A professional corporation is a corporation that comprises different types of professionals such as doctors, lawyers, architects, accountants, engineers, psychologists, etc. In most states, professionals who want to incorporate their practice can do so by forming a professional corporation or a professional service corporation.
A professional service corporation is different from a professional corporation, as the former is set up under specific regulations provided by the Internal Revenue Service (IRS). For example, one of the provisions of the IRS is that employee-owners should hold more than 10% of the corporation’s equity.
Professional corporations must be incorporated within the state where the professionals carry on their practice. While regular corporations absolve shareholders from personal liability, professional corporations allow professionals to enjoy the benefit of corporations, while only limiting their personal liability in certain situations.
Professional corporations cannot be formed with the goal of protecting the owner-employees from personal responsibility for professional malpractice. Professional corporations are taxed at the same tax rate as regular corporations, and the owners are required to pay the FICA tax instead of the self-employment tax.
A professional corporation is an entity established by a specific type of professional, such as an attorney, doctor, architect, or veterinarian, to provide a service related to their profession.
Professional corporations are registered according to the governing laws of a specific state.
The shareholders of a professional corporation are protected from personal liability for debts incurred by the corporation, and to some extent from malpractice by other owners of the corporation.
Legal Requirements of a Professional Corporation
The establishment of a professional corporation is governed by the prevailing laws of the state where the corporation is formed. In certain states, there are restrictions on the type of professionals who may own shares of the corporation. In most cases, professional corporations are limited to professionals in the same field.
For example, a corporation whose main focus is to offer medical care can only be formed by doctors, and they must hold the appropriate practicing certificates in the state of incorporation. The specific requirements of forming a professional corporation can be obtained from the office of the Secretary of State.
How to Create a Professional Corporation
The incorporation process for a professional corporation requires its founders to provide certain documentation to the appropriate authorities. The following are the basic steps of creating a professional corporation:
1. Draft the articles of association
The first step when creating a professional corporation is to draft the articles of incorporation, which will be filed with the state during registration. In that document, the organizers must state clearly the intent to operate as a professional corporation. The articles of incorporation should also state the purpose of the corporation, which is the service or product that the corporation will offer.
For example, if the corporation is comprised of Certified Public Accountants (CPAs), the purpose of the corporation would be to offer accountancy services. The professionals establishing the corporation should hold a practicing certificate in the state where they intend to offer the service.
2. Naming the corporation
The organizers should also specify the proposed corporation name, which should be different from the names of other registered entities. Ideally, the corporation should include the words “professional corporation” in the proposed name and should include the exact spelling, punctuation, or abbreviation designating the profession, such as M.D. or P.C.
3. Obtain local approval
Before the incorporation can be approved by the state, the parties may be required to obtain additional approval from the relevant licensing boards. For example, if the parties forming the corporation are doctors, they may be required to obtain approval from the State Medical Board of the state in which they practice medicine. The parties will also be required to provide copies of practicing licenses of all members forming the corporation.
Limits on Liability of Professional Corporations
The shareholders of a professional corporation enjoy protection from liability for debts incurred by the corporation. Therefore, the personal assets of the shareholders cannot be sold or auctioned off to pay the debts of the corporation. The shareholders can only incur liability up to a value equivalent to the amount of their shareholding in the corporation.
A professional corporation also protects shareholders from the liabilities of other employee-owners of the corporation. If one owner is found to have engaged in professional malpractice, he/she will have unlimited personal liability for their own acts. However, if an accuser can demonstrate that the professional corporation engaged in the malpractice as a whole, then the owners of the corporation are held liable.
Taxation of Professional Corporations
The professional corporation is taxed at a flat rate of 21%, instead of a graduated scale. The taxation rate is similar to the flat tax rate imposed on US resident corporations by the IRS. However, to qualify for the flat tax rate, the IRS requires that 95% of the business activities of the corporation be within the area of specialization that the corporation declared at the point of registration. Also, 95% of the professional corporation’s shares must be held by current and former employees who provide the relevant service for the corporation.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful: