What are the benefits of an incorporated legal practice?

Whether you’re a new lawyer who wants to establish a brand-new firm or a group of colleagues who want to formalize their operations, there are several options to choose from.

A good starting point is knowing what the benefits of incorporated legal practice are, along with the other possible business structures. We’ll discuss that and more in this article.

What is an incorporated legal practice?

Under the law, incorporating a legal practice may mean incorporation as a professional corporation (PC). This PC is treated as with any other corporation — there are shareholders who are separate from the corporation. These shareholders are also same lawyers forming the PC, and from among them would also be the chosen directors.

The benefits of incorporated legal practice were made possible in Canada when the provincial Business Corporations Act was amended. Starting in 2001, many of these provinces changed their incorporation laws to include professionals. These laws also provide the necessary steps when incorporating one’s professional practice, and the other qualifications for such incorporation.

Here’s a video that discusses what a corporation is in relation to the benefits of incorporated legal practice:

These benefits must also be read together with the Canadian laws regulating the legal profession. For more resources on the laws and rules governing lawyers, check out our Professional Regulation page.

What are the benefits of incorporated legal practice?

There are several benefits of incorporated legal practice, making it one of the most popular choices for lawyers and firms when organizing themselves. Although the term incorporating may refer to an incorporated PC, it can also refer to incorporated partnerships whenever it has been registered or formalized, such as LLPs. But when discussing the benefits of incorporated legal practice below, we mostly refer to PCs.

1. Deferral of income tax

One of the main benefits of incorporated legal practice is the deferral of income taxes. This is especially helpful for firms that are just starting out, or those whose operations are relatively smaller compared to the others. According to Canadian taxation laws, PCs can enjoy two tax benefits, among others:

Small-Business Deduction (SBD)

Because of the SBD, a PC can reduce its corporate income tax that it needs to pay in a tax year, if a specified amount of income is retained in the PC. The SBD is calculated by multiplying the PC's small business income for the tax year by the current SBD rate.

The SBD is not an exempting tax system, only a tax deferral. It means that the retained corporate surplus will have to be withdrawn from the corporation (e.g., future salary or dividend) and will be taxed at personal income tax rates.

Since the deferral could be for years, this tax benefit is helpful to defer income taxes and build wealth. This works not just for the firm, but also for the incorporating lawyer/s. 

Lifetime Capital Gains Exemption (LCGE)

A specified amount of capital gains tax can be offset under the LCGE when:

• the PC qualifies for this exemption
• the shares are sold, or the PC’s owner dies

In 2023, this amount was increased to $971,190.

2. Individual Pension Plans (IPPs)

Another benefit of incorporated legal practice is that lawyers can create an individual pension plan (or IPP). An IPP is a registered defined-benefit pension plan funded by the corporate assets, with the goal of providing income post-career.

In a lawyer’s mid-40s, IPP contribution rates are higher than registered retirement savings plan (RRSP) contribution rates. This makes it a popular alternative to RRSP, ensuring the retirement benefits of the lawyer in an incorporated business.

It also carries with it the benefit of allowing additional one-time contributions to an incorporated lawyer’s retirement plan. This is also higher compared to maximum RRSP contributions. In addition, IPPs are creditor-proof. In other words, creditors may not reach out to one’s IPP, since these are protected funds.

Business owners! Could an Individual Pension Plan help you save more for retirement?@TD_Canada's Pierre Letourneau explains: https://t.co/EiheH86tTs pic.twitter.com/OAiwKF7TTc

— MoneyTalk (@MoneyTalkGO) October 26, 2023

3. Health and Welfare Plans (HWPs)

A health and welfare plan (HWP) is a corporate arrangement through which an employer can provide employees reimbursements for medical and/or dental expenses. Also called a health and welfare trust (HWT), the coverage includes the incorporated lawyer and the health and welfare benefits not commonly covered by provincial or group insurance plans, such as:

• an insurance policy for sickness and/or accident
• a health services plan

As this is a tax-free benefit, HWP or HWT makes medical and dental expenses tax-deductible. This means that contributions to the HWP or HWT are a tax deduction for the corporation.

4. Attractive to clients with complex issues

Compared to solo practitioners or smaller firms, an incorporated legal practice has other advantages when it comes to attracting clients. If the corporation wants to, additional employees can be hired, who can then help in client intake and other processes with the court. This will also justify the corporation charging higher fees, because of the competent and swift legal services that it can now provide.

Find out how an award-winning lawyer left Deloitte LLP to start his own corporation.

Are there disadvantages in incorporating a legal practice?

As with any other business structure, an incorporated legal practice has both its benefits and disadvantages. Some of these disadvantages are the following:

Increased costs and administration

Because the PC is a separate entity from its lawyer-shareholder, it’s required to complete its own tax returns. This would result in additional accounting fees; not to mention that the same would happen when it sets up an IPP.

Inability to split income with family members

Lawyers are different from the other professionals forming a PC, since lawyers cannot pay immediate family members dividends from their own corporation. Law societies in most provinces restrict share ownership in the corporation to members of the same profession.

Beneficiary family members must be lawyers themselves to receive dividends paid from the legal corporation. This is a significant disadvantage to the owner of an incorporated legal firm, as paying dividends to family members results in an immediate pure tax saving, rather than just a deferral.

What are the different options for a law firm’s organizational structure?

To appreciate the benefits of incorporated legal practice, it helps to look at other organizational structures that lawyers and firms can choose from. In Canada, aside from the provincial Business Corporations Acts, the allowed structures are governed by:

• laws on corporations and partnerships
• rules and by-laws of the various law societies
• provincial laws about the law societies

These laws also cover:

• the steps on how to create an entity depending on the business structure
• the requirements, both documents and as for the incorporators
• the benefits and limitations of each structure

Because lawyers are regulated professionals in Canada, as elsewhere, these options available to lawyers and firms may be limited by law or by the law societies’ rules. Nevertheless, practice and history show us that these options, while restricted in some ways, have been effective when pursuing legal practice.

Sole proprietorships

One structure for solo practitioners is to organize their firm separately through sole proprietorship. In this structure, a solo practitioner both owns and operates the firm singly, under their own name.

Here, the firm and the lawyer have no separate legal entity; they are considered one under the law. As an effect, there’s no distinction between what the firm owns and what the practitioner owns. As such, the lawyer under sole proprietorship would have unlimited liability, which extends up to their personal assets.

Sole proprietorships are perfect for those who want to have total control over their own practice. As for the clientele, those who prefer a familiar and confidential atmosphere are more likely to go to solo practitioners, rather than the larger firms.

For more insights into sole proprietorship, here’s the story of a lawyer who took the leap from in-house counsel to solo practitioner.

Partnerships

A partnership, such as a limited liability partnership (LLP), is a legal relationship between two or more lawyers, who agree to become partners. Its main intent is to divide profits arising from the partnership.

The partners combine their resources, which can be a combination of:

• money
• labour
• property
• skills

The income of each partner will also depend on their contribution, among other factors.

When incorporated, the partnership becomes a distinct legal entity from the partners, limiting the liability of each partner as to the partnership debts.

Compared to a sole proprietorship, a partner’s personal assets are separate from their business’s assets. The same is true for LLPs, where a partner is not jointly liable for the debts and liabilities of the partnership. Although there are some exceptions to this, most firms are inclined to do the LLP structure, if not an incorporated legal practice.

Benefits of incorporated legal practice: factors to consider

If the benefits of incorporated legal practice sound right for you and your firm, it could potentially save you a significant amount of income tax. If it is not, then it could end up costing you thousands of dollars every year. This is why it’s important to seek the advice of other professionals, such as tax accountants, before incorporating your legal practice.

Interested in reading more about the benefits of incorporated legal practice and other articles on how to manage your law firm? Check out our Practice Management page.