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Law firms face partnership tax changes

27 February 2014

Following partnership tax reforms outlined in the Autumn Statement, law firms must assess how partners are taxed in order to adhere to new HMRC legislations.

The limited liability partnership tax regime will dramatically change how members in law firms pay tax. One of the aims of the legislation is to catch any tax motivated profit allocation structures such as disguised salaries, and as the April 6 deadline approaches, members at LLP status law firms must ensure they are paying the correct tax.

What do the changes mean for law firms?

If lawyers are currently salaried members in an LLP firm, and are therefore self-employed for tax purposes, those lawyers must become employees unless they can prove otherwise. The only way to prove they qualify for self-employed status is by failing one of HMRC’s three employee status tests.

Should a firm be unable to fail one of these tests, they will be responsible for paying employers national insurance contributions for the salaried members, inflating the individuals salaries by thousands of pounds. The next step for firms with numerous salaried members, will be to assess how many members the changes could affect and how much it will cost the firm.

In order to avoid this costly outcome, the question in the test that a firm is most likely to nominate to fail will be Condition C. Which as stated in HMRC’s Partnerships: A review of two aspects of the tax rules, dictates that the salaried member must fail to fulfil the following:

“Condition C looks at the capital contribution made to the LLP by the individual. A partner in a traditional partnership risks losing money if the business fails. To reflect this, an individual will not be a Salaried Member if he or she has invested an amount of money in the LLP that is at least 25% of their expected income from the LLP, which is fixed or variable income for a tax year as described under Condition A.”

However, as this will require the salaried member substantially increasing their fixed share contribution to the firm it may not be the best solution for all LLPs. As the risk and reward balance may not be acceptable to the salaried member who has no say in how the business is run.

Working towards a partnership

If you have been working towards a salaried membership in a law firm or have recently been offered a position as a salaried member, the partnership law solicitors at Ralli can help you discover your options and what would work best for your career.

Alternatively, if you are considering setting up a limited liability partnership our solicitors will help you protect your assets and your stake in the LLP with an LLP agreement. This bespoke deed allows you to decide the amount each of you will invest in the firm, how much time each of you will commit and where each of your responsibilities lie within the firm. If you would like to find out more from the expert team at Ralli Partnership Law, please contact us on 0161 832 6131.

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