Choosing the Right Legal Entity for Your Business - Exploring Professional Corporations
- Choosing the Right Legal Entity for Your Business - Exploring Professional Corporations
- What is a Professional Corporation?
- What Are the Best Types of Businesses to Operate as a Professional Corporation?
- Who Is Eligible to Operate as a Professional Corporation in the US?
- How to Register a Professional Corporation
- What are the Key Advantages of a Professional Corporation?
- What Are the Key Disadvantages of a Professional Corporation?
- Partnership vs. Sole Proprietorship vs. LLC vs. Corporation vs. Professional Corporation
- How is a Professional Corporation Taxed?
- How to Convert a Professional Corporation
Professional corporations differ from other types of legal entities and even corporations themselves. Unlike a regular corporation, there are strict rules about ownership and licensing with a professional corporation. When starting a new company, you must decide which business structure to use; your choices range from corporations, sole proprietorships, partnerships, and LLCs. The option requires planning and strategy. Before establishing a professional corporation, you must fully understand its benefits and drawbacks.
Although there is no exact figure on the number of professional corporations in the U.S., they are a subset of C corporations, totaling 1.7 million. These types of businesses are also referred to as Professional Service Corporations (PSC). There is no total because corporations are established according to state laws, not federal; therefore, there is no central database with this particular data. Professional corporations may be found in many different industries, but are typically used in healthcare, the legal sector, and accounting businesses.
The goal of a professional corporation is to benefit all owners and protect against any liability. This type of business entity offers flexibility. Professional corporations come with many pros and cons you must be aware of before establishing one. Further down this page, you can learn about what a professional corporation business is, how it works, how they are taxed, and the unique features and benefits of a professional corporation.
What is a Professional Corporation?
A Professional Corporation (PC) is a specific type of corporation primarily used by licensed professionals. It allows them to incorporate their practice while maintaining liability protection. The key is that, unlike with regular corporations, all owners within a professional corporation must be licensed in the same profession (e.g., accountants, attorneys, doctors, etc.).
Professional corporations are subject to state-specific laws, which vary throughout the U.S. It’s essential to consult with legal professionals when setting one up to cover all your bases. There is also the potential for double taxation. Professional corporations have complex administrative regulatory requirements, making them harder to maintain than other types of business structures.
Key Features of a Professional Corporation
A professional corporation offers its owners some of the same benefits of a corporation while also offering some differences. These unique entities come with a host of regulations that you must also comply with. The key features of a professional corporation are as follows:
- Liability Protection:
A professional corporation provides limited liability to its shareholders (owners), who are generally not personally liable for the corporation’s debts or obligations. This protects each owner’s personal property.
- Professional Ownership:
Almost always, the corporation’s owners must be licensed professionals in the same field, such as doctors, accountants, lawyers, or engineers.
- State-Level Regulations:
State law governs the formation and operation of a professional corporation. State agencies (usually the Secretary of State) decide which professionals are eligible to incorporate as a professional corporation and establish their rules and requirements.
- Taxation:
Professional corporations are typically taxed as C corporations, but they can elect to be taxed as S corporations, offering some tax advantages, like avoiding double taxation.
- Name Endings:
Professional corporations must add “PC” or “P.C.” to the end of their professional, registered name. This makes identifying them easy and distinguishing between a PC and a regular corporation.
What Are the Best Types of Businesses to Operate as a Professional Corporation?
Many different types of businesses operate as a professional corporation. It is highly dependent upon the state in which the company is formed. State regulations govern who can establish a professional corporation and how it must be operated. Some of the most common types are:
- Doctor’s Offices:
Any doctor’s office could register as a professional corporation. Usually, a group of doctors who want to share the expenses and revenue of a collective practice will open up an office and establish the company as a professional corporation.
- Chiropractors:
Chiropractors often group together to share an office and use a single professional corporation as their umbrella company.
- Registered Nurses:
Many times, a group of nurses will form a professional corporation and offer visiting nursing services to their local community.
- Veterinarians:
Veterinarian offices are lucrative businesses. Typically, a few vets form a professional corporation to share the workload in a veterinary office.
- Dentists:
Dentists often find it agreeable to form a professional corporation and share expenses, office space, and revenue.
- Optometrists:
Optometrists often have more work than they can handle. To solve this problem, they partner with other like-minded optometrists and form a professional corporation.
- Physical Therapists:
Injuries, age, and illness have resulted in a staggering need for physical therapists. Groups of them form a professional corporation to handle the multitude of patients flooding their office.
- Podiatrists:
Podiatrists may form a professional corporation to share office space, protect themselves from liability, and collaborate on services.
- Psychologists:
Psychologists often group and form a professional corporation to do business as.
- Lawyers/Attorneys:
Lawyers are notorious for forming professional corporations to provide limited liability, flexibility, and credibility to their practice.
- Accounting Services (CPAs):
CPAs are well known to operate under professional corporations.
- Engineering Firms:
These types of businesses include professional engineers, landscape architects, and others with the same industry licenses.
- Architects:
Architectural work is not consistent or regular, and it makes sense for many of them to partner under a professional corporation to share in the expenses and income.
- Social Work:
Social work organizations may also form a professional corporation to protect their owners, provide flexible arrangements and tax benefits, and add legitimacy to the business.
State regulations differ significantly. The specific professionals who can form a professional corporation vary from state to state. Some states even allow professionals to form Professional Limited Liability Companies (PLLCs). Unlike sole proprietorships or partnerships, these types of structures require more administrative tasks and reporting.
Who Is Eligible to Operate as a Professional Corporation in the US?
Eligibility to operate as a professional corporation will depend on the state rules where you incorporate. They can vary widely, but there are some similarities across the country. Typically, the number one requirement is that each owner be licensed in the same profession. That means that a CTO or business manager of a healthcare office, who is not also a doctor, could not own a piece of the business.
To be eligible to operate as a professional corporation, you must:
- Licensed Professional:
You must be a state-licensed professional in the same industry as the other owners.
- Specific Profession:
Based on state laws, only certain professionals can form professional corporations. Some examples are accountants, doctors, architects, dentists, lawyers, chiropractors, mental health professionals, land surveyors, and engineers.
- State-Specific Laws:
You must strictly adhere to state-specific rules or guidelines provided by the Secretary of State or other agencies regulating business entities.
How to Register a Professional Corporation
To register a professional corporation, you need to complete a few steps. They are as follows:
1. Determine Your Eligibility
First, you must determine if your organization can become a professional corporation. Check with the Secretary of State or other licensing board within your state to find out. Along with finding out if you can be a professional corporation, review the regulations and determine whether or not you can easily comply with them.
2. Incorporate Your Organization
Next, you must incorporate your organization through the Secretary of State or another agency responsible for business filings. Professional corporations are essentially corporations. Follow each of the steps below to do that.
3. Choose a Business Name
As with any business, the first step is to choose your business name. Keep the name simple, impactful, and related to your business purpose. Don’t choose a name that is too long or hard to remember or spell. The goal is to make it easy for your patrons to find you and remember your name. You will add PC or P.C. to the end of the name. Comply with other state rules regarding naming.
Check with your Secretary of State to ensure the name is available. You cannot use an existing name or one close to your chosen business name. Also, check the U.S. trademarks database to see if your proposed company name is already there. You do not want to infringe on anyone’s trademark.
4. Select Your State of Nonprofit
You can incorporate your company in any state within the U.S. Take some time to learn about the corporate laws, taxes, and fees to find a state that works best for you. Consider how easy or hard it is to incorporate in that state and how much it will cost. Some states offer a more business-friendly environment.
5. Draft and File Articles of Incorporation
Have an attorney draft your Articles of Incorporation, including the professional corporation’s name, purpose, and structure. File the completed and signed Articles of Incorporation with your state agency, which is most often the Secretary of State. Consult with your state agency and comply with the specifics in your state.
6. Draft & File Corporate Bylaws
Along with your Articles of Incorporation, have your lawyer draft your corporate bylaws detailing the operational rules of your professional corporation business, including membership requirements, duties, responsibilities, and procedures. Ensure that your bylaws comply with all federal and state laws.
Register with the IRS for an EIN
You should also obtain an EIN to file wage reports and other tax documents required by the IRS. This crucial step is easy to accomplish. Log onto the IRS.gov website, register your professional corporation, and get an EIN within a few days. You will need this EIN when you apply to open a business bank account.
7. Obtain Business Insurance
Find a corporate business insurance agent and purchase policies that protect you against catastrophic financial loss in case of legal issues or other problems. You will also need commercial auto insurance if you use vehicles in your business.
8. Apply for a Bank Account(s)
Apply for as many business bank accounts as you need to keep all business activities in one place. According to corporate laws, you must keep the nonprofit’s money separate from any board member’s or director’s.
9. Licensing
Ensure that each corporation owner has a valid and up-to-date license with the state in their chosen profession. These licenses are key to qualifying and keeping your professional corporation status.
10. Choose a Registered Agent
You must choose a registered agent for the professional corporation. This person or entity will be the legal point of contact and receiver of any legal documents and correspondence sent to the corporation.
11. Shareholder Meeting
Once your professional corporation is fully formed, you can hold your first shareholder meeting with all the owners. During the meeting, the initial “owners” will discuss the business plan and other topics of interest. The first order of business should be to discuss, approve, or amend the bylaws.
12. Register for State Filings
Your business may be required to file regular reports to a state agency. You may also be required to register with the state Attorney General’s office. Follow all state-level guidelines and file reports when necessary. Check with your state tax office to learn more about this step.
13. Secure Funding and Recruit Members
Explore financing options and secure funding to support the business for at least the first year. This may include taking out loans or asking new members to join and invest in the company.
14. What are the Key Advantages of a Professional Corporation?
A professional corporation (PC) offers several key advantages, primarily centered around liability protection, tax benefits, and increased credibility. It shields personal assets from business debts and lawsuits, allows for tax-advantaged retirement plans and other benefits, and enhances the business's reputation. Some of the key advantages of a professional corporation are:
A professional corporation can be a very attractive option for a group of licensed professionals.
What Are the Key Disadvantages of a Professional Corporation?
Along with some great benefits, professional corporations also have disadvantages you will want to review before deciding. The most significant drawbacks are tax issues, complexity, and license restrictions. The key disadvantages of a professional corporation are:
Partnership vs. Sole Proprietorship vs. LLC vs. Corporation vs. Professional Corporation
A professional corporation differs significantly from other business entities, but still retains some of the characteristics of a corporation. Review the chart below to learn about the different types of business formations and how they compare to see which structure makes the most sense for your professional corporation.
| Characteristic | Sole Proprietorship | Partnership | LLC | S-Corp | Nonprofit (C-Corp) |
|---|---|---|---|---|---|
| Formation | Quick and simple with no filing requirements with any government agency. | Simple to create with no legal filing requirements. | More expensive to create and requires filing with the state. | An S-Corp is more costly to establish, and it requires state filing. | It is more expensive to establish and requires filing with the state. |
| Cost of Formation | None | None | The cost of the state filing fee is usually between $100-$150. | The cost of registering an S-Corp with the state can be anywhere between $20 and $800. | The average cost to register a C-Corp in the United States is $633. |
| Business Name | Can operate under the owner’s name, or a fictitious name using a DBA. | Can operate under the owner’s name, or a fictitious name using a DBA. | Must register an official company name with the state that is established and secured. | Must register an official company name with the state that is established and secured. | Must register an official company name with the state that is established and secured. |
| Taxation | Pass-through taxation, where all everything is filed under the owner’s personal taxes. | Filed under the partners. Each partner claims their income and losses on their personal returns based on their percentage of the business. | Pass-through taxation, where everything is filed under the owner’s personal taxes. If there are multiple owners, taxation is treated like a nonprofit. | Each owner declares their share of profits/losses on their personal returns. Income is allocated based on owner percentage. Owners can use corporate losses to offset other types of income. Fringe benefits are limited to owners who own more than 2% of the shares. | The C-Corp is a separate taxable entity that must file returns. Owners split profits and only declare their portion on personal income tax returns. Owners can deduct fringe benefits as business expenses. |
| Liability | The owner is personally liable for all business actions, liabilities, debts, and damages. | Owners are personally liable for all business debts. | Business is its own entity; therefore, the owner(s) are protected against personal liability. | Owners have limited liability for personal debts, and business legal issues. | Owners have limited liability for personal debts and business legal issues. |
| Operational Requirements | No operational requirements are necessary. | No operational requirements are necessary. | More formal requirements than an LLC but not as strict as a C-Corp. | Much easier to maintain than a nonprofit. Annual member meetings and a report are required. | Annual meetings are required, and members must vote on changes. Shares of stock must be sold to raise capital. |
| Management | Full control of all decisions, management, and operations. | Each partner has equal control and decision-making ability unless it’s a limited partnership. | An operating agreement outlines how each member can manage the company. | Managed by a group of directors that shareholders vote in. | Managed by a group of directors that shareholders vote in. |
| Raising Capital | Can be challenging and the owner often has to invest his/her own money. | Each partner can invest, and more partners can be added to raise additional capital. | Managers can sell interest in the business to raise capital based on operating agreement restrictions. | Can sell shares of stock to raise capital. | Can sell shares of stock to raise capital. |
| Transferability of Interest | No | No | Possible based on the operating agreement restrictions. | Yes, as long as IRS regulations about who can own stock are honored. | Shares of stock can be easily transferred. |
How is a Professional Corporation Taxed?
Most professional corporations are typically taxed as C corporations by the IRS. That means they are subject to corporate income taxes on any profits. Plus, the corporation’s owners also pay income tax on any dividends they receive from the corporation, which is called “double taxation.”
Corporate Taxation
As a rule, professional corporations are treated as C corporations for tax purposes, meaning that the corporation itself must file a tax return and pay taxes on any profits earned during the year. They are subject to the corporate tax rate, which is a flat rate of 21%. Professional corporations pay taxes on their profits before any income is distributed to the owners as dividends. Professional corporations must often meet specific requirements to qualify for the flat 21% corporate tax rate. For example, 95% of their business activities must be within their declared field, and 95% of their shares must be held by licensed professionals providing services to the corporation.
Taxation of Owners/Shareholders
When the corporation distributes profits to its owners as dividends, those dividends are taxed again as personal income on the owners' tax returns. This is where the "double taxation" aspect comes in, as the income is taxed at the corporate level and then again at the individual level. Most people want to avoid double taxation, and some may elect to be taxed as an S corp.
Potential for S Corp Election
Some professional corporations have the option of electing to be taxed as an S corporation, which can help avoid double taxation. If a professional corporation qualifies as an S corporation and makes the election, all the corporation’s profits and losses are passed through to the personal owners’ income tax returns (pass-through taxation), avoiding corporate taxes.
Professional corporations must use a calendar year as their tax year, with some exceptions. Always consult a tax professional for specific rules pertaining to your business.
Pros and Cons of Professional Corporation Taxation
Professional corporation taxation can be complex and costly. There are both some advantages to how they are taxed and some disadvantages. They are listed below:
Use the table below from the IRS to be sure you are filing the correct forms when filing taxes:
How to Convert a Professional Corporation
There may come a time when converting your professional corporation to another type of business entity makes sense. This occurs for many different reasons and circumstances. The key is knowing all the complexities to get it right and avoid legal or regulatory issues later.
Converting a Professional Corporation to a Partnership
Converting to a partnership, whether a general partnership or a limited liability partnership (LLP), involves several steps and requires careful attention to detail to avoid any legal or tax implications. The steps to do so are as follows:
- Dissolution and Liquidation: You must dissolve the professional corporation completely before forming a partnership. This involves filing the necessary paperwork with the state (usually the Secretary of State). You must then liquidate (sell or convert to cash) the assets and distribute the proceeds to the shareholders.
- Formation of the Partnership: Former professional corporation shareholders who now become partners form a new partnership (general or limited). This step requires deciding which type to form, drafting a partnership agreement, and registering with the state as a partnership.
- Transfer of Assets: The assets previously owned by the professional corporation can now be transferred to the newly formed partnership.
- Research Tax Implications: Since the conversion is treated as a corporation liquidation, it can have significant tax consequences, such as potential capital gains taxes for shareholders.
- File with the State: To complete your conversion, you may also need to file a special “Certificate of Conversion” form and various other legal documents with the Secretary of State.
Converting a Professional Corporation to an LLC
Converting to an LLC offers members more flexibility, structure, and options. The process of converting from a professional corporation involves several key steps, is complex, and has potential tax implications. The steps to do so are as follows:
- Check Eligibility: Ensure the conversion is permissible under your state's laws.
- Obtain Shareholder Approval: Hold a meeting of all shareholders and take a vote to get approval from all the owners on the conversion.
- File Articles of Conversion: To formally convert the corporation to an LLC, file the required documents with the state’s Secretary of State.
- Dissolve the Corporation: If the business entity is a "C" corporation, it must be formally dissolved after the conversion.
- Form the LLC: Create the new LLC, including filing the Articles of Organization and drafting an Operating Agreement. File these with the Secretary of State.
- Transfer Assets and Liabilities: Transfer the corporation's assets and liabilities to the new LLC.
- Dissolve the Corporation: Dissolve the old corporation if necessary.
- Notify the IRS: Inform the IRS of the change in entity structure.
You can convert a professional corporation to an LLC in three different ways. They are as follows:
- Statutory Conversion:
This is the simplest method, involving filing a certificate of conversion with the state.
- Statutory Merger:
This involves creating a new LLC and merging the corporation into it.
- Asset Transfer:
This method involves transferring the corporation's assets and liabilities to a newly formed LLC.
The conversion can have significant tax consequences, potentially triggering taxes on the transfer of assets. Consult with a tax professional to understand these implications. Additionally, while an LLC offers some liability protection, the corporation’s existing liabilities may still apply after conversion. The conversion may impact ownership rights, the distribution of profits, and management roles.
Converting a Professional Corporation to a Standard Corporation
Converting from a professional corporation to a standard corporation typically involves amending the PC’s articles of incorporation and filing the necessary paperwork with the state. You may also have to change the name to reflect the new status. To go about it, follow the steps below:
- Review State Laws: Each state has its own rules regarding professional corporations and their conversion to other business structures. Consult with a legal professional to understand the specific requirements in your state.
- Obtain the Necessary Approvals: Depending on the state regulations and government documents of your PC, you may need approval from shareholders, directors, or even specific licensing boards (like the state medical board for doctors).
- Prepare and File Documents: Draft a Certificate of Conversion outlining the conversion details, including the new business structure and effective date. Amend your Articles of Incorporation to reflect the changes in the corporate structure and purpose. You may need to file additional forms (e.g., new Articles of Incorporation), along with those above, with the state.
- Elect S-Corp Status (Optional): If you want the corporation to be taxed as an S-Corp, you must file IRS Form 2553. This election must be made within a specific timeframe and is subject to IRS approval.
- Comply with Licensing Requirements: If the PC operated under a specific professional license, ensure that the new entity (C-Corp or S-Corp) meets all licensing requirements. A new license may be required.
- Address Tax Implications: Changes in business structure can have major tax consequences. Consult with a tax professional to understand the potential impact of the conversion.
Check with your state office to review the specifics of corporate law and how to change your professional corporation into a new business entity to avoid any legal hassles down the road.
- Choosing the Right Legal Entity for Your Business - Exploring Professional Corporations
- What is a Professional Corporation?
- Key Features of a Professional Corporation
- What Are the Best Types of Businesses to Operate as a Professional Corporation?
- How to Register a Professional Corporation
- What are the Key Advantages of a Professional Corporation?
- What Are the Key Disadvantages of a Professional Corporation?
- Partnership vs. Sole Proprietorship vs. LLC vs. Corporation vs. Professional Corporation
- How is a Professional Corporation Taxed?
- How to Convert a Professional Corporation