What is a Professional Corporation?
A professional corporation (“P.C.”) is a business entity formed under special state statutes which allow people that would otherwise not be able to organize as corporations to receive most of the benefits of the corporate form, subject to certain additional limitations. Under the Revised Model Business Corporation Act and the law of most states, certain professions, such as doctors, lawyers, accountants, and architects are prohibited from forming corporations for the purpose of practicing their profession because of a fear that organizing as a corporation would allow them to limit malpractice liability. Unlike an ordinary corporation, professionals in a professional corporation enjoy only partially limited liability. Professionals in a professional corporation are personally liable to for their own malpractice, but enjoy limited liability with regards to all other obligations.
Professional corporations are governed by the law of the state in which they incorporate and are generally governed by the state’s general corporation law, with a few limited carve outs. Most importantly, as a general rule, only licensed professionals can own shares in a professional corporation. Most states further limit ownership by mandating that all shares of a professional corporation can be owned only by practitioners of the same profession. For example, if a professional corporation is organized for the purposes of providing legal service, only lawyers are allowed to own shares of the corporation. In recent years, this limitation has been removed in several states.
How to Create a Professional Corporation
The process of creating a professional corporation is largely the same as the process for creating an ordinary corporation. For more information regarding this process see the article in this series on creating a corporation. Although details vary from state to state, the process for creating a professional corporation differs from the process of creating a normal corporation in four ways:
- Declaration of Intention to Operate as a Professional Corporation: The articles of incorporation filed by a professional corporation must state that the corporation is a professional corporation.
- Purpose: The articles of incorporation must state that the corporation’s purpose is to render services of a specific profession.
- Name: In additional to the naming requirements ordinarily imposed on corporations, a professional corporation’s name must contain either the phrase “professional corporation,” “service corporation,” “professional service corporation,” “professional association,” or the abbreviations “P.C.,” “P.A.,” or “S.C.”
- Approval: Some states require the profession’s licensing body to approve the incorporation.
Statutory Restrictions on Professional Corporations
Professional corporations are subject to several restrictions that are not imposed on other corporations. The most important of these restrictions are:
- Only people licensed in a professional that is not allowed to incorporate under a states general corporation law can create a professional corporation.
- A professional corporation can generally only practice one profession.
- Only people licensed to practice the profession in the state in which they are practicing can practice as a part of a professional corporation.
- Generally at least half of the board of directors and all of the officers (except the treasurer and secretary) of a professional corporation must be licensed to practice the specified profession.
- Only professionals licensed to practice the specified profession, partnerships practicing the same profession, and other professional corporations practicing the same profession can hold shares of a professional corporation
- Shares must clearly note they are shares of a professional corporation AND that their transfer is restricted.
Consequences of Organizing as a Professional Corporation
Tax Consequences
Most professional corporations are taxed as “professional service corporations” (“PSCs”). In order to be taxed as a PSC under Internal Revenue Service rules, a professional corporation must meet two tests:
- Functionality Test: At least 95% of the corporation’s business activities involve services within a specified field.
- At least 95% of the corporation’s outstanding stock is held by current or former employees who performed professional services for the corporation or by their heirs or estates.
PSCs are taxed in the same manner as C-corporations, except with a flat rather than gradual tax rate. Professional corporations that are not considered PSCs are taxed as general partnerships.
Liability Consequences
Shareholders in a professional corporation are not personally liable for the debts of the corporation or the malpractice of other owners unless a plaintiff “pierces the corporate veil” by showing the corporation failed to observe the requisite formalities and/or was undercapitalized. In this manner, the limited liability feature of a professional corporation is identical to the limited liability feature of an ordinary corporation. Unlike traditional corporations where a shareholder’s liability is limited to the amount they paid for their shares, shareholders in a professional corporation have unlimited personal liability for their own acts of malpractice or misconduct. In short, organization as a professional corporation allows owners to limit their liability for everything except their own professional negligence or misconduct.
Advantages of Operating as a Professional Corporation
The major advantages of a Professional Corporation are:
- Limited liability for the malpractice or misconduct of other professionals in the corporation.
- Limited liability for corporate debts.
- Access to tax breaks: Some tax advantages are available only to corporations. For example, higher 401(k) contribution limits and the ability to provide health and life insurance benefits to employees tax-free.
- Easier transferability of ownership than a partnership.
- Perpetual life: Unlike partnerships, professional corporations do not dissolve when an owner dies or leaves.
Disadvantages of Operating as a Professional Corporation
The disadvantages of a Professional Corporation are:
- Unlimited liability for personal misconduct or negligence.
- Possible Double Taxation: Although generally avoidable during normal business operations, profits from professional corporations may be subject to unavoidable double taxation in certain circumstances, such as when corporate assets are sold or when the corporation is liquidated.
- Limited Availability: Only certain professions can organize as professional corporations and professional corporations are generally limited to members of one profession.
Legal Disclaimer
This website provides information addressing legal topics of interest to the general reader. You should not consider this information designed or adequate to meet any of your particular legal needs, concerns or inquiries. You should consult with a lawyer licensed to practice law in the jurisdiction appropriate to your legal situation to assess your situation and provide you with appropriate legal advice. A good starting point for finding a lawyer is to contact your state’s bar association.
This article is copyrighted by Knowledge Website, LLC – 2010