Professional CorporationWhat Is It, How to Set It Up And How Are They Taxed?

The option professionals have in several states when coming to a point in their career that would push them to incorporate their practice is by establishing a professional corporation.

Professionals who are doctors, lawyers, and accountants among the like only have the option to incorporate their practices by establishing professional corporations or professional service corporations in many states.

Some professionals on the other hand, have the option to incorporate as either a regular corporation or a professional corporation in other states.

There are certain professionals of occupations not normally included in the list of those who can incorporate as professional corporations or professional service corporations but due to their circumstances, they are still allowed to do so in some states.

Today we are going to learn all about professional corporations and how they can benefit your business if you qualify!

What is a Professional Corporation?

Professional corporations are made up of various kinds of professionals from differing fields such as psychologists, engineers, accountants, architects, lawyers, doctors, etc.

Professional corporations are required to be incorporated in the very state where the incorporating professionals currently practice their trade.

Professional corporations differ from regular corporations. In regular corporations, shareholders are absolved and protected from personal liability.

In professional corporations, professionals may enjoy the benefits of having a corporation as a business entity that grants them a corporate veil otherwise understood as the placeholder that shields them from personal liability; however, personal liability protection is far more limited in a professional corporation than it is on a regular one.

It is impossible to form a professional corporation with the purpose of pardoning its owners or employees from their personal professional responsibilities.

It is also not possible to protect a professional corporation’s owners or employees from charges against them regarding professional malpractice or negligence.

Professional corporations are business entities that limit personal liabilities of the incorporated professionals who provides a service related to their occupation with their personal liability protection being exempted from negligence or malpractice.

Professional corporations are registered in compliance with the specific laws a state uses to govern these kinds of business entities.

Investors who buy shares of a professional corporation and become shareholders are fully shielded from the personal liability with regards to debt that is incurred by the corporation.

Owners of the professional corporation are also fully shielded from financial obligations that arise on the accounts of the corporation but they are still fully liable for their own professional negligence and malpractice.

There is also an extent to which a professional corporation’s shareholders and owners are protected from the malpractice of the corporation’s other associates.

It should be noted that professional service corporations are a different entity from a professional corporation.

Professional service corporations are set up under separate and distinct regulations mandated by the Internal Revenue Service (IRS).

One of the provisions for example of the IRS when setting up a professional service corporation is that employee owners must hold shares of more than 10% of the professional service corporation’s equity.

Who Are the Professionals That Use a Professional Corporation?

Professionals that are eligible to incorporate a professional corporation differ from state to state.

The professionals that typically fall under state mandatory professional requirements are the following:

•       Veterinarians
•       Social workers
•       Psychologists
•       Lawyers
•       Engineers
•       Accountants
•       Health care professionals such as speech pathologists, physicians, physical therapists, pharmacists, optometrists, opticians, nurses, dentists and audiologists.

Prior to incorporating a professional corporation, you will first need to check which professions are required to form professional corporations in your presiding state.

Checking to know which professions are eligible for incorporating a professional corporation can be done through your presiding state’s corporate filing office, usually by the Secretary of the State or the Corporate Commissioner.

How to Set up or Structure a Professional Corporation?

Founders of a professional corporation will need to create, compile and submit certain documentations to their presiding governing authorities.

Below are the basics of how to set up a professional corporation, and a brief discussion of each step that will be taken:

Draft the articles of association

The first step to establishing a professional corporation is to file the drafted articles of incorporation with the relevant state during registration.

Articles of incorporation require the upcoming professional corporation’s organizers to explicitly state the intent to run the business as a professional corporation.

The articles of incorporation will also need to explicitly state the purpose of setting up the professional corporation.

The purpose of set up refers to the products or services that the corporation will provide.

An example of this is if the professional corporation is composed of Certified Public Accountants (CPAs).

The purpose of incorporating the professional corporation is for those CPAs to provide their accountancy expertise and services.

Professionals who establish a professional corporation are required to have a practicing certificate in the state where they plan to offer their services.

Name the corporation

The names of new or upcoming corporations should not clash with the names of existing corporations.

Professional corporations are not exempted from this rule.

When filing articles of incorporation, the organizers of the upcoming professional corporation must state their proposed corporation name and ensure that it is completely distinct from names of already registered business entities.

It is ideal to have the corporation’s name specify that it is a professional corporation by including the words “professional corporation” in its proposed name.

The name of the corporation must include the exact abbreviation designating the profession of the founders down to its spelling and punctuation such as M.D. for a doctor of medicine or J.D. for a juris doctor or a doctor of law.

Your business name should matcj your businesses domain name.

Find available domain names here:

Obtain local approval

There are instances when a professional corporation will not be granted an approved incorporation by the state until the parties involved in the professional corporation attain additional approvals from the licensing boards relevant to their trade.

An example of this would be if the parties involved in forming a professional corporation are composed of doctors.

There might be instances when approval from the State Medical Board of the state where the doctors practice medicine in would be needed before incorporation is granted by the presiding state government.

The parties involved would also need to furnish copies of each of their active practicing licenses when establishing their professional corporation.

How Are Professional Corporations Taxed?

Professional corporations pay the same tax rate as regular corporations.

Owners of a professional corporation are mandated to pay Federal Insurance Contributions Act (FICA) tax rather than paying self employment taxes.

Professional corporations tend to be classified by the Internal Revenue Service as “personal service corporations”.

Professional corporations file professional corporation tax returns, paying a flat tax rate of 21% rather than a graduated tax scale.

However, in order for a professional corporation to qualify for the flat tax rate, the business activities of the corporation need to have at least 95% of its operations within the bounds of the corporation’s specialization as declared in its registration.

95% of the professional corporation’s shares must also be owned by current and even former employees who have been proven to provide services that are relevant to the corporation.

Professional corporations are not flexible business structures like partnerships, sole proprietorships or limited liability companies which is why they do not reap the benefits of pass through taxation.

This means that professional corporations must pay tax on its gross profits and from its net profit that includes the initial tax deductions, the owners of the professional corporation will also need to pay tax on their share of the already taxed profits but this time, they will declare their earnings on their personal tax returns.

Double taxation like the scenario described above can be avoided by forming a professional corporation with an elected S Corporation tax status.

Are There Tax Benefits for Professional Corporations?

There are some corporate tax benefits that are granted to professional corporations.

Professional corporate tax deductions are the same as the tax deductions granted to regular corporations.

What this means is that professional corporations can deduct the benefits paid to its employee owners and the cost of the salaries paid.

It is common for professional corporations to pay out nearly every dollar of their earnings into bonuses, salaries, and benefits which leaves almost no income left to tax at the professional corporation level.

Professional corporations can completely deduct any or all business expenses and interests the corporation owes to its employee owners.

Professional corporations can deduct any losses that occurred from the sales or exchanges of properties between the employee owners and the corporation.

To add to that, professional corporations are capable of creating 401(k)s and retirement plans for their employees with contribution limits that are higher than what unincorporated businesses are allowed to use.

Other corporations are typically required by the Internal Revenue Service to use an accrual basis of accounting for its tax reporting but professional corporations are allowed to use the cash method of accounting without posing any limits on its taxable income.

What this means is that a professional corporation has the ability to report income when it has received it instead of reporting income on the year it has billed for services rendered but has not collected payments yet.

Limiting Your Liability with a Professional Corporation

Professional corporations cannot protect its owners from liabilities arising from professional negligence or malpractice; however, its shareholders still enjoy personal protection from the liabilities incurred by the corporation’s debts and other responsibilities of the corporation that may arise.

Personal assets of a professional corporation’s owners cannot be used to reimburse, settle or pay for the corporation’s financial obligations.

Shareholders can only incur liabilities up to the amount they have contributed into the corporation.

Professional corporations also serve as a form of protection against the professional negligence or malpractices of other owners or associates.

This means that if an owner or two are found guilty of professional negligence or malpractice, they alone will be the ones who are responsible for the unlimited personal liability of their own actions.

However, it is still possible to sue the professional corporation as a whole for negligence or malpractice when an accuser can demonstrate and prove that every one of the owners of the corporation are responsible and therefore must be held accountable.

Legal Requirements of a Professional Corporation

Incorporating a professional corporation will differ on a state to state basis and will have to comply with the prevailing laws of its governing state.

There will be states that put restrictions on the kinds of professionals who can own shares in a professional corporation.

In general, forming a professional corporation is strictly limited to professionals that are in the same field or industry.

An example of this is when a corporation is formed by doctors who have their main focus in providing medical care services.

The corporation can only be formed by doctors themselves who must possess the appropriate certificates of practices in the state of incorporation.

Specific requirements that need to be complied with when forming a professional corporation can be acquired from the office of the Secretary of the State.

Alternatives to a Professional Corporation: Limited Liability Companies (LLCs) and Professional Limited Liability Companies (PLLCs)

There are alternatives to incorporation that would still grant professionals limits on their personal liability in the form of limited liability companies (LLCs).

Every state will have its own laws and regulations on what types of business entities certain professionals can form which is why it is always best to check in with the rules of your presiding state.

An example of this is the state of California where professionals are prohibited from forming limited liability companies or professional limited liability companies.

Instead, it is mandated for professionals to form either a registered limited liability partnership or a professional corporation.

In other states, the option to form a professional limited liability company (PLLC) exists.

Professional limited liability companies have structures that are similar to a professional corporation however, they enjoy the tax benefits of a limited liability company complemented with a more flexible management structure.

Professional limited liability companies are considered as pass through entities just like regular limited liability companies.

What this means is that the income and losses each owner receives or is dealt with will be declared on their own personal income tax returns.

There is no double taxation or tax payments made on a corporate level.

As with the laws in effect with professional corporations, a professional limited liability company cannot pardon its owners from claims made against their own professional negligence or malpractices.

The protection against the liabilities of the corporation’s obligations is still present in a PLLC.