If you’re starting a business, you’ll want to establish a business structure based on your company’s needs and industry. Limited liability companies (LLCs) are popular for their personal liability protection, but a professional corporation, also known as a PC or professional corp, might be worth considering if you are in an eligible line of work.
Before you start the incorporation process and file paperwork with your state, here’s what you need to know about these business entity types.
What is an LLC?
A limited liability company (LLC) is a business structure designed to let business owners avoid personal liability if their business has problems. If an LLC takes on debt or is subject to a legal judgment, only the company’s assets are at risk. The assets of the LLC owner, also called an LLC member, aren’t at risk except in specific circumstances. These can include instances of fraud or cosigning on a business loan. Ultimately, LLCs let business owners reduce the legal risks associated with starting a business.
What is a professional corporation?
A professional corporation (PC or professional corp for short) is a business entity intended to be formed by people in specific licensed professional service industries, such as attorneys, doctors, dentists or accountants. The exact industries vary by state but typically focus on these licensed professionals.
Owners of professional corps are liable for their own negligence or malpractice while working but are not liable for the negligence or malpractice of other owners of the professional corp. This means professional corps allow licensed professionals to start a business together without accepting liability for their partner’s actions.
How do LLCs and professional corporations compare?
While LLCs and professional corps allow business owners to organize their companies and limit their personal liability in some cases, there are a few key differences to keep in mind.
Formation
For the most part, anyone in any line of work can open an LLC to organize their business. Whether you’re an entrepreneur doing woodwork, working as a freelance writer or running a small store, you can likely open an LLC. There are a few exceptions of industries that can’t form LLCs, like banks or insurance companies. But these are the exceptions rather than the rule.
Professional corporations are more restrictive. Each state has its own list of service providers that can form a professional corporation, but it typically includes licensed service professionals like doctors, accountants or dentists. People outside the industries their state designates as eligible for a professional corp can’t start one.
Every state will have different filing requirements to officially form an LLC or professional corp. Check with your state government or Secretary of State to find out what forms to file and fees to pay.
Liability protection
LLCs are popular because they offer limited liability protection to their owners. If you follow proper procedures to keep your personal and business money separate, the LLC structure creates a legal separation between you and your business. In most cases, your company’s debts or losses won’t affect your personal assets unless you offer a personal guarantee on the loan.
Like an LLC, a professional corp offers liability protection. You aren’t responsible for the debts of your business. If one of your partners is found guilty of malpractice or making a major omission when providing a service, you won’t be liable for their mistakes. You’re only responsible for your own malpractice, errors or omissions.
For example, if Dr. John Smith and Dr. Jane Doe open a professional corp together and John Smith loses a malpractice suit, Dr. Doe won’t be liable for the lawsuit even though she co-owns the company with Dr. Smith.
Professional corp owners must carry adequate malpractice insurance to protect themselves from their own errors and omissions but can worry less about the risk of their partners making mistakes that result in lawsuits or other financial damages.
Taxation
Taxation is a significant consideration when deciding what type of business to form. Choosing the right structure can help you limit your tax liability with the IRS and keep more of the money that you earn.
LLCs are typically pass-through entities and pay taxes as sole proprietorships. All of the LLC’s earnings pass through to the individual owner’s personal tax returns and get reported on those income tax returns. While this makes the tax filing process easier, business owners who choose this legal entity will pay self-employment taxes, which can drive up their tax liability.
LLCs can opt to pay taxes in other ways, like being taxed as an S Corp, which can offer some tax benefits. For example, after paying yourself a reasonable compensation, S Corp owners can take the remaining business profits as distributions, avoiding additional payroll taxes.
Professional corps, by default, are taxed as regular corporations and pay the federal corporate tax rate. This means the business must file its own tax return and the owners must also pay tax on their salaries, bonuses and benefits.
Professional corp owners can also opt to be taxed as an S Corp if they qualify as a small business, which comes with the tax benefit of letting them avoid more complex corporate taxes. Professional corps also allow for various corporate tax deductions, retirement plan options, and other benefits.
Management and ownership
With an LLC, the owners run the business according to the rules outlined in the operating agreement. If you run a single-member LLC, this means you can run the company largely as you like. When you have other members in your LLC, the company may be member-managed. This means you make decisions together and distribute money based on the operating agreement and bylaws.
With a professional corp, each owner is both a shareholder that owns a portion of the company and an employee of the company. Some states restrict ownership in the professional corp only to those who provide the professional service the business focuses on. This means there are no outside investors unless they are also professionals. State law may also require professional corps to purchase specific insurance levels, appoint a board of directors and elect officers.
Flexibility
When it comes to day-to-day operations and flexibility, LLCs and professional corps are similar. If you’re in business alone, you’re free to run your company however you want as long as you keep your personal and business funds separate. If you have partners, you must make decisions together and work based on your operating agreement.
Professional corps may have additional restrictions, but they’re not likely to come up daily. For example, some states limit professional corps to working solely in one industry. This would mean you can’t open “Doe and Smith Veterinary Services and Dentist Office PC” because that mixes two different professional services.
Which is right for you?
To figure out which entity type is right for you, there are a few questions you can ask yourself before you start the business formation process and pay any filing fees to establish your company.
First, are you providing a professional service? If you don’t need a professional license, you probably aren’t, but check with your state government to verify the rules. For example, some services that count as professional services in New York include shorthand reporting, land surveying and midwifery. If you’re not providing a professional service, a professional corp isn’t the choice for you. Opt for an LLC instead.
Second, will you be working with partners? Remember that a professional corp leaves you liable for your own errors, omissions and malpractice but protects you from the mistakes of your partners. It can also be easier to change the ownership of a professional corp compared to an LLC when someone retires. If you’re not working with partners, you may prefer an LLC.
Third, is simplicity important to you? LLCs are typically less complex than professional corp. If you’re looking for simplicity, consider an LLC. Choosing a professional corp might require legal advice from a reputable law firm to ensure you follow all applicable rules and regulations in your state.
Finally, how can you limit your tax liability? To answer this question, consider consulting a CPA or tax firm. They can determine which structure makes the most sense for tax purposes. Plus, they can help you with things like distributions, annual reports and avoiding double taxation, ensuring you keep more money in your pocket.
Final word
Professional corps are similar to LLCs and provide liability protection to business owners. However, they’re only for people offering specific types of services. Check your local rules regarding professional corps to see if your line of work is eligible, then consider the pros and cons before forming one.
