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What is a Professional Corporation? – The Essential Guide

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Starting a business is an exciting journey, but forming a new organization is riddled with various decisions. One of the first decisions is the business entity type, such as a sole proprietorship, partnership, LLC, or corporation.

Certain professionals, such as doctors, lawyers, accountants, etc., also must decide about forming a professional corporation. This specialized business entity offers enhanced liability protections and tax status for companies that provide professional services from licensed professionals.

This guide explores what professional corporations are, how they work, the pros and cons, and the formation process. Specifically, we’ll answer these questions and more:

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    What is a Professional Corporation?

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    A professional corporation is a type of business structure typically used by licensed professionals. It allows these professionals to operate as a corporation, providing liability protection while maintaining their professional status. Shareholders in a professional corporation are usually required to be licensed in the same profession as the corporation’s primary business.

    You may see a professional corporation abbreviated to PC. Some states called these organizations Professional Service Corporations (PSC) or Professional Associations (PA).

    Types of professionals that commonly utilize professional corporations include:

    • Doctors.
    • Lawyers.
    • Accountants.
    • Architects.
    • Engineers.

    These professionals opt for professional corporations to safeguard their personal assets from business liabilities. They benefit from tax advantages and the ability to structure their businesses more efficiently.

    Professional Corporation Example

    Imagine a fictional professional corporation called Smith & Associates Legal Services. This firm specializes in providing legal services to clients in various fields, such as real estate, business law, and estate planning. By operating as a professional corporation, Smith & Associates can limit the personal liability of its shareholders, allowing them to protect their personal assets in case of legal action.

    Additionally, this structure enables the firm to attract top talent by offering ownership opportunities through shares in the corporation. With the ability to raise capital through the sale of shares and the advantage of limited liability, Smith & Associates Legal Services can grow and expand its services while providing high-quality legal representation to its clients.

    How do Professional Corporations differ from regular corporations?

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    Before discussing the differences, it’s essential to understand how a PC is similar to a regular corporation. Both types of organizations must follow rigid corporate formalities, including a three-part ownership and management structure.

    Shareholders own the corporation and elect a board of directors for strategic decision-making. The board then elects or hires officers (CEO, CFO, COO, etc.) to run the day-to-day business operations.

    One of the main benefits of any corporation is that it provides liability protection for shareholders. This protects the personal assets of the shareholders from business liabilities, such as debts or lawsuits.

    Most corporations are formed as C-Corporations, which involves double taxation. However, it may be possible to create an S-corporation if you meet specific requirements. S-corps avoid double taxation.

    Now, let’s explore the crucial differences between PCs and regular corporations. First, anyone can form a regular corporation, whereas only licensed professionals can form professional corporations. PCs also provide enhanced liability protections and unique tax structures for professionals.

    One of the limits on PC liability protections involves malpractice. While other shareholders are protected in instances of malpractice, the shareholder who committed the malpractice is personally liable. Owners, directors, and employees in a PC often carry additional insurance, such as malpractice insurance, to protect themselves against the gaps in liability protections.

    What are the requirements to form a Professional Corporation?

    The rules and regulations governing professional corporations vary from state to state. The following list consists of some standard requirements, but be sure to check with your state for additional requirements or exceptions.

    Licensing: One of the primary aspects of a PC is that only professionals licensed to provide the services can incorporate it. So, a law firm’s officers would all need to be licensed attorneys, for example.

    No Dual Practices: Professionals in a PC typically can’t engage in dual practices. This restriction is in place to ensure that professional corporations maintain a clear focus on their primary area of expertise and do not blur the lines between different professions.

    Board and Officers: In most cases, states require all officers and at least 50% of the board of directors to be licensed professionals in the services the business offers. The treasurer and secretary of the corporation may be exempt from this rule. A PC can appoint board members who aren’t licensed as long as they don’t comprise more than half the board.

    Stock Shares: When issuing shares of stock, it must specify that it’s for a professional corporation. This includes specifying that transferring stock shares is restricted.

    Insurance: Each owner of a professional corporation should purchase malpractice or errors and omissions insurance to protect themselves in instances of personal liability. This insurance coverage can help safeguard individual owners from financial losses or legal claims that may arise from professional mistakes or negligence. With this insurance in place, owners can focus on their work with peace of mind, knowing they have added protection.

    What are the advantages of a Professional Corporation?

    Professional corporations offer unique benefits to licensed professionals in specific fields, such as accounting, law, or medicine. These entities provide limited liability protection, safeguarding personal assets against business debts and lawsuits.

    One key advantage is reducing tax liability by taking advantage of tax deductions unavailable to sole proprietors or partnerships. This can lead to substantial savings for professionals running their own businesses.

    Moreover, professional corporations can provide enhanced credibility to clients and customers. By operating as a corporation, professionals can instill trust and confidence in their services, attracting more clients and expanding their business reach.

    Another significant benefit is the ability to purchase insurance coverage that extends beyond what is typically available to individuals. This additional layer of protection can be crucial in professions where the risk of lawsuits is higher.

    Professional corporations can raise capital through the sale of shares. This allows for potential growth and expansion opportunities that may not be feasible for other business structures.

    What are the disadvantages of a Professional Corporation?

    Professional corporations offer benefits, but they also come with drawbacks. Individual directors who commit malpractice or unethical behavior face unlimited personal liability. While other directors and shareholders have liability protections in these cases, it could be limited if the plaintiff in a lawsuit can prove organizational malfeasance.

    Moreover, unlike regular corporations, professional corporations have limitations on the services they can provide. For example, a professional corporation formed by doctors cannot offer legal services. This restriction can limit the diversification of services and revenue streams.

    Furthermore, professional corporations require adherence to strict regulations and reporting requirements. Failure to comply can result in penalties and legal consequences for the shareholders. This increased level of compliance can be burdensome and time-consuming for those involved.

    Professional Corporation Pros & Cons

    Pros:

    • Limited liability protection for owners.
    • Ability to deduct certain business expenses.
    • Opportunity for income splitting among owners.
    • Perpetual existence even if owners change.

    Cons:

    • Higher administrative and compliance requirements.
    • Restrictions on ownership and management.
    • Potential for double taxation.
    • Costs associated with setting up and maintaining the corporation.

    How do I form a Professional Corporation?

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    Follow these steps to form a professional corporation or professional service corporation.

    Step 1- Define Your Purpose & Services: Decide on the professional services you want to offer through your corporation. This could be anything from legal services to medical care, accounting, engineering, or consulting.

    Step 2 – Follow State Regulations: Research the specific requirements for forming a professional corporation in your state. Each state has its own regulations and guidelines that must be followed, so it’s crucial to understand what is needed before proceeding.

    Step 3 – Name Your Business: Choose a unique name for your professional corporation that complies with state regulations. Ensure the name is not already used by another business and accurately reflects the services you provide.

    Step 4 – Articles of incorporation: Draft and file articles of incorporation with the appropriate state agency, such as your state’s corporate filing office. These documents typically include details about the corporation’s name, address, purpose, and structure. You’ll also specify that you intend to operate as a professional corporation.

    Step 5 – Set Your Ownership Structure: Determine the number of shares of stock to issue and the initial shareholders of the corporation. This will depend on the ownership structure you want to establish for your professional corporation.

    Step 6 – Develop Corporate Bylaws: These outline how the corporation will be governed and operated. Bylaws typically cover shareholder meetings, officer roles, and decision-making processes.

    Step 7 – Licenses and Permits: Obtain any licenses or permits required to operate your professional services business legally in your state. This may include professional licenses for specific industries or general business licenses.

    Step 8 – Elect Officers & Approve Bylaws: Hold an organizational meeting with shareholders to elect officers, approve bylaws, and handle any other necessary business to officially establish the professional corporation.

    Step 9 – Get an EIN: Obtain an employer identification number (EIN) from the IRS for tax purposes. This number is used to identify your corporation for federal tax reporting and employment purposes.

    Step 10 – Get a business bank account: Open a business bank account in the name of your professional corporation to keep personal and business finances separate. This will help maintain the liability protection offered by forming a corporation.

    Frequently Asked Questions

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    Here are the most common questions about professional corporations.

    How are Professional Corporations taxed?

    The IRS classifies professional corporations as personal service corporations, meaning they typically follow C-corp taxation. This means that the business is taxed on all revenue at the corporate level with a flat corporate tax rate of 21%.

    The business owners then also pay individual income tax on any income from the business (salaries, bonuses, etc.). This is known as double taxation. Forming the PC as an S-corporation may be possible if your business meets those requirements. S-corps are taxed as pass-through entities, avoiding double taxation.

    Who can be a shareholder or director in a Professional Corporation?

    State laws determining who can or can’t be a shareholder or director in a professional corporation vary significantly. In some states, only licensed professionals in the business’s industry can be shareholders or directors. Other states dictate that the board must be at least 50% licensed professionals.

    There’s a little more leniency on shareholders. In many states, at least 50% of the PC’s ownership must be licensed. Individuals who are not licensed can typically still be shareholders if they don’t have a controlling interest. Some states allow partnerships to be shareholders, but the partnership must be comprised of licensed professionals.

    What are the alternatives to a Professional Corporation?

    Some alternatives exist to forming a professional corporation, but some states require you to form a PC to deliver your services. For example, California doesn’t allow professionals to form an LLC, so they must create either a PC or a registered limited liability partnership.

    Here are some alternatives to consider.

    Limited Liability Company (LLC)

    LLCs can be a viable alternative to a professional corporation for professionals looking to establish their own practice. In some states, professionals such as doctors, lawyers, and accountants may be required to form a professional limited liability company (PLLC) instead of a traditional LLC to comply with state regulations.

    A PLLC offers liability protection similar to an LLC but is specifically designed for licensed professionals. Before deciding between a professional corporation and a PLLC, professionals must research and understand the specific requirements in their state.

    Partnerships

    Partnerships offer flexibility in management and taxation. In some states, professionals forming a partnership may be required to establish a professional limited liability partnership (PLLP) to protect individual partners from liability related to the actions of other partners. This structure combines the benefits of a partnership with limited liability protection, making it a popular choice for certain professional practices.

    Sole Proprietorships

    A sole proprietorship is a business structure where a single individual owns and operates the business. It is not a separate legal entity from its owner, meaning the owner is personally liable for the business’s debts and obligations. While a sole proprietorship can be a simple and cost-effective way to start a business, it may not provide the same level of liability protection and tax benefits as a professional corporation.

    What is a Professional Corporation – Final Thoughts

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    Forming a professional corporation can offer numerous benefits to professionals in various fields. This business structure can help professionals better manage their practices and finances, from liability protection to tax advantages.

    By adhering to specific regulations and guidelines, professionals can enjoy the perks of operating as a PC while maintaining their professional standards and integrity. Consider consulting with legal and financial experts to determine if this structure fits your practice.

    Contact us if you have more questions about PCs or to apply for a small business loan. Our alternative business financing experts can help you find the best funding options for your business entity type.

    We will help you grow your small business.

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