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Legal update: 47% of all law firms are now incorporated businesses – up from 32% five years ago

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9 September 2019
•      Law firms moving away from traditional partnerships 
•      Sole practitioners and traditional partnerships fall 22% and 35% respectively
•      Reduced personal liability and tax benefits encouraging firms to convert

47% (4,890) of all 10,400 law firms in the UK are now incorporated businesses, up from 32% just five years ago*, as traditional partnerships increasingly choose to incorporate.

The increase in the proportion of law firms that are incorporated appears to be driven by sole practitioner law firms and traditional partnerships (as opposed to LLPs) changing their structure – the number of these structures have fallen by 22% and 35% respectively over the last five years.

There are two major advantages that incorporating a firm can bring compared to operating as a sole practitioner or partnership. In an incorporated business, partners’ personal exposure can be limited if a firm fails. With corporation tax rates still low, and set to reduce further, incorporation can be tax-efficient in certain situations.

Andy Harris, Partner, says: “Over the past five years there has been a huge shift in how law firms are structured. Some would say the ‘traditional’ partnership structure is fast becoming out of date.”

Reduced personal exposure if a firm fails

In a traditional partnership, or for a sole practitioner, partners have unlimited personal liability. If a firm fails, the partners themselves stand to lose everything, including their personal assets and family home.

In an incorporated company, the owners’ exposure is typically limited to the value of their investment, and therefore personal assets are protected.  This also applies to members of an LLP.

Potential tax savings for incorporated companies

Partners in a traditional partnership and sole practitioners are charged income tax (currently 20% at its lowest rate, rising to 45% at the additional rate) on all of their profits from the business, regardless of whether they are actually paid to them.

An incorporated company may be more tax efficient, despite the introduction of increased tax rates on dividends from April 2016. After taking into account corporation tax on the company’s profits, shareholders can take money out of the business as dividends that are subject to lower rates of income tax (currently 7.5% at its lowest rate, rising to 38.1% at its highest rate).

Says Andy Harris: “On top of limiting risk and potentially lowering the firm’s tax burden, there is also the thought that incorporating can free up time for fee earners by creating management boards.”

“However, incorporating a firm is not always the perfect solution, despite the clear upsides it can offer. Any structural change should not be motivated by tax alone, as there are plenty of administrative costs, such as company valuations, and other factors to consider.”

The number of incorporated law firms has risen by 43% over the last five years

 

 

*Analysis of SRA regulated population statistics