprietorships come with significant risks and limitations. The advantages and disadvantages of practicing law as a sole proprietor are compared below together with a recommendation for when a sole proprietorship is the best legal structure for practicing law.

Advantages of Sole Proprietorship for Attorneys

The primary benefit of a sole proprietorship for practicing law is its simplicity. There are few legal formalities to establish a sole proprietorship and tax reporting is equally straightforward.

Disadvantages of Sole Proprietorship for Attorneys

While sole proprietorships are simple to establish, they carry significant risks and are not tax efficient for most attorneys.

A sole proprietorship is not a separate legal entity, which means that attorney sole proprietors are personally liable for all debts, liabilities, obligations, and legal judgments (including malpractice liability). For attorneys in high-liability legal practices, this risk can be substantial.

The lack of a separate legal entity also means there is no distinction between personal and professional business assets for attorney sole proprietors, meaning the debts, liabilities, and legal judgments for which the attorney sole proprietor is liable are satisfied from the personal assets of the attorney.

When is a Sole Proprietorship the Right Business Structure for Practicing Law?

A sole proprietorship can be an ideal option for attorneys starting small-scale legal practices with the expectation of low net profit and low liability risks. However, before choosing to practice law as a sole proprietor, it is essential to weigh the benefits of simplicity against the risks of personal liability and the future growth of the legal practice. For attorneys in high-risk legal practice areas or those who anticipate growth in their legal practice may want to avoid practicing law as a sole proprietorship in favor of a business entity that is more tax efficient and provides limited liability protection together with the separation of personal assets from professional business assets.

For a more detailed understanding of the differences between professional sole proprietorships and California Professional Law Corporations and when a sole proprietorship is the best choice of business structure for legal practices, see “When Not to Use a California Professional Law Corporation” for more information.

Practicing Law with a California Professional Law Corporation

Practicing law with a California Professional Law Corporation is not as simple or straightforward as practicing law as a sole proprietor, however, a California Professional Law Corporation provides the tax efficiency, limited liability protection, and separation of personal assets of the attorney from the professional business assets of the legal practice that attorney sole proprietorships lack.

Administrative Requirements of Practicing Law with a California Professional Law Corporation

In order to enjoy the tax efficiency, limited liability protection, and separation of personal assets a California Professional Law Corporation provides, attorneys are faced with the complexity of establishing a California Professional Law Corporation. While this formation process is complex, attorneys may rely upon the experienced corporate attorneys at San Diego Corporate Law to draft and file all the required legal documents for the California Professional Law Corporation, leaving attorneys with essentially the same tasks they would undertake to establish a sole proprietorship. It is also worth noting that legal fees and costs of forming a California Professional Law Corporation are usually qualified business expenses that are tax deductible.

In addition to the initial formation of a California Professional Law Corporation, every year after the initial formation of a California Professional Law Corporation a Statement of Information must be filed with the California Secretary of State and a shareholder and board of directors meeting must be held. Just as with the formation of a California Professional Law Corporation, San Diego Corporate Law can assist in the annual requirements of practicing law with a California Professional Law Corporation.

Despite the additional administrative requirements of practicing law with a California Professional Law Corporation compared to practicing law as a sole proprietorship, an experienced corporate attorney can make the difference in requirements comparable.

For a more detailed understanding of the administrative requirements for forming and maintaining a California Corporation, see “The 7 Steps for Forming a California Professional Law Corporation” for more information.

Taxation of California Professional Law Corporations

As with attorney sole proprietorships, tax considerations are a critical aspect to be examined when planning to practice law with a California Professional Law Corporation. While attorneys practicing law with a California Professional Law Corporation are subject to business income taxation, payroll taxes for wages, and franchise taxes paid to the California Franchise Tax Board, attorneys practicing law with a California Professional Law Corporation are not subject to self-employment taxation or additional Medicare taxes. Understanding how these taxes apply to legal practices is essential for attorneys choosing a business structure in which to operate their legal practices.

Business Income Taxation When Practicing Law with a California Professional Law Corporation

A California Professional Law Corporation is by default taxed as a personal service corporation (sometimes referred to as a professional service corporation), which is essentially a C Corporation (commonly referred to as a C-Corp) wherein corporate taxes applied to corporate profits are taxed directly at the federal and state levels at the corporate income tax rate, and any distributed dividends are subject to taxation again against the individuals receiving the dividends (referred to as “double taxation”). However, a California Professional Law Corporation may (and almost always should) elect to be treated as an S Corporation (commonly referred to as an S-Corp), which fundamentally changes how income is taxed. This article will focus on S Corporation taxation of California Professional Law Corporations.

Electing S Corporation status alters the tax treatment by enabling pass-through taxation. This means the profits and losses of the California Professional Law Corporation after payment of a reasonable salary to the attorney are passed directly to the attorney as the shareholder who in turn reports those profits on their personal income tax returns to pay federal income tax and state income tax on the net profit of the California Professional Law Corporation to pay personal income tax of the net profits of the legal practice.

For more information about the election of S Corporation status for a California Professional Law Corporation, see “Can a California Professional Law Corporation Be an S-Corp?” for more information.

Self-Employment Tax When Practicing Law with a California Professional Law Corporation

Unlike attorney sole proprietorships, which require the attorney sole proprietor to pay self-employment tax on the entire net profit of the professional practice, the attorney-shareholder of a California Professional Law Corporation is not subject to self-employment taxes.

Instead of self-employment taxes on the entire net profit of the legal practice, with a California Professional Law Corporation employee and employer contributions to payroll tax are only paid on the reasonable salary of the attorney. While the sum of the employee and employer contributions total 15.3% (the same percentage as self-employment tax), the calculation of the tax is based upon the reasonable salary of the attorney only and not the net profit of the California Professional Law Corporation, which may result in significant annual tax savings compared to a sole proprietorship.

Additional Medicare Tax When Practicing Law with a California Professional Law Corporation

As discussed above for attorney sole proprietorships, the Additional Medicare Tax is an extra 0.9% tax applied to earned income exceeding certain thresholds. However, because the Additional Medicare Tax is only applied to earned income and the net profit of a California Professional Law Corporation is not deemed to be “earned” income, the Additional Medicare Tax would only be applicable to attorneys practicing law with a California Professional Law Corporation if the reasonable salary of the attorney exceeded the thresholds, meaning for all intents and purposes, practicing law with a California Professional Law Corporation does not subject attorneys to the Additional Medicare Tax.

Annual Franchise Tax for California Professional Law Corporations

California Professional Law Corporations must pay an annual franchise tax that attorney sole proprietorships do not pay. The franchise tax paid by a California Professional Law Corporation taxed as an S Corporation is 1.5% of net profit with a minimum of $800 annually. While this is a tax not paid by attorney sole proprietorships, the annual franchise tax is very small in comparison to self-employment taxes and the Additional Medicare Taxes paid by attorney sole proprietors.

Conclusions About Taxation of California Professional Law Corporations

Understanding the tax benefits of a California Professional Law Corporation is integral when deciding which of the available business entities will be the most tax efficient, and understanding self-employment and the Additional Medicare Tax liabilities is the first step in planning and efficiently managing future tax liabilities.

For a more detailed understanding of the taxation of California Professional Law Corporations, see “What Tax Benefits Does a California Professional Law Corporation Provide?” for more information.

Personal Liability Protection and Personal Asset Protection When Practicing Law with a California Professional Law Corporation

Practicing law with a California Professional Law Corporation, while more complex than practicing law as a sole proprietorship, overcomes many of the personal liability protection and asset protection shortcomings of attorney sole proprietorships. A California Professional Law Corporation is a separate legal entity distinct from the attorney, thus offering a legal distinction between the attorney and the legal practice as well as personal and business assets of the attorney.

Personal Liability Protection for Attorneys When Practicing Law with a California Professional Law Corporation

Practicing law with a California Professional Law Corporation resolves most of the risks faced by attorney sole proprietors for personal liability. California Professional Law Corporations provide a separate legal entity distinct from the attorney, meaning the attorney is generally not personally liable for the debts, liabilities, obligations, and legal judgments incurred by the legal practice.

Under California law, claims for professional negligence, better known as malpractice, for errors and omissions of attorneys are personal to the attorneys and not shielded by the existence of the California Professional Law Corporation, however, malpractice insurance claims are an insurable risk and appropriately apportioned professional liability insurance may be used to indemnify the attorney from this risk.

Personal Asset Protection for Attorneys When Practicing Law with a California Professional Law Corporation

The separate legal entity and distinction between the attorney and the legal practice provided by a California Professional Law Corporation means that, unlike a sole proprietorship, the California Professional Law Corporation separates the personal assets of the attorney from professional business assets of the legal practice. Therefore, claims by creditors and legal claimants against the California Professional Law Corporation are generally limited to the professional business assets of the California Professional Law Corporation and are not satisfied against the personal assets (such as homes, bank accounts, investments, and other property) of the attorney.

Conclusions About Personal Liability and Asset Protection When Practicing Law with a California Professional Law Corporation

The limitation of personal liability for debts, liabilities, obligations, and legal judgments against the California Professional Law Corporation coupled with the ability to separate personal assets from professional business assets makes the use of a California Professional Law Corporation the choice for attorneys who wish to limit their personal liability and protect their personal wealth and future earnings from most claims arising out of their legal practice.

For a more detailed understanding of the liability protection and asset protection of California Professional Law Corporations, see “What Liability Protection Does a California Professional Law Corporation Provide?” for more information.

Conclusions About Practicing Law with a California Professional Law Corporation

When deciding if practicing law as a California Professional Law Corporation is worth the additional cost and administrative requirements, it is essential to weigh the benefits and drawbacks of this business structure. While California Professional Law Corporations are more complex, California Professional Law Corporations resolve many of the significant risks and limitations inherent to practicing law as a sole proprietorship. The advantages and disadvantages of operating with a California Professional Law Corporation are compared below together with a recommendation for when a California Professional Law Corporation is the best legal structure for practicing law.

Advantages of California Professional Law Corporations

While practicing law as a sole proprietorship is simple to establish, doing so carries significant risks and is not tax efficient for most law. California Professional Law Corporations significantly reduce liability risks and are more tax efficient for most law.

A California Professional Law Corporation is a separate legal entity, which means the attorney is generally shielded from personally liable for debts, liabilities, obligations, and legal judgments (other than the insurable risk of malpractice liability). For attorneys in high-liability legal practices, this reduction in risk can be substantial.

The separate legal entity status also means there is a distinction between personal and professional business assets for attorneys, meaning the debts, liabilities, and legal judgments against their legal practice are not generally satisfied from the personal assets of the attorney.

Disadvantages of California Professional Law Corporations

The primary benefit of a sole proprietorship is its simplicity, and in turn the primary disadvantage of a California Professional Law Corporation is the relative complexity of formation and operation. However, attorneys may rely upon the experienced corporate attorneys at San Diego Corporate Law to draft and file all the required legal documents for establishing and maintaining the California Professional Law Corporation, leaving these attorneys with essentially the same tasks they would undertake to establish and maintain a sole proprietorship.

When is a California Professional Law Corporation the Right Business Structure for Practicing Law?

A California Professional Law Corporation can be an ideal option for attorneys starting legal practices based upon the tax efficiency, limited liability protection, and separation of personal assets from professional business assets that California Professional Law Corporations provide. Small-scale legal practices with the expectation of revenue growth can benefit from starting as a California Professional Law Corporation to avoid the future need to reestablish the legal practice as revenue grows. Similarly, small-scale legal practices in high-risk practice areas may benefit from the limited liability protection and separation of personal assets from professional business assets provided by a California Professional Law Corporation regardless of revenue or profitability.

For a more detailed understanding of the differences between attorney sole proprietorships and California Professional Law Corporations, and when a California Professional Corporation is the best choice of business structure for a professional practice, see “When to Use a California Professional Law Corporation” and “Sole Proprietorship vs Professional Law Corporation in California” for more information.

Attorneys in California May Not Practice Law as a Limited Liability Company (LLC) or Professional Limited Liability Company (PLLC)

A The experienced corporate attorneys at San Diego Corporate Law are frequently asked about limited liability companies and professional limited liability companies, so this topic will be briefly discussed here.

California law explicitly prohibits attorneys from operating their law firm as Limited Liability Companies (LLCs) or Professional Limited Liability Companies (PLLCs). This prohibition may be found in California Corporations Code Section 17701.04(e), which reads:

“Nothing in this title shall be construed to permit a domestic or foreign limited liability company to render professional services, as defined in subdivision (a) of Section 13401 and in Section 13401.3, in this state.”

Instead, California requires attorneys who wish to operate in corporate form to utilize other types of business entities, such as California Professional Law Corporations.

For a more detailed understanding of the prohibition on the use of LLCs for legal practices in California, see “Can an Attorney Practice Law Using a California LLC?” and “Can I Use a PLLC to Practice Law in California?” and for more information.

If an LLC or PLLC is currently being used for a legal practice in California, see “10 Steps to Convert LLC to Professional Law Corporation in California” and “Four Reasons Not to Convert LLC to Professional Law Corporation in California” or “12 Steps to Convert a PLLC to a California Professional Law Corporation” and “Four Reasons Not to Convert Foreign LLC or PLLC to a California Professional Law Corporation” for more information about bringing the professional practice into compliance with California law.