Introduction
Many law firms in Canada operate as general partnerships rather than professional corporations — particularly smaller and mid-sized firms where the partnership model has been traditional. The tax rules that apply to a partnership are meaningfully different from those that apply to a corporation, and understanding those differences is essential for partners who want to manage their personal tax position effectively.
How Partnership Income Is Taxed
A partnership is not itself a taxable entity in Canada. It does not pay income tax. Instead, the partnership calculates its income or loss for the year, and each partner includes their allocated share of that income or loss in their own personal tax return.
This "flow-through" treatment is a defining feature of partnerships. The income retains its character as it flows through — business income remains business income, capital gains remain capital gains. Each partner reports their share on their personal T1, paying personal tax at their applicable marginal rate.
A law firm partnership files a T5013 Partnership Information Return each year, which reports the partnership's income and each partner's allocated share. Partners use the T5013 slips to report their shares on their personal returns.
The Draw vs. Income Distinction
Partners in a law firm typically take regular draws — periodic cash withdrawals from the partnership account, analogous to a salary in function but different in tax treatment. Draws are not employment income. They are advances against the partner's share of partnership income for the year.
At year end, the partnership calculates its actual income, allocates it among partners according to the partnership agreement, and each partner pays tax on their allocated share — regardless of how much they actually drew during the year. A partner whose draws exceeded their income allocation has effectively borrowed from the partnership; a partner whose draws were less than their allocation has accumulated a balance in their capital account.
This timing difference — income is taxed in the year it is earned by the partnership, not in the year the partner draws cash — is an important point for personal tax planning, particularly in years where partnership income is significantly higher or lower than expected.
Capital Accounts and ACB
Each partner maintains a capital account in the partnership, representing their economic interest. The adjusted cost base of a partnership interest is affected by contributions, withdrawals, allocated income and losses, and other events. Accurate tracking of each partner's ACB is important for calculating the capital gain or loss when a partner exits the partnership or when the partnership is dissolved.
A partner who has been receiving income allocations and leaving money in the partnership (rather than drawing all of it out) builds up a capital account balance. Conversely, draws that exceed income allocations reduce the capital account. If the ACB of a partnership interest falls below zero, there may be an immediate deemed capital gain.
GST/HST in a Partnership
A law firm partnership that provides taxable services must register for GST/HST if its annual taxable supplies exceed $30,000. In practice, virtually all law firm partnerships are registered. The partnership files HST returns and remits net tax in the same manner as any other registrant.
Individual partners do not separately register for HST on income received through the partnership — the partnership is the registrant.
Comparing Partnership to Professional Corporation
For lawyers considering whether a partnership or professional corporation structure is more appropriate, the key differences include:
Tax deferral: A professional corporation can retain after-tax corporate income at the small business rate, deferring personal tax. A partnership does not offer this — all income is taxed personally in the year earned.
Liability protection: A general partnership does not provide personal liability protection. A limited liability partnership (LLP), available to lawyers in Ontario, limits each partner's personal liability for the negligence of other partners. A professional corporation provides corporate liability protection (with the professional's personal liability remaining for professional negligence).
Administrative complexity: A partnership is generally simpler to maintain than a professional corporation — no T2, no corporate filings, no minute book. The T5013 is the primary annual compliance obligation.
Income splitting: A professional corporation has more flexibility in income distribution (with TOSI limitations), while a partnership allocates income according to the partnership agreement.
When to Speak With a CPA
Partners in law firm partnerships benefit from annual planning around their income allocation, draw schedule, and personal tax position. For partners considering whether to restructure into a professional corporation arrangement, a CPA can model the tax implications of both structures at the specific income levels involved.