As a licensed professional starting a solo practice, choosing the right business structure starts with understanding your options. Both limited liability companies and professional corporations have advantages and disadvantages in terms of taxation and personal liability protection.
The choice you make can have long-term repercussions for your practice, so it's worth spending some time looking into what makes the most sense for your situation.
What Is a Limited Liability Company?
A limited liability company or LLC is a legal entity that combines the limited liability protection of a corporation with the tax benefits of a partnership.
All 50 states and the District of Columbia recognize single-owner LLCs.
Should you choose to incorporate your sole proprietorship as an LLC in the future, you can do so under the IRS “check-the-box" regulations without incurring federal tax consequences.
How Is a Professional Limited Liability Company Different?
Certain businesses, such as those in the banking and insurance industries, are prohibited from forming an LLC. While some states allow professionals to form an LLC, others require that professionals form a professional limited liability company (PLLC) as set out by state statutes.
In a PLLC, the members and managers must be licensed to practice the same profession. In California, licensed professionals are limited to forming a sole proprietorship, general partnership, or professional corporation (PC).
One advantage of an LLC is that each owner—also called a member—has limited liability, which means they are not personally liable for the financial obligations of the LLC. Unlike corporations, LLCs do not have to abide by shareholders' directives or hold annual meetings.
What Is a Professional Corporation?
A professional corporation or PC is one variation of a corporation. Licensed professionals who want to incorporate their practice can form a PC.
However, the shareholders, directors, and officers must belong to the same profession. PCs aren't as popular as they once were, in part because of tax law changes and in part because LLCs or PLLCs provide the same limited liability protection as a PC does and are easier to run.
The list of professions that are required by statute to incorporate as a PC varies by state, so check with your state's corporate filing office—usually the Secretary of State. The following are often required to form a PC:
There are exceptions. Some states give professionals a choice between incorporating as a PC or as a regular corporation. In all states, certain professionals—again, check your state statutes—have the option to form a PC.
There are advantages and disadvantages to a PC.
If a professional retires or leaves, ownership is easily transferred to the others, and professionals can share management responsibilities and profits without worrying about being liable for each other's malpractice actions. The flat corporate tax rate, however, could limit corporate growth.
Differences in Taxation
There are differences between how a LLC vs. Professional Corporation is taxed. In the single-member LLC, taxes are handled as in a sole proprietorship, and all income passes through the LLC.
The owner reports all profits, or losses, as self-employment income on their Schedule C and submits it with the 1040 form in their personal taxes.
The PC pays corporation taxes, and this means a sole practitioner gets hit with double taxation.
Not only is their income taxed first at the corporation level, but it's taxed again as personal income. They can deduct corporate expenses, including disability insurance, life and health insurance, and payroll taxes.
LLCs are not required to pay state taxes in most states—again, check your state statutes. The owner pays state taxes on their personal tax return.
A few states require LLCs to also pay state taxes. In addition, some states impose a fee, often called an annual registration fee, franchise tax, or renewal fee.
Both can file as an S corporation—which is a special type of corporation that is created through an IRS tax election—to avoid double taxation. In an S corp., profits and losses pass through to your personal tax return.
There are similarities between a PC vs. LLC when it comes to personal liability. Both limit an owner's personal liability for business debts and claims to business assets, and creditors cannot come after personal assets.
Neither protects you against personal liability for your own malpractice, negligence, or personal wrongdoing.
Malpractice protection is often why professionals file as a PC to avoid financial liability for the wrongdoings of others in the practice.
For solo practitioners, however, this advantage doesn't matter, unless they plan to add additional professionals at a later date.
In this case, forming as an LLC is often the better choice. In some states, however, single-member LLCs don't have any creditor protection.
It's important to choose the right business structure to protect your business from unforeseen legal and tax consequences.
When choosing between an LLC and a PC, check the state statutes to make sure the legal entity can operate in your state. While each shares many similarities, there are also differences between them, so choose the one that meets your needs. If you have any questions, always check with an attorney.