Professional Corporations

In many states, professionals who want to incorporate their practices must create what's called a professional corporation.

In many states, people in certain occupations (for example, doctors, lawyers or accountants) who want to incorporate their practice can do so only through a "professional corporations" or "professional service corporations." In other states, some professionals have a choice of incorporating as either a professional corporation or a regular corporation. And in all states, certain professionals are allowed to form professional corporations or professional service corporations.

The list of professionals required to incorporate as a professional corporation is different in each state. Usually, though, mandatory professional incorporation requirements apply to these professionals:

• accountants
• engineers
• health care professionals such as audiologists, dentists, nurses, opticians, optometrists, pharmacists, physical therapists, physicians and speech pathologists
• lawyers
• psychologists
• social workers
• veterinarians.

You'll need to call your state's corporate filing office (usually the Secretary of State or Corporation Commissioner) to see which professions are required to form professional corporations in your own state.

Professional corporations aren't as popular as they used to be. The main reason for professionals to incorporate -- favorable corporate taxation rules -- has disappeared. Before 1986, professionals who incorporated could shelter more money from taxes than sole proprietors or partners could. This has all changed. Most professional corporations are classified as "personal service corporations" by the IRS, which means that their corporate income is taxed at a flat 35%. So there's no longer any advantage to be gained by the two-tiered tax structure that allows ordinary corporations to save taxes on some retained earnings.

Are there any reasons left for professionals to form professional corporations? Perhaps. Professional corporations provide a limit on the owners' personal liability for business debts and claims. Incorporating can't protect a professional against liability for his or her negligence or malpractice, but it can protect against liability for the negligence or malpractice of an associate.

Example 1 Dr. Anton and Dr. Bartolo are surgeons who practice as partners. Dr. Bartolo leaves an instrument inside a patient, who bleeds to death. The jury returns a $2 million verdict against Dr. Bartolo and the partnership. There is only $1 million in malpractice insurance to cover the judgment. Dr. Anton (along with Dr. Bartolo) would be personally liable for the $1 million not covered by insurance.

Example 2 Drs. Anton and Bartolo create a professional corporation. Dr. Bartolo commits the malpractice described in Example 1. Dr. Anton, a corporate employee, would not be personally liable for the portion of the verdict not covered by insurance. Dr. Bartolo, however, would still be personally responsible for the $1 million excess, because he was the one guilty of malpractice. (In some states, Dr. Anton would be free from personal liability only if the professional corporation carried at least the minimum amount of insurance mandated by state law.)

As an alternative to incorporating, professionals wishing to limit their personal liability should consider forming a limited liability company (LLC).