There are definite tax advantages to setting up a law corporation, especially if you’re a sole practitioner.
Lawyers first setting up their practice are often faced with a barrage of questions, from what kind of law to practise, to where they want to set up an office, and in some provinces whether they want to incorporate.
For more than a decade, Alberta and British Columbia have been national leaders in the corporate structure for law offices. According to statistics kept by the Federation of Law Societies, the two western provinces favoured the corporate model for law offices vastly more than any other provincial counterpart. In the federation's December 2006 numbers, B.C. had 2,532 law corporations. Alberta came in second that year in the corporate model with 2,101 corporations. In the same year Ontario, Canada’s most populous province — in terms of both people and lawyers — had only 262 professional corporations, although that number had gone up dramatically by this year when the province showed 1,480 registered professional corporations.
In simple terms, law or professional corporations are set up with the lawyer creating a company using his or her own name. Lawyer Jane Smith would become Jane Smith Law Corp., and she would be the director of the corporation. While professional liability would remain the same, incorporating can offer significant tax benefits.
Victoria, B.C., lawyer Michael Butterfield went the law corporation route after spending a year as a sole practitioner. The University of Victoria Law School graduate and seven-year call, says he wishes he had set up Butterfield Law Corp. in his first year of practice. The key for him was mapping out long-term goals, and knowing what kind of law he wanted to practise first. “I’d run a number of successful businesses,” says Butterfield. “But it’s pointless to go into the time and expense of [incorporating] unless you are going to remain as either a sole proprietor or as a member of the private bar. It’s pointless to fork over the $2,000 or $3,000 dollars to set one up and then go and work for the government. You have to know what your intention is.”
If you have decided on creating a law corporation then Butterfield suggests getting a tax accountant familiar with them. It’s always helpful in setting up your practice to have someone who can really show you the different and significant tax advantages of incorporating.
One such advantage could be whether you use your car for work, going to clients’ houses, or going back and forth between your office and court. Some would think that simply leasing the vehicle through the company and then using that vehicle may be the best way to realize a tax saving. However, the downside is that the car would be considered a taxable benefit, and you would eventually have to pay for it. Perhaps having the corporation pay your mileage for a vehicle you already own, then claiming the vehicle’s usage on your taxes may be a better way to go about it. Hard to know the answers if you’re not an expert. “This is why you need to get a good tax accountant, is to plan these things,” says Butterfield.
The other issue facing lawyers who consider setting up their practice using the corporate model, is how to set up the corporation itself? Butterfield again advises getting professional help before you head down that road. He says a call from the law society questioning the way your practice is put together is a lot easier to take when you can pass the message on. “Do not do the incorporation yourself, have someone else do it. That way if there is a screw up you have someone else to blame,” Butterfield jokes. “The reality is it is a complex procedure and if you are not familiar with corporate law, the part governing law corporations, you can screw it up . . . and the $2,000 [to pay someone to set up the corporation] is tax deductible.”
For associates who have joined a firm, especially in B.C., they may have noticed partners with the distinction of law corporations. One such firm is the Vancouver office of Fasken Martineau DuMoulin LLP, which allows for both individual lawyers and the law corporations to be partners.
“Before Fasken Martineau turned into [a limited liability partnership] we still allowed partners to incorporate, I was a partner and now my law corporation is a partner,” says lawyer Frank Schober. The University of British Columbia Law School graduate was called to the B.C. bar in 1988. As a member of the firm’s corporate and commercial group, Schober focuses exclusively on tax planning and tax motivated commercial transactions. He agrees the main advantage for looking at the professional or corporate model is “primarily people do this for tax reasons.”
In a law firm partnership, corporations would be treated just like any other individual member of the partnership. The proceeds of the firm are divided equally among its partners. In the case of a law corporation as a partner, the equal share would be given to that corporation. The corporation would then provide wages to its employees, the first of which is the lawyer who set up the law corporation. The rest of the share of the proceeds of the partnership would go to any employees of the corporation. Whatever is left over could be used to build the company.
The key to the whole set-up is the tax benefits. “You only pay yourself enough of a salary that you need, you will pay tax on the salary that you paid yourself, the rest of the income will remain in the company,” says Schober. “The salary that you’ve paid yourself represents a deductible expense to the company, the company will have net income over and above all its expenses, what it earned, what it paid out in salaries, and other expenses including the salary it paid out to you. It will then pay tax at a rate, but that tax may be lower than what you would have paid, the advantage is the company can pay tax at a lower rate and then leave it in the company to be re-invested.”
One of the further tax advantages is “income splitting.” This allows the corporation to employ, for example, a spouse to do legitimate work such as research or administrative duties. The spouse can be paid a salary, and then pay the applicable tax on that salary.
Additionally in B.C., the LLP itself can be incorporated with the law corporation partners being part of the larger corporation. “A law partnership can convert into a structure where it is carrying on business as a corporation — its practice can be carried on as a corporate entity,” says Schober. “Most haven’t done that, most have been satisfied with the limited liability partnership structure, where the partners are individuals if they don’t care about the tax benefits or they are law corporations.”
Schober concludes that many associates are employees of a firm or corporation, and it really makes no difference to them, as they cannot realize a tax advantage one way or the other.
David Bilinsky is the practice management adviser for the Law Society of British Columbia. In working with young lawyers, he says the most important thing is to think about the kind of law you want to practise. While he looks at law corporations as giving potential tax savings to lawyers, he warns that creating a practice may be the most important thing. “Mostly what I do is talk to them about their business, what kind of law they want to practise, what kind of work.”
Getting into an office-sharing agreement where there are other, often more experienced lawyers, around to bounce questions off of and rely on others expertise may be the better route to go. “Proprietorship is fine starting out,” says Bilinsky. “Then they can look at getting into a corporation.”