How to Set Up a Law Firm: Entity, IOLTA, and Insurance

To set up a law firm, you choose an entity type, file formation papers with your state, get a federal EIN, open a separate client trust account, put a written governance agreement in place, secure malpractice insurance, and prepare payroll and data-security systems before you accept your first client. The steps run in that order because each one depends on what came before, and skipping any of them can trigger bar discipline or strip away the personal liability protection you thought the entity gave you.

Pick an Entity Type

The structure you choose sets your personal exposure, your tax treatment, and how the firm handles new owners and departures. Three forms dominate legal practice, and most states allow all three for lawyers, though a handful restrict which are available. Check your state’s professional entity statute before you commit.

A Professional Corporation works like a standard corporation but is limited to licensed professionals. Shareholders are shielded from the firm’s general business debts, but every attorney remains personally liable for their own malpractice. PCs require formal bylaws, issued stock, and corporate officers, along with annual meetings and minutes.

A Limited Liability Partnership is the most common structure for multi-attorney firms. One partner is not on the hook for another partner’s negligence or misconduct. Profits flow through to each partner’s individual return, avoiding the double taxation that hits C corporations. Many states condition the LLP liability shield on maintaining a minimum level of malpractice insurance, so budget for that cost from the start.

A Limited Liability Company combines pass-through taxation with corporate-style liability protection. Members are not personally responsible for the firm’s business obligations such as office leases or vendor contracts. You can run it member-managed or manager-managed. Not every state allows lawyers to practice through an LLC, so confirm eligibility before you file.

Who Can Own the Firm

Whichever structure you pick, every owner must hold an active law license. Under ABA Model Rule 5.4, a nonlawyer cannot own any interest in a law firm, serve as a corporate director or officer, or direct the professional judgment of a lawyer practicing within the entity.¹ A lawyer also cannot form a partnership with a nonlawyer if any of the partnership’s activities involve practicing law. A few jurisdictions have begun experimenting with limited exceptions, but the vast majority follow the rule strictly. A business-minded co-founder who is not a lawyer cannot hold equity.

The S-Corp Election

If you form a PC or an LLC taxed as a corporation, you can elect S-corporation status by filing IRS Form 2553 no later than two months and 15 days after the beginning of the tax year you want the election to take effect.² As an S-corp owner, you pay yourself a reasonable salary subject to payroll taxes, and remaining profit passes through as a distribution not subject to self-employment tax. The IRS scrutinizes whether the salary is genuinely reasonable for the work performed.

S-corp eligibility caps you at 100 shareholders, all of whom must be individuals or certain trusts, and you can only issue one class of stock.² Owners of pass-through entities may also qualify for the Section 199A Qualified Business Income deduction of up to 20% of qualified business income, but law firms are classified as specified service trades, and the deduction phases out above certain income thresholds.³ Talk to a tax advisor before assuming you qualify.

Choose and Clear a Name

Your firm name is governed by ethics rules, not just marketing instincts. ABA Model Rule 7.5 prohibits any name that would be misleading. Trade names are permitted in private practice as long as they do not suggest a connection to a government agency or a public legal services organization.⁴ Something like “National Justice Bureau” would cross the line.

If you add “and Associates” to your firm name, there had better be another attorney working there. Rule 7.5(d) says lawyers may state or imply they practice in a partnership or organization only when that is actually true.⁴ A solo calling the firm “Smith & Associates” misrepresents the size of the practice and can trigger a bar complaint. Names of deceased or retired partners can generally remain in the firm name if there is an ongoing succession, but the name of an attorney currently holding public office cannot be used during any substantial period when that attorney is not actively practicing with the firm.

Before finalizing, search your state’s business entity database and the U.S. Patent and Trademark Office records. A name already registered to another firm creates both a trademark problem and a bar ethics issue.

File Formation Documents

Once the structure and name are settled, file formation documents with your Secretary of State. The specific document depends on entity type: Articles of Incorporation for a PC, a Certificate of Limited Liability Partnership for an LLP, or Articles of Organization for an LLC. The purpose-of-business field should explicitly state the practice of law, and attorney names must match the names on their bar cards exactly.

You will designate a registered agent with a physical street address in the state of formation. This is the person or company authorized to receive lawsuits, subpoenas, and government notices for the firm. Missing a served document because you had no reliable agent can lead to a default judgment. You can serve as your own registered agent, but a commercial service ensures someone is available during business hours even when you are in court.

Filing fees vary by state and entity type, typically from around $50 to several hundred dollars. Most states now offer online filing portals. Processing runs from a few days for expedited electronic filings to several weeks for standard mail. You will receive a Certificate of Authority or Certificate of Organization confirming legal existence.

Many state bar associations also require a separate registration of the professional entity, on top of the Secretary of State filing. It involves confirming that all owners are licensed and in good standing. Check your bar’s website for the specific form and fee.

Get a Federal EIN

A federal Employer Identification Number is your firm’s tax identity, and you need it before you can open a bank account, hire employees, or file tax returns. The IRS expects you to form the entity with the state first. Applying before formation may delay processing.⁵

The fastest route is the IRS online application, which issues the EIN immediately. You must finish in one session because it cannot be saved and times out after 15 minutes of inactivity. You will need the responsible party’s Social Security number and your entity type. The IRS limits applications to one EIN per responsible party per day.⁵ Print the confirmation notice. You will need it for the IOLTA application and your malpractice insurance underwriting.

Open an IOLTA Trust Account

Before you accept a single dollar of client money, you need a separate trust account. ABA Model Rule 1.15 requires that client funds be held in an account separate from your own property, maintained in the state where your office is located.⁶ For nominal or short-term deposits, that account is an Interest on Lawyers’ Trust Account, where interest on pooled client funds goes to legal aid programs rather than to you or your clients.

To open it, bring your EIN, formation documents, and bar card to a bank that participates in your state’s IOLTA program. The bank sets up the account under the firm’s name with a trust designation. You may deposit a small amount of your own funds to cover bank service charges, but nothing more.⁶ Record the routing and account numbers, because some bar registration forms require them.

Fees you receive in advance must be deposited into the trust account and withdrawn only as earned.⁶ This is the rule that trips up more new lawyers than almost any other. Moving unearned fees into the operating account is commingling and one of the most common grounds for discipline. Keep complete records of every trust transaction and preserve them for at least five years after the representation ends.

Put a Governance Agreement in Writing

Forming the entity gives you a legal shell. The operating agreement (for LLCs) or partnership agreement (for LLPs) is what makes it functional. Skipping it is one of the costliest mistakes new firms make, because every dispute about money, control, or departure then defaults to your state’s generic statutory rules, which almost never match what the founders actually intended.

At minimum, the agreement should cover:

How profits and losses are allocated, whether by equal shares, percentage of origination, or a formula based on hours billed and collected.
Capital contributions at formation and whether additional contributions can be required later.
Decision-making authority: which decisions require a simple majority, which require a supermajority, and which any single partner can make alone. Admitting a new member often requires a two-thirds vote.
What happens when a partner leaves, retires, dies, or loses their license. Without buyout terms, departures turn into litigation.
Client transition and notice obligations on departure. Ethics rules generally prohibit lawyers from entering restrictive covenants that limit a departing attorney’s right to practice, so standard corporate non-competes do not work here.
Dissolution triggers and how remaining assets and liabilities are distributed.

For a PC, the equivalent document is a shareholder agreement combined with corporate bylaws. The bylaws establish officer roles, meeting requirements, and share transfer restrictions. Because only licensed attorneys may hold shares, include a provision requiring the forced redemption of shares if a shareholder loses their license or dies.

Buy Malpractice Insurance

Only a couple of states require individual attorneys to carry malpractice insurance. But many states require firms organized as LLPs or PCs to maintain minimum coverage as a condition of the liability shield that protects partners from each other’s mistakes. Let the policy lapse and you may lose the protection that was the whole reason you chose the entity. Other states do not mandate coverage but require you to disclose your insurance status to clients.

Policies are written on a claims-made basis, meaning they cover claims reported during the policy period for acts that occurred while the policy was active. Minimum coverage in states that set them is commonly $100,000 per claim with a $300,000 annual aggregate, though most firms carry higher limits. Premiums depend on practice area, firm size, claims history, and jurisdiction. Litigation-heavy practices pay significantly more than transactional firms.

Tail Coverage

If you dissolve the firm, merge, or a partner retires, a standard claims-made policy stops covering claims the moment it terminates, even for work done while it was in force. Tail coverage, formally called an extended reporting period endorsement, fills the gap. It gives you a window, typically one to five years and sometimes unlimited, to report claims arising from past work. Without it, a malpractice claim filed two years after dissolution could hit you personally. Negotiate tail terms when you first buy the policy, not when you are winding down and have no leverage.

Use Written Fee Agreements

ABA Model Rule 1.5 requires that the scope of representation and the basis of your fee be communicated to the client, preferably in writing, before or within a reasonable time after starting work. For contingent fee arrangements, a signed written agreement is mandatory. It must spell out the percentage that goes to the lawyer at each stage (settlement, trial, appeal), which expenses are deducted, and whether expenses come out before or after the fee is calculated.⁷

Even for hourly and flat-fee work where a written agreement is not strictly required in every state, put it in writing. An engagement letter is the single most effective tool for preventing fee disputes and bar complaints. Include the scope of work, billing rate, retainer amount, how trust funds will be handled, the client’s right to terminate, and any limitations on the representation. Template letters are a fine starting point, but customize them for each practice area. A criminal defense retainer letter looks nothing like a corporate formation engagement.

Set Up Payroll Before the First Hire

The moment you hire anyone — a paralegal, a legal assistant, a receptionist — you take on federal employment tax obligations. You must withhold federal income tax from employee wages based on each Form W-4, and you must withhold and match Social Security and Medicare taxes. If any employee earns more than $200,000 in a calendar year, you also withhold the 0.9% Additional Medicare Tax on wages above that threshold, though you do not match that portion.⁸

You report and deposit these taxes quarterly on IRS Form 941. Federal Unemployment Tax is paid entirely by the employer and reported annually on Form 940.⁸ Most states impose a separate unemployment insurance tax. Set up a payroll system or hire a payroll service before the first employee’s start date, not after.

Every new hire must complete Form I-9 on their first day of work. You then have three business days to physically examine their original identity and work authorization documents. You cannot specify which documents the employee presents. Requiring a particular document is considered discrimination under the Immigration and Nationality Act. If your firm is enrolled in E-Verify, you can examine documents remotely via live video; otherwise the inspection must happen in person.

Protect Client Data

A law firm is a high-value target for cyberattacks. ABA Model Rule 1.6(c) imposes a straightforward duty: you must make reasonable efforts to prevent the unauthorized disclosure of, or unauthorized access to, client information.⁹

In practical terms, that means multi-factor authentication on email and cloud applications, encryption of client files in storage and in transit, endpoint detection on every device that touches client data, and staff training on phishing. If you outsource technology functions, you remain responsible for vetting the vendor’s security practices. ABA Model Rule 1.1 also requires lawyers to stay current with the risks associated with relevant technology, so “I’m not a tech person” is not a defense if a preventable breach compromises client confidentiality.

Cyber liability insurance is increasingly a practical necessity. Many carriers now require specific security controls, including immutable backups, privileged access management, and regular phishing simulations, before they will issue a policy. Even where cyber coverage is not mandated, a single breach can generate notification costs, regulatory fines, and malpractice claims that dwarf the annual premium.

Beneficial Ownership Reporting Does Not Currently Apply

The Corporate Transparency Act originally required most new business entities to report beneficial ownership information to FinCEN. As of March 2025, FinCEN issued an interim final rule exempting all domestic entities from this requirement. Only entities formed under foreign law that have registered to do business in the United States must file. If your law firm is formed under the law of any U.S. state, you currently have no obligation to file a beneficial ownership report, and FinCEN is not enforcing penalties against domestic entities as of this writing.¹⁰ This could change if Congress revises the rule, so keep an eye on it.

1
American Bar Association. ABA Model Rule 5.4 Professional Independence of a Lawyer
2
Internal Revenue Service. Instructions for Form 2553
3
Internal Revenue Service. Qualified Business Income Deduction
4
American Bar Association. ABA Model Rule 7.5 Firm Names and Letterheads
5
Internal Revenue Service. Get an Employer Identification Number
6
American Bar Association. ABA Model Rule 1.15 Safekeeping Property
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American Bar Association. ABA Model Rule 1.5 Fees
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Internal Revenue Service. Understanding Employment Taxes
9
American Bar Association. ABA Model Rule 1.6 Confidentiality of Information
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FinCEN. Beneficial Ownership Information Reporting