Texas Law Firm Business Entity Formation – Limited Liability Partnership
Limited Liability Partnerships
In this week’s blog, we look at limited liability partnerships.
The IRS defines a partnership as, “the relationship between two or more people to do trade or business. Each person contributes money, property, labor or skill, and shares in the profits and losses of the business.” This is a broad definition for a general partnership. In this article, we want to pinpoint what is necessary for attorneys who wish to join in a partnership and do business in Texas.
Some of the advantages of going into business with other attorneys include sharing in expenses, possible cross-referrals for business outside of your area of expertise and having others around you to “brainstorm” on cases. But, most importantly, partnerships generate more money than solo practices. How much more? It can amount to a great deal more.
Texas law firms who are general or limited partnerships are not required to form a limited liability partnership (LLP), but Michael Navarro of Shackelford, Bowen, McKinley & Norton often sees and forms LLPs for his law firm clients.
A limited liability partnership is not separate and apart from its underlying partnership; it is a registration made by a pre-existing limited partnership. Unlike the limited partnership, a LLP provides liability protection to its partners for the obligations of the partnership and its liabilities to the partners or third parties, which is a considerable advantage over a limited partnership.
To become a limited liability partnership, pursuant to the Texas Business Organizations Code, an already formed general or limited partnership may register by filing a certification of formation with the Secretary of State.
In this form of entity, there are two types of partners: general and limited. Limited partners are considered passive and are not active in the business of the partnership. General partners, however, are active in partnership management. There must be at least one general and one limited partner in an LLP.
For tax purposes, let us first discuss IRS obligations under a partnership. A partnership will need to file for its own tax ID number, or EIN. Annually, partnerships file form 1065, US Return of Partnership Income. This form is informational only. The partnership does not pay tax on its income, but “passes through” profits and/or losses to the partners. A partnership is allowed to deduct certain business expenses. These are discussed in IRS Publication 535. LLPs are subject to a state franchise tax.
General partners are not employees of the partnership and do not receive wages. Additionally, because they are not employees, the partnership does not pay payroll taxes on the partners’ income. Partnerships pay distributions to the partners via withdrawals, or as a distribution of earnings. Partners report their K-1 partnership income on their individual Form 1040, using Schedule E. General partners are also required to pay self-employment taxes on their share of the partnership profits. This is reported on Schedule SE when the partner files a personal Form 1040.
A Partnership Agreement is paramount with this entity. The Partnership Agreement shall outline partnership levels, allocations, management, annual distributions, as well as other necessary requirements including management of exiting partners and any other miscellaneous items.
In addition to liability, malpractice, and unemployment insurance, partners must provide insurance for errors and omissions.
Under certain circumstances, partners of a general partnership may make the decision to convert to an LLC. When this happens, the partnership does not terminate and may continue to use the partnership’s Tax ID.
Something to note regarding the benefits of an LLP is every state in the United States recognizes LLPs. This is not the case for PLLCs which will be discussed in our next blog. Also, many older, more prestigious law firms are LLPs. While this might not be an integral part of consideration between LLP and PLLC, in the legal community, there is a sense of prestige with an LLP.
If you have any further questions about this form of business entity, please contact Michael Navarro, Shackelford, Bowen, McKinley & Norton at MNavarro@Shackelford.law.
For tax questions regarding this form of business entity, please contact Matt Pittsford: MPittsford@PittsfordSamuels.com.
Sources:
Daily, Frederick W. Tax Savvy for Small Business. Nolo, 2019.
Davis, Hal. How To Start A Solo Law Practice. Hal Davis, 2005
Eagan, Lauren A. How To Start A Law Firm When You’re Broke. American Bar Association, 2020
Foonberg, Jay G. How to Start and Build a Law Practice. ABA Law Practice Management Section, 2016
Huss, William W. Start Your Own Law Practice: a Guide to All the Things They Don’t Teach in Law School about Starting Your Own Firm. Sphinx(r) Pub., 2005.
Internal Revenue Service. Tax Information for Partnerships. https://www.irs.gov/businesses/partnerships
Internal Revenue Service Publication 535. https://www.irs.gov/pub/irs-pdf/p535.pdf
Internal Revenue Service Publication 541. https://www.irs.gov/publications/p541
Secretary of State Form 701 – General Information for Registration of a Limited Liability Partnership: https://www.sos.state.tx.us/corp/forms/701_boc.pdf
State of Texas. Texas Business Organizations Code, Title 7: Chapter 301. Provisions Relating to Professional Entities:
State of Texas. Texas Business Organizations Code: Title 4: Chapter 153 – Limited Partnerships:
Texas Secretary of State. Formation of Texas Entities. https://www.sos.state.tx.us/corp/formationfaqs.shtml
Texas Secretary of State Texas Limited Liability Partnership: https://texassecretaryofstate.com/texas-limited-liability-partnership/
The American Bar Association Legal Guide for Small Business: Everything You Need to Know about Small Business, from Start-up to Employment Laws to Financing and Selling. American Bar Association, 2010.
U.S. Small Business Administration: Business Structures – Limited Liability: https://www.sba.gov/offices/district/nd/fargo/resources/business-structures-limited-liability
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