A professional corporation is an incorporated business whose shareholders are licensed to provide professional services. In some states, licensed professionals, such as doctors and lawyers, must form a professional corporation or other professional business entity.
If you’re a member of a professional occupation, then you’re already used to dealing with more government regulation than the average small business. The licensing process for professionals can be lengthy and complicated. There are regulations around keeping your license active and ensuring that your customers are safe and well-protected. Some states also have rules around what types of business entities you can or must form as a member of a professional occupation.
Many states require or allow licensed professionals to form a professional corporation (PC). Professional corporations are incorporated businesses that are specially designated for licensed professionals. A professional corporation comes with certain benefits, like personal liability protection for each owner when another commits malpractice. In this guide, we’ll explain how a professional corporation works and the steps for forming one.
Professional corporations and regular corporations are similar in many ways. To begin with, both have a three-part ownership and management structure. The corporation is owned by shareholders, who elect a board of directors to manage strategic decisions. The board elects officers to run the corporation on a day-to-day basis. The primary advantage of any corporation is that shareholders are protected from personal liability for the debts and obligations of the business.
Anyone can form a regular C-corporation or S-corporation, whether they’re the sole owner of the business or have business partners. A professional corporation can also have one or more owners, but is reserved for licensed professionals.
According to Walter Gumersell, a partner at the law firm of Rivkin Radler LLP, the major selling point of a professional corporation is that it “limits the professional’s liability to their investment in the professional corporation. However, there is an exception to this limitation of liability. Professionals cannot use the professional corporation to limit their own liability for malpractice.” In other words, if one partner of a professional corporation commits malpractice, the others can’t be held personally liable. But, they can be held personally liable for their own malpractice.
In some states, professionals must form a professional corporation or other type of professional business entity, such as a professional limited liability company (PLLC) or professional limited liability partnership (PLLP). Keep in mind that state requirements vary, so make sure you understand the rules in your state before you set out to form a professional corporation or other professional business entity.
A member of any profession that requires state licensing is eligible (or required in some states) to start a professional corporation if they wish to incorporate. Examples include doctors, lawyers, accountants, architects, civil engineers, cosmetologists, and home inspectors.
The main rule for forming a professional corporation is that every owner of the business must have a valid license to perform the occupation. For example, if you have a law firm organized as a professional corporation, every owner in the firm must be a licensed attorney. You can’t make a non-lawyer an owner in the business, unless your state laws specifically allow it.
Gumersell says, “Some states permit non-professionals to be shareholders in professional corporations. For example, some states would permit non-professionals to acquire a non-controlling interest in an architectural professional corporation.” Professional corporations are highly regulated at the state level, so it’s important to learn your state’s rules.
Professional corporations work in much the same way as regular corporations, with a few important differences. Here’s a closer look at professional corporations.
The owners of a professional corporation are shareholders who own stock in the business, as well as employees who provide professional services for the business. As mentioned above, states differ in terms of whether non-professionals can own stock in a professional corporation. Another professional corporation or partnership can also own stock in a professional corporation as long as both belong to the same profession. In other words, a professional corporation of doctors can’t own stock in a professional corporation of lawyers.
Some states also have restrictions against dual practices, meaning that the owner of a professional corporation can’t provide more than one type of professional service. For example, if a group of licensed architects are also licensed engineers, the firm cannot provide both architecture and engineering services.
The professional corporation’s owner-employees must appoint a board of directors, who decide on strategic matters affecting the company. The directors elect officers—such as the CEO or CTO—to run the business on a day-to-day basis. In some states, a professional corporation’s officers and board of directors must also be licensed to practice the profession of the corporation. For example, an architecture professional corporation might have to name licensed architects as officers and board members.
As with other corporations, a big benefit of a professional corporation is limited liability. The owners of a professional corporation are not liable for the debts and obligations of the business. In addition, one owner is also not personally liable if another owner commits malpractice, which is a key motivation for forming a professional corporation. That said, there’s no limit on personal liability for an owner’s own malpractice, so it’s important that each owner purchase sufficient malpractice insurance or errors and omissions insurance.
All professional corporations, like regular corporations, have to pay the federal corporate income tax. The federal corporate income tax rate is currently 21% and applies to any income retained in the business. Compensation that’s paid to employees is tax deductible for the professional corporation. However, the owners have to pay personal income taxes on their salaries, bonuses, and fringe benefits.
The owners of a professional corporation can elect for the business to be taxed as an S-corporation. In that case, the profits and losses of the business will pass through to the tax returns of each owner and will be taxed at each owner’s personal income tax rate.
Some professional corporations are considered personal service corporations by the Internal Revenue Service (IRS). To meet the definition of personal service corporation, the business’s activities must fall in the realm of health, law, engineering, accounting, actuarial science, consulting, or performing arts. In addition, at least 95% of the professional corporation’s stock must be held by the owner-employees, retired owner-employees, or their heirs or estates.
Personal service corporations have to comply with some specific tax laws. For example, a personal service corporation must follow a calendar tax year.
Professional corporations offer most of the same advantages as a regular corporation: personal asset protection, the ability to issue stock, and tax advantages. The downsides to a professional corporation are also the same as those of a regular corporation, such as the time and money spent on corporate formalities.
A professional corporation is not the only type of business entity that licensed professionals can form. Many states also recognize the PLLC and PLLP as valid business entity structures for licensed professionals.
A PLLC, like a professional corporation, shields each member of the business from personal liability for the malpractice of other members. A PLLC with multiple members is taxed like a partnership, with income flowing through to each owner’s personal income tax return. A PLLC has fewer reporting requirements than a professional corporation. The downside to a PLLC is that this type of business entity can’t issue stock, which can make it difficult to attract new owners to a professional practice.
A PLLP is a partnership of licensed professionals where, again, each partner is shielded from personal liability for errors committed by other owners. In a PLLP, the profits and losses of the business pass through to each owner’s personal tax return. A PLLP is also slightly easier to form and maintain compared to a professional corporation.
Forming a professional corporation is similar to forming a regular corporation, with a few additional steps.
Here are the steps to form a professional corporation:
Once you have formed your professional corporation, keep it active by paying taxes on time, renewing the professional licenses of each owner, and by complying with other regulatory requirements.
A professional corporation is an excellent way for licensed professionals to get legal protection while joining forces with peers to form a business. In some states, forming a professional corporation isn’t optional. If a group of licensed professionals want to go into business together, they might have to form a professional corporation or other type of professional business entity. Every type of business entity has a different set of pros and cons, so it’s a good idea to consult with a business attorney before making your decision.
Priyanka Prakash is a senior contributing writer at Fundera.
Priyanka specializes in small business finance, credit, law, and insurance, helping businesses owners navigate complicated concepts and decisions. Since earning her law degree from the University of Washington, Priyanka has spent half a decade writing on small business financial and legal concerns. Prior to joining Fundera, Priyanka was managing editor at a small business resource site and in-house counsel at a Y Combinator tech startup.