California Professional Corporations and the S Corporation
By Ann Tran, Staff Attorney
If you are a licensed mental health professional who wants to establish a private practice, an essential first step is to choose which business structure would be most suitable for your business. In California, licensed professionals are not permitted to form limited liability companies for the purpose of rendering professional services.1 As a licensed mental health professional in California, you may organize your private practice as either a sole proprietorship or a professional corporation. In order to set up a sole proprietorship, a licensed professional is typically engaged to file a business license with the city or county (check with your city or county to see if this step is necessary). In addition to the business license, the county usually requires a nominal filing fee. Once you have your business license, you can rent office space, circulate advertisements, and start practicing. Incorporating, in comparison, involves relatively more work and yet, many licensed professionals choose to organize their businesses as professional corporations as it provides several advantages that a sole proprietorship does not.
What is a Professional Corporation?
California law defines a professional corporation as a corporation organized under the General Corporation Law that engages in rendering professional services.2 The term "professional services" is defined as any type of professional service that may be lawfully rendered only pursuant to a license, certification, or registration authorized by the Business and Professions Code, the Chiropractic Act, or the Osteopathic Act.3 Thus, a licensed marriage and family therapist, a licensed clinical social worker, and a licensed psychologist may set up their private practices as California professional corporations.
Advantages of Incorporating
One of the main advantages of incorporating is that a corporation can shield you and any other owners, officers, and professional employees from personal liability against claims that are unrelated to the rendering of professional services. A professional corporation is treated as if it were a person. In other words, it can enter into contracts, incur debt, own property, engage in business, sue, and be sued. Because it is treated as a person, the corporation will be responsible for its losses, debts, and obligations. Creditors and claimants may only look to the corporation and its business assets for compensation. For instance, if a party brings an action against the corporation for breach of contract, and the corporation loses, the party cannot take your home, your car, and your personal assets. However, a corporation does not protect you from liability claims arising from your professional services. If a client files suit against you alleging professional negligence, the professional corporation will not deflect that claim of malpractice. Rather, you will be held personally liable in the event a judgment is rendered against you.
Another advantage of forming a professional corporation is that the corporation may take an income tax deduction for the payment of health insurance premiums for its employees, and the employees will not be required to pay tax on the benefits.
Who Can be Owners, Directors and Officers?
California requires that a professional corporation consists of directors and officers. If you are the sole owner of your professional corporation, you must also be the director, and serve as both the president and the treasurer of the corporation. The other officers of the corporation, such as the secretary, do not have to be licensed professionals.9 If you and one other colleague establish a professional corporation, you two will then serve as directors, and between the two of you, fill the offices of president, vice president, secretary and treasurer of the corporation.10 If there are more than two owners, the owners must meet and elect directors for the corporation. The owners can also elect officers or have the directors choose who will serve as officers.11
If you decide to establish your private practice with other licensed professionals, the law limits who can actually be the owners, directors, or officers of the professional corporation. Even the employees you hire to render professional services are restricted to the following limitations: An marriage and family therapy corporation and a licensed clinical social worker corporation may have for their owners, directors, officers, or professional employees the following licensed professionals: licensed marriage and family therapists, licensed clinical social workers, licensed physicians and surgeons, licensed psychologists, registered nurses, licensed chiropractors, licensed acupuncturists, and naturopathic doctors.4 An MFT must own at least 51 percent of the outstanding shares of a marriage and family therapy corporation and the remaining 49 percent may be owned by licensed physicians and surgeons, licensed psychologists, licensed clinical social workers, registered nurses, licensed chiropractors, licensed acupuncturists, and naturopathic doctors. The number of these licensed persons cannot exceed the number of MFTs in the corporation and cannot surpass a combined share total of 49 percent.5 Similarly, an LCSW must own at least 51 percent of the outstanding shares of a licensed clinical social worker corporation and the remaining 49 percent may be owned by licensed marriage and family therapists, licensed physicians and surgeons, licensed psychologists, registered nurses, licensed chiropractors, licensed acupuncturists, and naturopathic doctors. The number of these licensed persons cannot exceed the number of LCSWs in the corporation and cannot surpass a combined share total of 49 percent.6 A psychological corporation may be comprised of licensed psychologists, licensed physicians and surgeons, licensed doctors of podiatric medicine, registered nurses, licensed optometrists, licensed marriage and family therapists, licensed clinical social workers, licensed chiropractors, licensed acupuncturists, and naturopathic doctors.7 A psychologist must own at least 51 percent of the outstanding shares of a psychological corporation and the remaining 49 percent may be owned by licensed physicians and surgeons, licensed doctors of podiatric medicine, registered nurses, licensed optometrists, licensed marriage and family therapists, licensed clinical social workers, licensed chiropractors, licensed acupuncturists, and naturopathic doctors. The number of these licensed persons cannot exceed the number of psychologists in the corporation and cannot surpass a combined share total of 49 percent.8
Other employees of your professional corporation, such as a receptionist or billing assistant who are not rendering professional services, are not required to be licensed professionals.
The Name of Your Professional Corporation
In addition, California has specified criteria with respect to how a professional corporation can be designated. The name of a marriage and family therapy corporation must contain one or more of the words: “marriage,” “family,” or “child” together with one or more of the words: “counseling,” “counselor,” “therapy,” or “therapist.”12 MFTs are required to inform clients, at the outset of treatment, that the business is conducted by a marriage and family therapy corporation.13 The name of a licensed clinical social worker corporation and any name or names under which it may be operating must contain the words: “licensed clinical social worker.”14 LCSWs must also inform their clients that the business is conducted by a licensed clinical social worker corporation. A psychological corporation must have in its name one of the following words: “psychology,” “psychological,” “psychologist,” “psychology consultation,” “psychology consultant,” “psychometry,” “psychometrics,” “psychometrist, ” “psychotherapy, ” “psychotherapist,” “psychoanalysis,” or “psychoanalyst.” 15 Additionally, all three professional corporations are required to include in their name, wording or abbreviations that are indicative of corporate existence, such as “a professional corporation.” Moreover, an MFT corporation, an LCSW corporation, and a psychological corporation that conducts business under a fictitious business name, rather than their corporate names must not use any name that is false, misleading or deceptive. A corporation’s fictitious business name is any name other than the corporate name stated in its Articles of Incorporation filed with the California Secretary of State.16 If your corporation plans on doing business under a fictitious business name, you will generally need to perform a search through your city or county’s database to make certain the name is not already in use and submit a form with a nominal filing fee. Some cities or counties will require that you publish a notice in the local newspaper and submit an affidavit to show that you have fulfilled the publication requirement. You should check with your city or county clerk’s office to get more information on this process.
A disadvantage of forming a professional corporation is that incorporating entails a number of formalities and organizational expenses. To incorporate as a professional corporation in California, you must file the Articles of sIncorporation with the Secretary of State.17 A sample, which meets the minimum statutory requirements, can be found on the California Secretary of State website.18 The sample should only be used as a guide in preparing the Articles of Incorporation. The Articles of Incorporation of a professional corporation must contain a specific statement that denotes the corporation as a professional corporation.19 Documents can be hand delivered to a regional office location or mailed to the Sacramento office. The office locations can also be found on the Secretary of State website. The fee for filing the Articles of Incorporation is $100. There is an additional $15 fee for processing a document delivered in person to the Sacramento office or the regional offices. The Secretary of State will certify up to two copies of the filed document without charge, provided that the copies are submitted to the Secretary of State with the document to be filed. The corporate existence begins upon the filing of the articles and continues perpetually, unless otherwise expressly provided by law or in the Articles of Incorporation.20
A professional corporation must also create bylaws in order to establish provisions on how to operate the business and conduct the affairs of the corporation. Bylaws generally provide guidance on certain items including, but not limited to, owners’ meetings, directors’ meetings, the number of directors and officers, and their duties.21 In addition, California requires that your professional corporation maintain adequate books and accurate records of account. The corporation must also keep minutes of the proceedings, such as meetings of its owners and directors. It must also have on record, the names and addresses of all the owners and the number and class of shares held by each.22 A professional corporation in California is a taxable entity. Because the law treats a professional corporation as a distinct taxable entity separate from its owners, professional corporations must pay taxes on their annual earnings, just as individuals do. A professional corporation is taxed on its net income at a rate of 8.84 percent, with a minimum franchise tax of $800, except no minimum amount is applied in the first year of corporate existence. When corporations pay out dividends to owners, the owners incur income-tax liabilities for these payments, even though the earnings that provided the cash to pay the dividends had already been taxed at the corporate level. However, some businesses in California may elect to be classified as “S corporations,” which have a reduced annual tax rates on net income. Not all businesses qualify for S corporation status, and for some, this election may not be tax favorable.
What is an S Corporation?
An S corporation is in essence a corporation or a professional corporation that elects the “S corporation” tax status. Federal law provides that an S corporation is a hybrid business entity. It has corporate features such as limited liability, but gives the owners tax benefits that are comparable to a partnership. This means that the taxable income or loss of the corporation flows through to the owners who report the income or loss on their returns. The special tax status of S corporations was intended for small businesses, thus the law has a few limitations on which businesses may make the election. The S corporation must be a small domestic business that does not have more than 100 owners. It cannot have a nonresident alien as an owner and cannot have more than one class of stock.23 All of the owners must unanimously consent to the election each taxable year. 24
Corporate Tax on S Corporations
Most states adhere to the federal pattern and do not impose a corporate tax on S corporations. Some states, however, subject S corporations to an annual corporate tax. California has adopted most of the federal provisions regarding S corporations, but it is one of the states that require S corporations to pay taxes on the net income, but at a reduced annual tax rate. The current annual tax rate for S corporations in California is the greater of 1.5 percent of the corporation’s net income or the franchise tax of $800. Newly incorporated or qualified corporations are exempt from the annual franchise tax for their first year of business. If your S corporation has a loss in its first year of business, it will not be subject to the minimum franchise tax for its first tax return, and thus owes no tax. However, if it has a net income of $100,000 in its first year of business, it will have to pay a tax of $1,500. If in the second year the corporation shows a loss, it will only owe the $800 minimum franchise tax. The net profit or loss after expenses, including salaries paid to employees, is reported on Federal Form 1120S, and passed through to the owner or owners’ personal tax return(s) via Schedule K-1, where it avoids payroll taxes and is subject only to income taxes. Thus, each owner will be responsible for paying taxes on their distributive share. Depending on your specific situation, there may be additional tax benefits for your professional corporation if it elects to be an S corporation.
How should you proceed if you are interested in organizing a professional corporation for your practice?
Although it is not necessary to consult with an attorney, it is wise to do so, for the following reasons: if you have plans to implement a complex business structure; if you are inexperienced in incorporating; if there is more than one incorporator; or if there is any interest in making the S corporation election. A corporate attorney can help you explore and identify what is most profitable for your business and provide you with viable options. Every business is different. While incorporating offers liability and tax benefits, choosing a business structure depends on your specific situation. Services such as Nolo, a business that provides legal advice to consumers and small businesses, may be able to assist you in incorporating your business on your own, if you choose to do so. However, those services will not provide you with the information an attorney can for your particular situation. An attorney can draft the required documents necessary for incorporation such as the Articles of Incorporation, bylaws, and any shareholder agreements. Further, if you plan to set-up a business with other professionals, seeking guidance from an attorney is prudent. A group of individuals who are interested in establishing a business together may have differing views on how the business should operate. Although attorney’s fees may be expensive, it may be worth it in the long run when you consider the necessity of protecting your personal and corporate assets, and the potential profitability of your business.
To conclude, you should determine your particular business needs before making the decision to form a sole proprietorship or a professional corporation. Choosing the right business structure will contribute largely to the profitability and success of your business.
Ann Tran, JD, is a Staff Attorney for CAMFT. She is available to answer member calls regarding business, legal, and ethical issues.
1 Cal. Corp. Code §17375.
2 Cal. Corp. Code §13401(b).
3 Cal. Corp. Code §13401(a).
4 Cal. Corp. Code §13401.5(g); Cal. Corp. Code
5 Cal. Corp. Code §13401.5.
7 Cal. Corp. Code §13401.5(c).
8 Cal. Corp. Code §13401.5.
9 Cal. Corp. Code §13403.
11 Cal. Corp. Code §312.
12 Cal. Bus. & Prof. Code §4987.7.
14 Cal. Bus. & Prof. Code §4998.2.
15 Cal. Bus. & Prof. Code §2998; Cal. Bus. & Prof. Code
16 Cal. Bus. & Prof. Code 17900§ (b)(3).
17 Cal. Corp. Code §200(a).
18 California Secretary of State Debra Brown. 15 Jan. 2008
19 Cal. Corp. Code §13404.
20 Cal. Corp. Code §200(c).
21 Cal. Corp. Code §212.
22 Cal. Corp. Code §1500.
23 26 U.S.C. Corp. §1361(b)(1).
24 26 U.S.C. Corp. §1362(a)(2).