Professional corporations (PCs), or professional service corporations, are a unique corporate structure which is comprised of a specific group of professionals. An S corporation or a C corporation may be formed by certain professionals including physicians, attorneys, engineers, or accountants. There are certain legal requirements and restrictions that apply only to these types of business entities.
Before a professional corporation is established, it is important to check the state laws where the corporation will be formed. Most states limit the type of people who may create a professional corporation; in general, these corporations are limited to accountants, engineers, physicians and other healthcare professionals, lawyers, veterinarians, and social workers. The purpose of the corporation must be to provide professional services. All professionals in the corporation must hold the appropriate licenses. For example, all physicians must hold an active license in the state of incorporation.
A professional corporation is governed by state law, and states place certain restrictions on who may own shares in the corporation. For example, in many states, only those who are of the same profession may be owners of a professional corporation. This would mean, for example, that only lawyers would be allowed to own shares in a professional corporation if the main focus of the business is legal services. Some states have loosened these requirements, so it is important to find out what the state rules are. In most cases, information may be available from the Secretary of State.
As with any corporation, there are certain documents that must be drafted to get started. Keep in mind that there may be some state-specific requirements; however, the general process is as follows:
While most corporations do have some restrictions placed on them, there are specific restrictions that apply to professional corporations. Since this is not a comprehensive list, it is a good idea to determine which restrictions exist in your state.
In nearly all cases, a professional corporation's taxes are the same as a C corporation. There is, however, a flat tax rate rather than a graduated tax rate. To qualify for this, the IRS requires 95% of the business activities to be within the field that the corporation declared. Additionally, 95% of the outstanding shares must be held by employees, both current and former, who provided services to the corporation. There is an exception for heirs of current and former employees as well as estates of former employees.
Professional service corporations must also use a calendar year as their tax year. There are exceptions to this, provided the corporation requests and receives approval from the tax commissioner. There are other exceptions, but this is important to remember when forming a professional corporation.
As with a typical corporation, shareholders in professional corporations are offered protection from liability for debt of the corporation. The shareholders also have no liability if another owner is guilty of malpractice. However, in the case of malpractice, if a plaintiff can point to the overall corporation's malfeasance in the malpractice, then the professional corporation may be liable.
Another way that liability rules apply differently than they do in a traditional corporation is limits on liability. In the event that one owner is found to have engaged in any practice that could fall under malpractice statutes, then they have unlimited personal liability for their own acts; they do not have liability for the acts of others. The corporation should ensure that it has the proper levels of insurance. Each individual owner should also carry the appropriate insurance policies, such as malpractice or errors and omissions policies.
As previously discussed, one of the main advantages is the limit on liability for the misconduct or malpractice of others who are part of the corporation. The benefits do not end there, however. There are some tax benefits, including the ability to contribute higher amounts to 401(k) plans. These types of corporations may also be able to provide certain benefits to employees on a tax-free basis, including life and health insurance. Shareholders may also gain tax benefits; however, it is important to note that the tax rate for a professional corporation in 2017 is 35%. Unlike a corporation where the tax rate is graduated, this applies to all earnings.
When compared to partnerships, there are other advantages that must be taken into consideration. For example, ownership is easier to transfer, even though it is restricted. Typically, restrictions may be explained in the shareholder agreement. In addition, while a partnership may have to dissolve when an owner dies or leaves the partnership, a professional corporation is able to move on in perpetuity. This is a significant advantage over other types of ownership. In addition, the fact that members may leave or new members may be added over time is often seen as a benefit. Keep in mind that adding or removing members may require you to file updated articles of incorporation with the state.
While the formation of a professional corporation does offer liability protection, it does not protect one from personal liability for individual misconduct or malpractice. Additionally, because of tax laws, a professional corporation is likely to be subjected to double taxation like other corporations. Finally, not every profession is able to form a professional corporation (the states determine eligibility). Professional corporations are nearly always limited to specific groups such as physicians, veterinarians, attorneys, and other select groups. Not every state allows every type of professional corporation.
Any time more than one person is conducting business together, they have formed a partnership. However, if a partnership is formed, each partner may be liable for the debts of the partnership and may also be liable for the misconduct or malpractice of the other partners. A professional corporation provides protections similar to that offered by a standard corporation. Before setting up a professional corporation, make sure you understand what protections are offered in your state. In some states (as seen below), there are no waivers of liability among owners.
One of the primary reasons for establishing a professional corporation may be to limit liability. It is imperative that you determine what the rules are in your state because individual states may not allow limits on liability even with a professional corporation designation. For example, in Oregon, they strictly hold all members of the professional corporation accountable. The Oregon PC statute Sec. 58.185(4) specifically states, “Shareholders shall be jointly and severally liable with all of the other shareholders of the corporation for the negligent or wrongful acts or misconduct of any shareholder, or by a person under the direct supervision and control of any shareholder.”
The typical corporate formalities must still be observed when setting up a company as a professional corporation. This includes holding annual meetings and recording meeting minutes, holding a shareholders' meeting, and following any state-required annual filings. The following items may be laid out in corporate bylaws:
Keep in mind that even though the corporation may be set up as a professional corporation, you will still need to deal with the basics of meeting corporate obligations. The corporation will be required to have its own Employer Identification Number (EIN). Additionally, payroll taxes are a necessity for non-owner employees. The IRS also requires that the professional corporation issue a Form K-1 to all owners of the corporation for their individual tax returns.
There are many benefits to setting up a professional corporation. For some businesses, this may be the only option available. Be sure to check the regulations in your own state before deciding on which corporate structure works best for your organization. Due to some of the limitations placed on professional corporations, it may not be the best business structure to meet your needs.
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