Law Firm Entity Structure: LLP, PLLC, PC, S-Corp Election, and the SSTB Problem

Law firms almost never operate as C corporations, and the reason is straightforward: a C corp pays tax at the entity level and the shareholders pay again when they receive dividends, creating double taxation on the same income. Since a law firm’s primary output is personal services and there is no inventory, no heavy equipment, and no compelling reason to retain large amounts of earnings inside the entity, double taxation is pure cost with no offsetting benefit. The result is that nearly every law firm in the United States is organized as a pass-through entity, typically a Limited Liability Partnership (LLP), a Professional Limited Liability Company (PLLC), or a Professional Corporation (PC) that has elected S-corp status. The choice among these structures affects three things that matter: how much self-employment or payroll tax the partners or shareholders pay, whether the firm can claim the 20% qualified business income (QBI) deduction under IRC 199A, and how much flexibility the firm has in designing retirement plans. The answer to the QBI question is almost always “no” for any law firm partner earning above the income threshold, because law firms are classified as specified service trades or businesses (SSTBs) under IRC 199A(d)(2), which phases out the deduction entirely at higher income levels. This guide walks through the entity options, the tax consequences of each, and the tradeoffs that should drive the decision.

Why are law firms almost always pass-through entities?

The fundamental reason is the absence of double taxation. A pass-through entity (partnership, LLC, or S corporation) does not pay federal income tax at the entity level. Instead, the income passes through to the individual partners or shareholders, who report it on their personal returns and pay tax at their individual rates.

A C corporation pays corporate income tax (currently 21% under IRC 11) on its net income, and then shareholders pay tax again on dividends or distributions. For a professional services firm where virtually all net income will be distributed to the owners, the combined tax rate under a C-corp structure is significantly higher than the individual rate applied to pass-through income.

Narrow exceptions exist (fringe benefit deductions, deferred compensation), but for the vast majority of law firms the math points to a pass-through structure.

What’s the difference between an LLP, PLLC, and PC?

These are three different entity types, and their differences fall into two buckets: liability protection and default tax classification.

LLP (Limited Liability Partnership). An LLP is a general partnership where the partners have limited liability for the malpractice and negligence of other partners. Each partner remains personally liable for their own acts and for the general contractual obligations of the firm (leases, credit lines, vendor contracts), but is shielded from personal liability for another partner’s malpractice. The LLP files Form 1065 and issues K-1s to partners. It is taxed as a partnership by default.

PLLC (Professional Limited Liability Company). A PLLC is an LLC restricted to licensed professionals. It provides the same liability shield as a standard LLC (members are generally not personally liable for the company’s debts and obligations), with the caveat that each member remains personally liable for their own professional malpractice. A PLLC with two or more members is taxed as a partnership by default (Form 1065, K-1s). A single-member PLLC is a disregarded entity by default, reported on the owner’s Schedule C.

PC (Professional Corporation). A PC is a corporation whose shareholders must all hold the relevant professional license. Like the PLLC, each shareholder remains personally liable for their own malpractice. By default, a PC is taxed as a C corporation (Form 1120). To avoid double taxation, most law firm PCs make an S-corp election under IRC 1362, which converts the entity to pass-through taxation (Form 1120-S, K-1s) while retaining the corporate liability structure.

State-specific restrictions. Not every entity type is available to lawyers in every state. California, for example, prohibits lawyers from practicing through an LLC or PLLC; California law firms organize as LLPs or PCs. Other states have varying requirements around who can be a member or shareholder, how many owners the entity can have, and what entity name conventions must be followed. Before selecting an entity type, check the specific rules of the state(s) where the firm practices.

How does partnership taxation work for a law firm?

When a law firm is organized as an LLP or a multi-member PLLC (taxed as a partnership), the firm files Form 1065 (U.S. Return of Partnership Income) and issues a Schedule K-1 to each partner. The K-1 reports each partner’s share of the firm’s income, deductions, and credits. The partner reports this income on their personal Form 1040 and pays income tax at their individual rate.

The critical tax issue for partnership-taxed law firms is self-employment (SE) tax. Under IRC 1402, a general partner’s entire distributive share of partnership income is subject to self-employment tax, which is 15.3% (12.4% Social Security up to the $184,500 wage base for 2026, plus 2.9% Medicare on all earnings). Partners earning above $200,000 (single) or $250,000 (married filing jointly) also owe the 0.9% Additional Medicare Tax on earnings above those thresholds.

For a partner earning $500,000 in distributive share, the SE tax calculation looks like this: 12.4% on $184,500 (Social Security cap) = $22,878, plus 2.9% on $500,000 = $14,500, plus 0.9% on $300,000 (the amount above $200,000) = $2,700. Total SE tax: approximately $40,078, before the 50% deduction for the employer-equivalent portion.

There is a limited partner exception under IRC 1402(a)(13) that excludes the distributive share (but not guaranteed payments for services) of a “limited partner, as such” from SE tax. The Fifth Circuit addressed this in early 2026 (Sirius Solutions v. Commissioner), but the legal landscape remains unsettled. For most law firm partners who actively practice law, relying on the limited partner exception is a risky position.

How does S-corp taxation differ?

When a law firm PC makes an S-corp election, the firm files Form 1120-S and issues K-1s to shareholders. Like a partnership, the income passes through to the shareholders and is taxed at their individual rates. The critical difference is in payroll tax treatment.

An S-corp shareholder who works in the business must receive a “reasonable salary” as a W-2 employee. That salary is subject to FICA taxes (the employer and employee each pay 7.65%, for a combined 15.3% up to the Social Security wage base, and 2.9% Medicare above it). However, the shareholder’s remaining share of the firm’s profits, distributed as dividends or distributions, is not subject to FICA or SE tax.

This is the S-corp payroll tax savings: the spread between the shareholder’s reasonable salary and their total income from the firm avoids the 2.9% Medicare tax (and the 0.9% Additional Medicare Tax above the relevant threshold). There is no savings on Social Security tax for high-earning law firm partners because their salary alone will exceed the $184,500 wage base. The savings is entirely on the Medicare side.

For a shareholder earning $500,000 total from the firm, with a reasonable salary set at $250,000, the savings works out to the Medicare tax (2.9% plus 0.9% Additional Medicare Tax) on the $250,000 in distributions: approximately $9,500 per year. That is real money, but it comes with a real constraint.

What’s reasonable compensation and why is it audited?

The IRS requires that an S-corp shareholder-employee receive compensation that is reasonable for the services they actually perform. The standard is what a comparable employer would pay a comparable employee for comparable work. If the IRS determines that the salary is artificially low (to minimize payroll taxes), it can reclassify distributions as wages, assess back FICA taxes, add penalties and interest, and potentially adjust the shareholder’s QBI deduction.

For law firm shareholders, the analysis considers billable rate, hours worked, management responsibilities, years of experience, and what comparable attorneys earn at similar firms. A partner who bills $600 per hour and generates $800,000 in revenue cannot credibly set their salary at $80,000. Professional services firms face the highest scrutiny because the income is almost entirely attributable to the shareholders’ personal efforts.

The documentation defense is critical: maintain a written compensation analysis, board minutes establishing the salary, and market data (BLS wage data, legal salary surveys) supporting reasonableness.

Why does the SSTB classification kill the QBI deduction?

Under IRC 199A, owners of pass-through businesses can generally deduct 20% of their qualified business income (QBI). For 2026, the deduction begins to phase out when taxable income exceeds $201,775 (single) or $403,500 (married filing jointly), and the phase-out range is $75,000 (single) or $150,000 (MFJ).

However, the law draws a distinction between “regular” qualified trades or businesses and specified service trades or businesses (SSTBs). An SSTB is a business that performs services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset is the reputation or skill of one or more employees. Law is explicitly listed. There is no ambiguity: every law firm is an SSTB.

For SSTBs, the QBI deduction phases out entirely once taxable income exceeds the upper threshold ($276,775 for single filers, $553,500 for MFJ in 2026). Above that level, the deduction is zero, regardless of the firm’s W-2 wages paid or qualified property held. Since most equity partners in established law firms earn well above these thresholds (especially when combined with a spouse’s income for married filers), the QBI deduction is effectively unavailable to them.

The practical consequence: entity choice for a law firm should not be driven by the QBI deduction. It should be driven by SE tax savings, liability protection, and retirement plan design.

For partners whose income falls near the phase-out threshold (junior equity partners, solo practitioners in early years), the QBI deduction can produce meaningful savings. In those cases, income management strategies (maximizing retirement plan contributions, timing income recognition) can preserve some or all of the deduction.

How does SE tax differ between partnerships and S corps?

In a partnership (LLP or PLLC taxed as a partnership), a general partner’s entire distributive share of income is subject to SE tax under IRC 1402. This includes the partner’s share of the firm’s net income, even if the firm retains some of that income and does not distribute it.

In an S corporation (PC with S election), only the shareholder’s W-2 salary is subject to FICA. Distributions are not subject to FICA or SE tax.

The savings is concentrated in Medicare tax (2.9%) and Additional Medicare Tax (0.9% above the threshold), because most law firm partners exceed the Social Security wage base ($184,500 for 2026) on salary alone. The IRS is aware that S corps create this savings opportunity, which is why reasonable compensation is an audit priority. The savings is legitimate when the salary is genuinely reasonable; it becomes a problem when the salary is artificially low.

How does entity choice affect retirement plan design?

Entity structure constrains the retirement plan options available to the firm, and for high-earning law firm partners, retirement plan contributions are often the single largest deductible expense.

Partnerships (LLP or PLLC). Partners are self-employed individuals for retirement plan purposes. They can contribute to a SEP-IRA, a Solo 401(k) (if the firm has no common-law employees), or a defined benefit plan. The contribution limits for 2026 are: $70,000 for a 401(k)/SEP (including the employee elective deferral of $23,500 and employer contributions), with a $7,500 catch-up for age 50 and over. Defined benefit plans allow significantly higher contributions (potentially $200,000 or more, depending on the partner’s age and the plan’s actuarial assumptions).

S corporations (PC with S election). Shareholder-employees participate in the plan as W-2 employees. The contribution limits are the same dollar amounts, but the employer contribution is calculated as a percentage of W-2 compensation, not total income. This means a lower salary produces a lower employer contribution ceiling. Setting the salary at $250,000 gives the firm more room for employer contributions than setting it at $150,000, but the salary decision is also constrained by the reasonable compensation analysis.

Defined benefit plans are particularly common in law firms because partners tend to be older, the income is high and predictable, and defined benefit contribution limits increase with age. A 55-year-old partner earning $500,000 can contribute far more to a defined benefit plan than to a 401(k), and the entire contribution is deductible. The key interaction: partnerships allow contributions based on self-employment income, while S-corps limit employer contributions to a percentage of W-2 salary.

For a deeper treatment, see Law firm retirement plans and Solo 401(k) and defined benefit plans.

What about entity classification under IRC 7701?

Under the check-the-box regulations (IRC 7701 and Treas. Reg. 301.7701-3), an LLC or PLLC can elect its tax classification. By default, a multi-member LLC is taxed as a partnership and a single-member LLC is a disregarded entity. If a PLLC wants S-corp tax treatment without converting to a PC, it files Form 8832 (electing corporate classification) and then Form 2553 (S election). This gives S-corp tax treatment while retaining the LLC’s state-law liability protections, and it avoids the corporate governance formalities (minutes, bylaws, shareholder meetings) that a PC requires. The federal tax consequences of a PLLC-electing-S and a PC-electing-S are the same; the differences are at the state level (operating agreement flexibility, annual filings, state tax treatment).

How do state entity taxes and PTET change the analysis?

State-level taxes can shift the entity analysis in ways that federal law alone does not predict. Several states impose entity-level taxes on S-corps, LLCs, or partnerships that reduce the net benefit of the S-corp election or add costs that would not exist under a different structure.

California imposes a minimum franchise tax of $800 on every LLC and every S-corp, regardless of income. S-corps pay an additional 1.5% tax on net income. That 1.5% entity-level tax does not exist for partnerships or sole proprietorships, so a California S-corp election has a built-in cost that most other states do not impose. New York imposes a fixed-dollar minimum tax on S-corps based on New York receipts, ranging from $25 to $4,500, and New York City adds its own corporate tax at rates that can be significant for Manhattan-based firms. Illinois imposes a 1.5% replacement tax on both S-corp and partnership income, so the S-corp election does not create a state-level advantage or disadvantage relative to partnership taxation in Illinois.

The pass-through entity tax (PTET) election is a separate planning layer that works alongside the entity structure. Now available in most states, the PTET allows a pass-through entity (S-corp, partnership, or LLC) to pay state income tax at the entity level rather than having the tax flow through to the owners’ personal returns. Because the entity-level tax is deductible as a business expense, it bypasses the $40,000 SALT deduction cap imposed by IRC 164(b)(6). For law firm partners in high-tax states (New York, California, New Jersey, Illinois), the PTET election can recover thousands of dollars in state tax deductions that would otherwise be lost to the SALT cap. The PTET mechanics vary by state (some require annual election, some require estimated payments, some apply only to certain entity types), so the analysis has to be done state by state. But for any law firm in a high-tax state, ignoring the PTET election leaves money on the table.

What tax issues arise when partners join or leave the firm?

Partner transitions produce some of the most complex tax questions in professional services. Every multi-partner firm needs a buy-sell agreement that governs what happens when a partner retires, dies, becomes disabled, or is expelled. The agreement should specify the valuation method (formula, appraisal, or fixed price), the payment terms (lump sum or installment), and the funding mechanism (life insurance, firm reserves, or a combination). The two main tax structures are the cross-purchase (where the remaining partners buy the departing partner’s interest) and the entity redemption (where the firm itself buys back the interest). A cross-purchase gives the buying partners a step-up in their outside basis in the partnership; an entity redemption does not, unless the firm has a Section 754 election in place.

When a partner retires or withdraws, payments to the departing partner are classified under IRC 736. Payments for the partner’s interest in partnership property (IRC 736(b)) are treated as a distribution or as payment in exchange for the partnership interest. Payments for goodwill and unrealized receivables (IRC 736(a)), where the partnership agreement does not provide for goodwill payments, are treated as a distributive share of partnership income or a guaranteed payment. The distinction matters because IRC 736(a) payments are deductible by the partnership (they reduce the remaining partners’ taxable income), while IRC 736(b) payments are not. For law firms, unbilled work in progress and accounts receivable can be substantial, and whether the buyout payment for those items falls under 736(a) or 736(b) has a real dollar impact on both the departing partner and the ones who remain.

A Section 754 election allows the partnership to adjust the inside basis of its assets to match a new partner’s outside basis, eliminating the phantom income problem where a partner pays tax on income that economically just returns their purchase price. The election is irrevocable once made and applies to all future transfers, so the firm should weigh the long-term administrative burden before filing.

What should the firm actually do?

The entity decision for a law firm depends on three variables: the number of partners, their individual income levels, and the firm’s administrative capacity.

Solo practitioners and small firms (1 to 3 partners) with income above $300,000 per partner typically benefit from S-corp taxation. The payroll tax savings on distributions is meaningful, and the administrative burden is manageable.

Larger firms (4 or more partners) with varying income levels often stay with partnership taxation because partnership agreements provide more flexibility in allocating income, and the administrative burden of reasonable compensation determinations for multiple shareholders is significant.

Firms near the QBI phase-out threshold may benefit from income management to keep taxable income below $276,775 (single) or $553,500 (MFJ) for 2026, but this is tactical, not structural.

In every case, the entity decision should be made alongside retirement plan design: the entity type constrains plan options, and plan contributions are often the largest single deduction available to the partners.

Related guides:

• Trust account and IOLTA accounting, the trust accounting and reconciliation obligations that apply regardless of entity structure
• Law firm bookkeeping and chart of accounts, the operating-side books, billing, and monthly close process
• Partner compensation and guaranteed payments, how K-1 allocations, guaranteed payments, and draws interact with SE tax
• Law firm retirement plans, plan design for Solo 401(k), SEP, and defined benefit plans
• Solo 401(k) and defined benefit plans for law firms, the existing guide on retirement plan mechanics
• Contingency fee income recognition, the timing question for cash-basis firms with contingency arrangements
• Law firm tax deductions, malpractice insurance, CLE, marketing, and other deductible expenses
• Associate-to-partner compensation, how the transition from W-2 associate to equity partner changes the tax picture
• Law firm merger and acquisition, the entity-level consequences when firms combine or split

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.