Are there any legal and financial benefits to incorporating my law practice?

The deciding factor will be whether your income is above or below the 42.4% marginal tax rate threshold.

I hope you can assist me with some advice. I am a 44-year-old practising attorney with my own firm conducting business as a sole proprietor specialising in conveyancing.

The firm is seven years old and consists of myself and two paralegals. I own the business premises in my personal name and the property is unbonded. I have no plan to take on any partners in future and my firm will cease when I retire or die, whichever event occurs first. 

From my understanding of company law, the directors of incorporated legal practices are personally liable for the debts of the firm. My question to you is: from both a legal and financial point of view, are there any benefits in incorporating my practice (ie. registering a company)? I have asked the opinions of colleagues and have received conflicting opinions. Your advice would be greatly appreciated.

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Thank you very much for your question. To answer it, I will separate my response into two parts.

1. Sole proprietorship vs personal liability company

In terms of our company law, the owner of a sole proprietorship is personally liable for any debts or obligations of the business. A sole proprietorship is not seen as a separate juristic person; instead, the owner and business are one and the same. This means that lawsuit claimants or creditors may have access to the owner’s personal accounts, assets, or property if any business accounts cannot cover the debt.

When it comes to private companies, such a company is regarded as a separate entity even in a situation where there is only one owner, and therefore company creditors should not be able to come after the company directors personally.

However, at the core of our company law is the concept of limited liability which provides that shareholders and directors of a company will not be liable for the actions or conduct of the company unless it can be proved that they were negligent or reckless in carrying out their duties. This is provided for in Section 22(1) of the Companies Act, which holds directors personally liable for the debts of a company in circumstances where the business of the company has been carried on in a reckless or negligent manner.

With regard to incorporating your practice, you are able to do this in terms of Section 23(1)(a) of the Attorneys Act 53 of 1979, which makes provision for a private company to conduct the business of an attorney’s practice. This section provides that a company may conduct a practice if the company is set up as a personal liability company as per the Companies Act.

A personal liability company is a private company mainly used by associations such as lawyers, engineers and accountants, and the name of the company must end with the word ‘incorporated’. Because it operates on the basis of personal liability, directors of the company, as well as previous directors, will be held responsible for the debts of the company, as provided for by Section 19(3) of the Companies Act. This section creates a statutory liability that is intended to protect the company’s creditors. However, it is important to note that a director’s liability is limited to the company’s contractual debts and liabilities incurred during the director’s tenure.

2. Tax differences between sole proprietorship vs personal liability company

With regard to your particular situation, a very important consideration is the tax that you will pay on your income or profit in each of the two structures.

Currently, any profit that your sole proprietorship makes after expenses is taxed on your personal income tax tables regardless of whether you pay it to yourself as a salary, bonus, or leave it in the business banking account.

On the other hand, if you were to register a private company, you would be able to make use of the fixed company tax rate of 28% and dividend tax rate of 20%.

Assuming that your marginal tax rate is above 42.4% for any salary you pay yourself, and taking the above tax rates into account, it would make mathematical sense to register a private company where any income generated by the business above this threshold could be distributed to yourself via a dividend distribution rather than in the form of income.

As you are already operating a business structure where you have total liability, there will be no change in the extent of your liability should you register a private company. However, if your income is above the threshold of 42.4% marginal tax rate, then it would make financial sense to rather set up a private company.

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Remember to take into account the rules of the Fidelity Fund as it relates to using a private company as an operating structure for a law firm.

If your meet the requirements of a small business corporation in the Incorporated company, you will have the benefit of depreciating assets at 50:30:20 and a significantly lower effective tax rate.

Another factor is that as a sole proprietor, all the assets of the practice are yours.

Should you wish to take in a partner (or dispose of your practice) the assets will belong to your and your partner according to your agreement. Take in more partners, and it gets messy. This especially applies to fixed property (say you purchase your business premises). Incorporation means that assets belong to the company and you merely transfer/issue shares to the new partner.

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