Tax Advantages If You Are a Professional Corporation

Tax Advantages If You Are a Professional Corporation

by Brette Sember, Esq., April 2018

First, what is a professional corporation? A professional corporation, or PC, is a type of business organization used by members of certain professions who seek the benefits and protections of a corporation but who are not permitted to form a traditional corporation.

Those who work in the designated professions—which include lawyers, architects, physicians, accountants, engineers, and performing artists—and who form a business and would like the protections available to corporations must, in many states, opt to become a PC. This type of corporation is only available to the professions specifically listed by state law, so not every business is eligible to become a PC.

Professional Corporation Taxes

While professional corporations are recognized by most states—and this is the general term used to describe this type of organization—the IRS designates these entities as "personal service corporations" and defines them as corporations with a primary purpose of providing personal services where 95% of the services provided are in the qualifying fields. A PC must file a professional corporation tax return and pay taxes on its earnings. This is in contrast to LLCs or partnerships that have pass-through taxation, meaning the LLC members or partners pay tax on the profits of the company themselves and the company itself is not subject to direct taxation.

PCs are subject to a 35% flat federal tax rate on their corporate earnings, which can be a disadvantage since C corporations are taxed at 15 to 34% for their earnings below $100,000. With an LLC or partnership, income is passed through to the members and partners who pay personal tax rates on the income, with rates between 10 and 35%.

Tax Benefits

PCs do have some corporate tax advantages. Professional corporation tax deductions are the same types that are available to regular corporations and so PCs can deduct the cost of salaries and benefits paid to the employee-owners. Many PCs pay out nearly all of their earnings in salaries, benefits, and bonuses, leaving almost no income to actually tax at the PC level.

Because they are a corporation and not a partnership, PCs can completely deduct any business expenses or interest the corporation owes to employee-owners. They can also deduct losses from the sale or exchange of property between the corporation and employee-owners. Additionally, PCs can create retirement plans and 401(k)s for employees with higher contribution limits than unincorporated businesses are permitted to use.

While the IRS requires that other corporations use an accrual accounting method for tax reporting, professional corporations are permitted to use the cash accounting method, with no limit on their taxable income. This means the PC can defer the reporting of income that is taxable until the year in which it receives payment for services (not the year in which it bills for them).

A professional corporation can provide numerous benefits, yet it also has tax rate implications, for people in specific professions who wish to take advantage of corporation status.