For attorneys setting up a practice, one of the first and most critical decisions to make is selecting the right legal entity. This decision will not only affect the firm's liability and operational flexibility but also its tax obligations and potential benefits. In this article, we delve deep into the world of PLLCs, PCs, and LLPs, highlighting their respective tax advantages and challenges.
1. Professional Limited Liability Company (PLLC)
Pass-Through Taxation: Like traditional LLCs, PLLCs often benefit from pass-through taxation. Instead of the company paying federal income taxes, profits and losses are reported on the owners' personal tax returns, potentially preventing double taxation.
Flexible Profit Distribution: PLLCs allow for flexibility in profit distribution. Owners can allocate profits and losses disproportionately among members, which can be tax-efficient in certain scenarios.
Self-Employment Taxes: Members of a PLLC may be liable for self-employment taxes on their share of the business's profits, which can be higher than traditional employment taxes.
2. Professional Corporation (PC)
Salary Deductions: Owners or shareholders of a PC can be treated as employees. As a result, their salaries and benefits can be deducted as business expenses, potentially lowering the corporation's taxable income.
Retained Earnings: PCs have the flexibility to retain earnings (to a certain limit) which can be beneficial for tax planning.
Double Taxation: One of the most significant potential pitfalls of a PC is the possibility of double taxation. The corporation pays taxes on its profits, and then shareholders pay taxes again on dividends.
Complexity: PCs often have more complex tax filing requirements and regulatory compliance, which can increase administrative costs.
3. Limited Liability Partnership (LLP)
Pass-Through Taxation: Like PLLCs, LLPs typically benefit from pass-through taxation, where business profits and losses pass through to the individual partners' tax returns.
Limited Liability: While this is more of a legal benefit than a tax one, partners in an LLP typically aren't personally liable for the actions of other partners. This can indirectly have financial and tax implications.
Self-Employment Taxes: Similar to PLLCs, partners in an LLP might be subject to self-employment taxes, which can be higher than the regular employment tax rate.
State Variations: Tax treatments and benefits of LLPs can vary significantly from one state to another, necessitating a close review of state-specific regulations.
The decision to select a PLLC, PC, or LLP isn't solely based on tax implications. Operational needs, liability concerns, and future growth plans should also influence the choice. However, understanding the tax landscape of each entity can significantly aid attorneys in making informed and financially savvy decisions.
As always, it's advisable for attorneys to consult with tax professionals and legal consultants familiar with their state's regulations and their specific circumstances to ensure optimal entity selection.