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Professional Corporation

Description

The Professional Corporation form of business ownership provides that certain services may be offered only through persons who are properly licensed to engage in particular professions. The Professional Corporation is recognized only at the state level, not at the federal level. In California, for example, attorneys, chiropractors, clinical social workers, dentists, doctors, and members of several other professions who wish to incorporate must do so as Professional Corporations. Others, such as engineers and financial advisors, may incorporate as a regular “C-Corp.” but have many other options as well.

An additional benefit of a Professional Corporation is that persons outside of the chosen profession cannot end up as partners with equal rights. For example, Dr. Sarah Bellum and Dr. Ann Eurism are brain surgeons who are in business together. Sarah dies. Dr. Ann is relieved that Sarah’s sit-at-home husband, who aspires to appear on “Celebrity Bowling” will not end up as an equal partner. Of course, this also allows the public to be confident that Professional Corporations are owned and managed only by professionals.

Tax Treatment

“Professional Corporation” is a state designation and has no meaning to the IRS. Small businesses offering professional services must determine whether to file at the federal level as a C-Corp. or as an S-Corp. In either case, the small business files IRS Form 1120 (Corporation Income Tax Return).

Fans of tax minimization may prefer to be treated as a C-Corp., due to the relatively low initial tax rates (currently 15 percent on the first $50,000 in taxable income); however, Form 1120 asks taxpayers to “check [box] if a qualified personal service corporation under section 448(d)(2).” (In case you are not already confused, this will do it: The IRS does not recognize Professional Corporations, but it does recognize “qualified personal service corporations” that perform professional services where substantially all activities involve accounting, actuarial science, architecture, consulting, engineering, health, law, and the performing arts, and where at least 95 percent of the firm’s stock is owned by employees performing services for the corporation, retired employees, the estates of deceased employees, or other persons acquiring stock in the corporation by reason of the death of employees.)

When the IRS understands that your small business fits the definition of a qualified personal service corporation, a different--and much higher--tax schedule must be used, in which shareholders pay a flat (not graduated) rate on all income. In fact, the personal service corporation is a penalty situation as far as the IRS is concerned: Corporate taxpayers are slapped on the wrist for even thinking about the 15 percent initial C-Corp. tax rates. The taxable income of qualified personal service corporations is currently subject to a flat tax rate of 35 percent instead of the graduated rates available to most corporations.

The IRS believes that professionals who earn the majority of their income from the performance of services should not be allowed to enjoy the low, graduated tax rates offered to C-Corps. Since the tax-minimization factor is not relevant to professionals, other factors will normally determine the best form of ownership (such as limited liability).

Small business owners must check state laws to determine which professions require registration as Professional Corporations.