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The professional corporation, or PC, is a form of business organization available under various state laws to narrow list of licensed professionals, including doctors, dentists, chiropractors and acupuncturists. Decisions about business form tend to boil down to weighing the advantages and disadvantages of any particular structure with respect to personal liability and tax matters, but other factors such as transferability of interests and ease of management play a role as well. This decision is additionally complicated by state licensing laws.

Why a PC?

State professional licensing laws, it must be remembered, are basically consumer protection statutes. States license various professionals, after having reviewed their credentials in some way, to protect members of the public from the harm that could be caused by quack doctors, phony lawyers and other pretenders.

States also generally prohibit licensed professionals from organizing their businesses as general corporations because the owners of a corporation, aka shareholders, are only liable for any harm caused by the corporation to the extent of their own interests. This limited liability feature runs contrary to the public policy of making sure that clients are protected.

So, with the basic corporate form of organization off the table, two chiropractors who wanted to set up a practice would then traditionally have organized it as a partnership.

In a general partnership, though, each partner is fully liable for any harm caused by the other. Dr. A would be fully liable for her own bad acts, including professional malpractice and for any malfeasance or malpractice committed by her partner, Dr. B, even if Dr. B were acting alone. Dr. A might buy insurance to deal with the first risk, but the second could present a greater problem. This makes a general partnership pretty risky and not a completely attractive solution. This a problem state legislatures began to recognized  some ago.

Enter the professional corporation. Organizing the hypothetical chiropractic practice as a PC solves part of the liability problem. Each chiropractor would be fully liable for the consequences of her own actions, including malpractice, but because the two are not partners but shareholders in a corporation, neither would be on the hook for the other’s failure to act in accordance with professional standards or for corporate actions in which the individual had no role. The limited liability feature has a price, however, in the form of some bothersome tax consequences, discussed below.

Forming a PC may also require additional steps on the part of the owners. Along with approval from the Secretary of State, professional entities must often seek approval of their formation documents from the state professional licensing body.

In addition, professional corporations that operate in more than one state will, like Subchapter C corporations, be considered residents of both the state of formation and the state of the principal place of business for purposes of federal diversity jurisdiction. This can make legal defense planning somewhat more complicated.

But What About Mixed Practices?

At the outset, it is important to be clear that someone without the proper license may not own a professional corporation. This is why, at least in the US, paralegals who may actually do the lion’s share of the work, cannot have an ownership interest in a law firm organized as a PC.

The real issue comes up with the task of organizing a practice to be owned by professionals with different licenses. What if our hypothetical chiropractors wanted to expand their practice to include a licensed acupuncturist and a licensed physical therapist?  It might make sense from a medical and business perspective, why not a legal one?

The answer is that it varies with the state.  Under California Business Corporations Code Section 13401.5, it could be done, as long as the acupuncturist and physical therapist together did not own more than 49 percent of the total shares of the corporation.  The statute sets out 16 different varieties of professional corporation and lists for each the licensed individuals who may participate as owners. This is an exclusive list, so the chiropractors could not add in a licensed family therapist. The statute also does not limit employment by the PC, just ownership.

In Texas, under Section 301.303 of the Business Organizations Code, the answer would be “no.”  All owners would have to have the same license. The same is true under New York law and in many other states. California is the outlier, in this situation.  In neither New York nor California could the chiropractors’ PC offer management services to any other professional corporation, including other chiropractors.

What About Taxes?

It is something of a good news/bad news story. When compared to unincorporated business entities, such as sole proprietorships, professional corporations have certain tax advantages.

  • They can create retirement plans and 401(k) plans for their employees that have higher contribution limits than plans available to individuals.
  • Professional corporations can provide health and life insurance as a tax-free benefit to their employees by establishing a Voluntary Employees' Beneficiary Association.
  • They can also take tax deductions for disability insurance, dependent care, and other employee fringe benefits. Generally, these benefits are tax-deductible for the corporation, and are not considered taxable income for the employees.

This may be sufficient incentive for a single professional person to become a professional corporation and his own PC’s employee, even absent the benefit of limited liability. It is also why PCs are often the sub-components of larger, more complicated organizations, such as law firm or medical practice partnerships.

A major drawback to the professional corporation structure is double taxation. Income is taxed to the corporation at relatively high corporate tax rates and again at individual rates when distributed to shareholders. Because of this, it makes very little sense to retain earnings in a PC. This can make it additionally expensive to build a practice from earnings.

Unlike a partnership, where all partners can deduct their share of business losses from personal taxable income, passive loss limitations may restrict the amount non-active shareholders can deduct in the event of losses.  Since professional corporations rarely have non-active shareholders, this may not make a difference.

Unlike a regular “C” corporation, PCs also have relatively little flexibility in the way income is distributed to shareholder/employees. This makes it more difficult to maximize individual tax bracket advantages or to recognize different roles in management.

Ease of Management

Professional corporations, unlike sole proprietorships and partnerships, also have the benefit of perpetual existence.  The corporate structure will not dissolve on the death or retirement of an owner. It may also be easier to transfer ownership interests, enter into buy/ sell agreements and to define the management structure.

Alternatives to PCs

Depending on state law, a professional corporation is not necessarily the only limited liability business structure available to licensed professionals.  A limited liability partnership (LLP) or professional limited liability company (PLLC), in those states that recognize this form, may offer a better mix of liability, tax and management features, depending on the details of state law.

Like PCs, both LLPs and PLLCs offer the protection of limited liability. In none of these structures, however, is an owner or partner shielded from liability arising from personal professional malpractice. All three entities  benefit from the same federal rules governing contributions to qualified retirement plans. Partners in an LLC and PLLC may borrow from their retirement accounts just as PC owners do.

Both PLLCs and LLPs may offer the flexibility in management arrangements characteristic of professional corporations, but only if specified in the partnership agreement .

The biggest difference is in tax structure. Partners in multiple-person LLPs and PLLCs may choose to be taxed under partnership rules, which eliminates the problem of double taxation. (It makes no difference for a single-person entity.) This may make it easier to retain earnings in the partnership to be used for business building.  The pass through nature of partnership taxation may also make it easier for individual partners to deduct losses.

Another distinction may have to do with the ease with which interests may be transferred. In theory, under most state laws, LLPs and PLLCs, like partnerships, dissolve on the death or withdrawal of a partner, but partnership agreements frequently specify otherwise.

Choosing an appropriate limited liability business structure is an important decision with long-lasting consequences. It depends, above all, on some long-range planning for the business. Only after this preparation, is it possible to determine, for example, whether tax considerations or ease of transferability, often an issue with newer businesses, should be paramount.  Particularly with the limited-liability partnership structures, it is essential to design the partnership agreement carefully in order to take advantage of some of the characteristics associated with professional corporations.

The essential details of business organization law vary from one state to the next. It is always important to work with an attorney qualified to practice law within a certain jurisdiction, but this is no occasion for a generalist even within that jurisdiction. As a client, it is essential to look for expertise in business formation and tax planning in order to be assured that the form of business organization supports long range plans as well as current needs.

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