Incorporated legal practice: a guide for law firms

Most guidance on incorporated legal practices is written from a regulatory perspective. It usually answers one question well: how do you register an incorporated legal practice and meet your professional obligations?

The question law firm principals often need answered is different: should your firm incorporate at all, and what would that change for tax, profit, cash flow, drawings, succession and commercial risk?

This guide looks at the financial side of the decision. It explains what an incorporated legal practice is, how it differs from other law firm structures, and when incorporation may make sense for an Australian law firm.

What an incorporated legal practice is

An incorporated legal practice, often called an ILP, is a company that engages in legal practice.

Instead of trading as a sole practitioner or a traditional partnership, the firm operates through a corporation with its own legal identity, tax file number, financial records and balance sheet. The company earns the fees, employs the staff, enters into contracts and pays tax in its own name.

The principals are usually directors and shareholders of the company, rather than owning the practice in their personal names or through a simple partnership structure. That shift is what changes the tax, drawings, reporting, succession and commercial risk position.

An ILP does not remove the professional obligations that apply to lawyers. It adds a corporate structure around the legal practice, while the firm and its authorised principals remain subject to the rules that apply in the relevant state or territory.

The practice structures available to Australian law firms

An ILP is one of several structures a firm can use. Choosing well means understanding the alternatives, because the regulator treats each differently and so does the tax system.

• Sole practitioner. One solicitor practising in their own name. Simple and cheap to run, but the practitioner is personally liable and all profit is taxed at their marginal rate.
• Partnership (law firm). Two or more principals practising together. Profit flows to the partners and is taxed in their hands. Partners are generally jointly liable for the obligations of the firm.
• Incorporated legal practice. A company that engages in legal practice. The company earns the income, pays company tax, and limits the liability of its owners in the way any company does.
• Unincorporated legal practice. A practice that provides legal and other services without incorporating, sitting between a traditional firm and an ILP.
• Community legal service. A not-for-profit structure for community legal centres, outside the scope of most commercial firms.

For a growing commercial or general practice firm, the real contest is usually between a partnership and an ILP, or between a sole practice and an ILP. The rest of this guide focuses on that decision.

Incorporated legal practice NSW, QLD and Victoria: why location matters

The rules for commencing and operating an ILP vary by jurisdiction. A firm considering an incorporated legal practice NSW, incorporated legal practice QLD or incorporated legal practice Victoria pathway should check the current requirements with the relevant regulator before starting.

In Uniform Law jurisdictions such as New South Wales and Victoria, an ILP must generally notify the designated local regulatory authority before it starts engaging in legal practice. It must also have at least one authorised principal.

Queensland has its own Legal Profession Act framework. A Queensland ILP must also meet the requirements that apply to incorporated legal practices in that state, including professional indemnity insurance obligations.

The financial decision and the regulatory decision should be worked through together. Incorporating may make sense commercially, but the structure still needs to be implemented correctly from the beginning.

The rules every ILP must consider

Incorporation does not remove the responsibilities that come with running a legal practice. Before weighing the tax and commercial benefits, principals need to understand the compliance layer.

Authorised principal requirements

An incorporated legal practice must have at least one authorised principal. In practical terms, that means a legal practitioner director who is authorised to practise as a principal and who takes responsibility for the legal services and compliance systems of the firm.

This is not just an administrative detail. If the firm has only one authorised principal and that person ceases to hold the required practising certificate, the firm may not be able to continue engaging in legal practice until the issue is resolved.

Regulator notification

An ILP must notify the relevant regulator before it starts engaging in legal practice. The exact process, timing and form depend on the jurisdiction.

This is one of the most important steps in commencing an incorporated legal practice checklist. The company structure should not be treated as complete simply because ASIC registration has occurred. A law firm is regulated as a law practice as well as a company.

Professional obligations and insurance

An incorporated legal practice must meet the professional obligations that apply to legal practices. This includes professional indemnity insurance requirements, client disclosure obligations and conduct obligations.

An ILP can provide legal services through a corporate structure, but it is still a regulated law practice. The structure should be set up with that reality in mind.

The benefits of incorporated legal practice

The benefits of incorporated legal practice are usually financial, structural and strategic. They are not automatic, and they depend on how profitable the firm is and how much profit can be retained in the business.

Company tax treatment

A sole practitioner or partner is generally taxed personally on their share of taxable income. For high-income principals, this can mean individual marginal tax rates apply.

An incorporated legal practice is taxed as a company. A company that qualifies as a base rate entity may pay company tax at 25%. Other companies are generally taxed at the full company rate of 30%.

This distinction matters most where the firm is generating profit that does not all need to be drawn by the principals each year. Retained company profit may be taxed at a lower rate than personal marginal rates, then reinvested into the firm.

That does not mean incorporation automatically lowers tax. If every dollar of profit is paid out to the principal as salary, directors’ fees or dividends, the personal tax outcome still needs to be modelled. The value is usually strongest where the firm can retain some profit to fund growth.

Retained earnings for growth

A growing firm often needs working capital. It may need to hire fee earners, upgrade systems, carry WIP, fund premises, improve reporting or manage uneven cash flow.

In a partnership, profit is generally assessed to the partners whether or not the cash stays in the firm. In an ILP, profit retained in the company can be taxed at the company rate and used for business purposes.

This can provide a working-capital advantage. It can also create more discipline around budgets, drawings and reinvestment, especially when paired with proper cash flow forecasting and management reporting.

Commercial risk separation

A company is a separate legal person. Trading through an incorporated legal practice may help separate some ordinary commercial risks from the principals personally.

That protection has limits. Incorporation does not remove a solicitor’s professional obligations. It does not remove director duties. It does not replace professional indemnity insurance. It may not protect principals from personal guarantees, misconduct, negligence or obligations they have personally accepted.

The benefit is more precise than “asset protection”. A better way to think about it is commercial risk separation. The company provides a clearer boundary between the firm as a business and the individuals who own and manage it.

Succession and future ownership

An incorporated legal practice can make future ownership changes easier to plan. Shares can be issued, transferred or bought back, subject to the firm’s constitution, shareholder arrangements, tax advice and regulatory requirements.

For firms thinking about admitting new principals, managing partner exits or building a more saleable practice, structure matters. Succession planning is easier when ownership, profit allocation, valuation and capital arrangements are clear.

When does incorporating make sense?

An ILP is not automatically the right answer. The benefits scale with profit and with how much of that profit you can leave in the business.

Incorporating tends to make sense when the firm generates profit consistently above the top marginal thresholds, when the principals do not need to draw every dollar of profit each year, and when limiting commercial liability or bringing in equity holders matters. It makes less sense for a small sole practice that extracts all of its profit as income each year, because if every dollar is paid out to the principal, it is taxed at their marginal rate regardless of the wrapper around it, and the company simply adds cost.

The deciding factors are your profit level, your drawings pattern and your growth plans, not a rule of thumb. This is exactly the kind of question we model with clients inside our Grow Your Firm advisory program before recommending any change.

How principals get paid from an ILP

Moving from a partnership to an ILP changes how principals access money. In a partnership, partners usually take drawings against their share of profit. In a company, money must come out through properly documented channels.

Salary and directors’ fees. The company may pay principals a salary or directors’ fees for work performed. These payments are generally deductible to the company and assessable to the principal. This is often the simplest way to pay principals a regular working income from the firm.

Dividends. Where profit has been retained and taxed in the company, it may later be paid to shareholders as dividends. Those dividends may carry franking credits for company tax already paid. This is part of the reason company structures can be effective when retained earnings are used properly. The objective is not to avoid tax. It is to manage timing, cash flow and the correct mix of salary, dividends and retained profit.

Division 7A is one of the areas where incorporated practices can get into trouble. If a private company makes payments, loans or forgives debts for shareholders or their associates, those amounts can be treated as unfranked deemed dividends unless the rules are managed correctly. For law firm principals, the practical risk is informal drawings. If principals take money out of the company during the year without the right documentation, loan arrangements or repayment discipline, they can create an unexpected tax problem. This is why remuneration planning should be part of the structure decision from the start, and why it should be modelled alongside cash flow, retained profit and growth planning through Grow Your Firm.

ILP versus partnership and trust structures

The structure question is rarely just company or partnership. Many firms use a company alongside a discretionary or service trust, and the trade-offs are worth understanding.

A company delivers a flat tax rate and limited liability, but it has one notable drawback. The 50% capital gains tax discount is available to individuals and trusts that have held an asset for at least 12 months, but companies are not eligible for it. If a substantial capital gain is likely, for example on the eventual sale of the practice or its goodwill, holding certain assets in a company can cost you that discount. This is why some firms operate the practice through a company for its income tax and liability benefits while holding goodwill or investments in a structure that preserves access to the discount. A trust can also allow profit to be distributed across beneficiaries. The right combination depends on your profit, your risk profile and your exit plans, and it needs to be designed deliberately, not inherited by accident. The interaction of average rate and lock-up that we cover in The two numbers that drive law firm profitability matters here too, because a structure only pays off if the underlying firm is profitable.

The tax cost of restructuring into an ILP

Moving an existing practice into a company is itself a taxing event, and this is the point most firms underestimate. Transferring the goodwill and assets of a sole practice or partnership into a new ILP can trigger capital gains tax, because you are disposing of assets from one structure to another.

There are concessions designed for exactly this situation, but they must be planned before the change, not discovered after. The small business restructure rollover in Subdivision 328-G of the ITAA 1997 lets a small business transfer active assets between entities as part of a genuine restructure of an ongoing business without an income tax liability, provided there is no change in the ultimate economic ownership of those assets. Separately, the four small business CGT concessions (the 15-year exemption, the 50% active asset reduction, the retirement exemption with its $500,000 lifetime limit, and the small business rollover) can reduce or eliminate a capital gain where the eligibility tests are met. Whether you qualify, and which path leaves you best off, depends on your turnover, your asset position and how the restructure is documented. Model it before you sign anything.

The ongoing cost of running an ILP

A balanced decision weighs the tax saving against the cost of the wrapper. An ILP is more expensive to run than a sole practice, and those costs are ongoing.

• ASIC registration and annual review fees for the company.
• A separate company tax return and financial statements each year, on top of the principals’ personal returns.
• Additional bookkeeping and accounting to keep the company, the drawings and any Division 7A obligations clean.
• Regulator notifications and the compliance administration that comes with operating as an ILP.

For a profitable firm, the tax and asset-protection benefits usually outweigh these costs comfortably. For a marginal one, they may not. The point is to run the numbers rather than assume. Tight billing discipline, the subject of our blog on discretion and law firm profit, often does more for a small firm’s bottom line than the structure does.

How FWO helps law firms choose the right structure

At FWO Chartered Accountants, we specialise in strategic financial advisory and accounting for SME law firms across Australia. We help principals and practice managers understand what their numbers mean and what to do next.

When a firm is considering an incorporated legal practice, we focus on the financial side of the decision. That includes:

• Comparing the tax outcome under the current structure and proposed ILP structure.
• Modelling principal drawings, retained earnings and cash flow.
• Identifying possible restructure tax costs and concessions.
• Considering how the structure affects succession, valuation and future principal changes.
• Building reporting discipline through Grow Your Firm and MiNumbers.
• Connecting structure to profitability, WIP, average rate, lock-up and cash flow.

An incorporated legal practice is not the goal in itself. The goal is a firm that is clearer, more profitable, more resilient and better prepared for future decisions.

Frequently asked questions