Everything You Need to Know about Professional Corporations

Legal Requirements

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.

Governing Law

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.

Creating a Professional Corporation

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:

• Intent to operate as a professional corporation – When drafting articles of incorporation, it must be stated clearly that the owners of the corporation intend to operate as a professional corporation. It is important to determine if the state has any specific requirements before filing the articles.
• Defining purpose – The articles of incorporation must clearly state the purpose of the corporation. For example, if the professional corporation is comprised of lawyers, the purpose of the corporation would be to provide legal services.
• Naming the company – Along with the normal issues with naming a company, a professional corporation must include certain language. The terms 'professional association,' 'service corporation,' 'professional corporation,' or 'professional service corporation' must be included in the name. It is also acceptable to use the abbreviations S.C., P.C., or P.A.
• Obtaining local approval – Individual states often require the parties involved to obtain additional approvals from the appropriate licensing boards. This will likely involve providing copies of licenses for all persons involved as owners of the corporation.

Restrictions on Professional Corporation Formation

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.

• Licensing – Only those who are licensed to practice the specific service may incorporate. For example, if the professional corporation is made up of physicians, they must all be licensed to practice medicine in the state of incorporation.
• No dual practices – In some cases, a group of people may hold more than one license. For example, a group of attorneys may also be licensed to provide accounting services. If the professional corporation is set up for the purposes of providing legal services, they may not provide accounting services.
• Board and officers – While the treasurer and secretary of the corporation are exempt, all officers and one-half of the board of directors must be licensed to practice the specific profession of the corporation. For example, a veterinary professional corporation may offer board positions to pet groomers, those who own a boarding service, or office staff members. This is fine so long as their participation is not more than one-half of the board.
• Accepting partnerships – Ownership is not limited to only individuals. Partnerships may also be part of the corporation as long as the partners are of the same profession. The same holds true for other professional corporations. A partnership or professional corporation of attorneys may not be the owners of a professional corporation of physicians.
• Handling stock shares – Issued shares of stock must specify the shares are part of a professional corporation. In addition, the stock shares must clearly state that transfer of such shares is restricted.

Understanding Taxation of Professional Corporations

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.

Limits on Liability

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.

Advantages of a Professional Corporation

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.

Disadvantages of a Professional Corporation

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.

Why Choose a 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.

Individual State Regulations May Vary

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.”

Corporate Formalities Still Required

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:

• Handling of funds – There should be a process in place that prohibits the commingling of personal and corporate funds. It may be necessary to spell this out in the bylaws as well as bring it up in the minutes of the first meeting of the board of directors.
• Setting up bank accounts – The corporation should have its own checking accounts, lines of credit, and credit accounts as needed. In general, a separate corporate resolution may be required to obtain bank accounts for the corporation.
• Written agreements – A professional corporation should ensure all agreements are preserved in writing. This may include lease agreements for real estate or equipment, employment agreements, and benefits plan agreements.

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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