Incorporator The Journal of U.S. Formation
Start Free Quiz
Editorial 6 MIN READ

The professional corporation, honestly: when you must, when you shouldn't

California forces a doctor, a lawyer, or a CPA into a PC. The federal tax code charges a flat 35% for the privilege

The Editors
Staff, Incorporator.org
6 min read Updated
Contents 5 sections
  1. When a PC is the right form (usually because it's the only form)
  2. Formation mechanics: clear the licensing board first
  3. Tax: the flat 35% that catches most PCs
  4. Failure modes
  5. Sources

professional corporation is rarely a choice. For most licensed professionals in California, and many in New York and Illinois, it is the only corporate form state law allows them to practice through. The question is how to keep the form from costing more than it is worth.

In December 2016, the federal tax penalty for getting this wrong is a flat 35% on taxable income, where an ordinary C-corp would pay 15%.

When a PC is the right form (usually because it's the only form)

California's Moscone-Knox Professional Corporation Act, Corp. Code §§ 13400–13410, maps licensed practice onto the PC and almost nowhere else. Section 13401 defines a professional corporation as one rendering services in a "single profession" for which California requires a license under the Business and Professions Code, the Chiropractic Act, or the Osteopathic Act. The list is long: medicine, law, dentistry, accountancy, architecture, psychology, optometry, pharmacy, veterinary medicine, chiropractic, and several dozen others. California does not let licensed professionals form an LLC to practice a licensed profession at all — the carve-out in Corp. Code § 17701.04(b) is the reason every California physician group you have ever met is a "Medical Corporation" and not "Acme Medical, LLC."

New York routes some professions toward the PLLC. NY Business Corporation Law Article 15 (§§ 1501–1516) governs the PC for physicians, lawyers, dentists, architects, engineers, and accountants. Since 1994, NY LLC Law Article 12 has also permitted a professional service LLC; lawyers commonly use the PLLC, medicine can use either, and the Education Department's Office of the Professions must consent before the Department of State accepts the filing. Illinois splits the difference — the Professional Service Corporation Act, 805 ILCS 10, governs PCs, and PLLCs are allowed for most of the same professions, but the PC remains the default for medicine and multi-shareholder practices.

If a state licensing board regulates your profession, form at home and expect a PC unless the board blesses a PLLC.

Formation mechanics: clear the licensing board first

The formation sequence is inverted from an ordinary corporation. You clear the licensing board first; in most states it issues a certificate of registration the Secretary of State will require, or that the board requires before the corporation can render services.

California Corp. Code § 13404 requires the PC to hold "a currently effective certificate of registration issued by the governmental agency regulating the profession" before rendering services — though the Medical Board of California and several other healing-arts boards regulate the corporation directly instead. A law corporation registers with the State Bar; an accountancy corporation with the California Board of Accountancy. The articles must state under § 13404 that the corporation is a professional corporation, and the name must comply with § 13409. Illinois follows the same pattern under 805 ILCS 10; New York BCL § 1503 requires the licensing authority's certificate of consent attached to the articles.

These statutes restrict shareholders to licensees of the same profession. California Corp. Code § 13406 voids any share issuance or transfer to a non-licensee; Illinois 805 ILCS 10/11 is to the same effect. A few states permit minority cross-ownership among allied health professionals (§ 13401.5 lets specified practitioners hold up to 49% of a medical, dental, or nursing corporation), but the baseline rule is: one profession, same-license owners.

Tax: the flat 35% that catches most PCs

Here is where the bill lands. IRC § 11(b)(2) taxes the income of a "qualified personal service corporation" — as defined in IRC § 448(d)(2) — at a flat 35%. No graduated brackets. A PC with $100,000 of taxable income owes $35,000; an ordinary C-corp with that same income, under the 2016 graduated structure in § 11(b)(1), would owe $22,250.

Section 448(d)(2) defines the qualified personal service corporation by a function test and an ownership test. Substantially all the corporation's activities must involve services in health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting; and substantially all the stock (by value) must be held by employees performing those services or their estates. Treasury reads "substantially all" at 95% for each prong (Treas. Reg. § 1.448-1T(e)(4)).

Most PCs solve this by zeroing out corporate taxable income through shareholder compensation — pay the physician-shareholders as employees and leave nothing at the corporate level for § 11(b)(2) to tax. It works until it doesn't; reasonable-compensation challenges and year-end bonus timing routinely push residual income into the 35% bracket. The S-election is the standard workaround; a practicing-professional PC that has not elected S status should ask its CPA why.

Failure modes

Three recur.

First, the fiscal-year problem. Under IRC § 441 and Treas. Reg. § 1.441-3, a PSC must use a calendar year unless it elects under § 444 (deferral period capped at three months, so only September, October, or November year-ends), establishes a natural business year, or obtains discretionary permission under § 442. The § 444 election costs a required minimum distribution to shareholders in the deferred months, which partly defeats the planning. Most PCs capitulate to calendar-year reporting.

Second, the malpractice carve-out. The PC shield does not protect the practitioner from her own negligence. NY BCL § 1505 states the rule most plainly: each shareholder, employee, or agent "shall be personally and fully liable and accountable for any negligent or wrongful act or misconduct committed by him or by any person under his direct supervision and control while rendering professional services." Illinois 805 ILCS 10/8 is to the same effect. California Corp. Code § 13410 requires every PC to carry security for malpractice claims against its shareholders. What the shield does protect against is ordinary-business liability — leases, vendor contracts, trade debt. We're Associates Co. v. Cohen, Stracher & Bloom, P.C., 103 A.D.2d 130 (N.Y. App. Div. 2d Dep't 1984), is the canonical holding: a landlord could not reach a law firm's shareholders personally on the office lease; § 1505's liability rule is confined to malpractice. The PC shields co-owners from each other's malpractice and shields everyone from ordinary business debt, but never shields the practitioner from her own professional negligence.

Third, ownership succession. Every PC statute forces shares out of the hands of a disqualified person — death, surrender or suspension of the license, disciplinary action. California Corp. Code § 13407 and the Illinois Act each require shares to be transferred to a licensed person or redeemed by the corporation within a statutory window. A PC without a funded buy-sell that triggers on death or license loss defaults into statutory redemption at book value at the worst possible moment, and it is the single most-overlooked document in small-practice formations.

The PC is less a tax structure than a regulatory one. The state licensing board writes most of the rules; the IRS writes the rest, and the rest is expensive. If you are a licensed professional in California, Illinois, or New York, the form is probably not optional. File the S-election, fund the buy-sell, and don't mistake the PC for a shield against your own work.

Sources

Keep reading

More from the journal.