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

Laws in every state permit certain professionals to form corporations known as "professionalcorporations" or "professional service corporations." In many states, people in certain occupations (forexample, doctors, lawyers, or accountants) who want to incorporate their practice can do so only through aprofessional corporation. In some states, some professionals have a choice of incorporating as either aprofessional corporation or a regular corporation (which can elect to be an S corporation).

The list of professionals eligible to incorporate is different in each state. Usually, though, mandatoryprofessional 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

Call your state's corporate filing office (usually the secretary of state or corporation commissioner) to seewho is covered in your own state. Typically, a professional corporation must be organized for the solepurpose of rendering professional services. All shareholders must be licensed to render that service. Forexample, in a medical corporation, all of the shareholders must be licensed physicians.

Professional corporations aren't as popular as they used to be. The main reason for professionals toincorporate -- favorable corporate taxation rules -- has disappeared. Before 1986, professionals whoincorporated could shelter more money from taxes than sole proprietors or partners could. This has allchanged. 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 begained by the two-tiered tax structure that allows ordinary corporations to save taxes on some retainedearnings.

Are there any reasons left for professionals to incorporate? Perhaps. Tax laws still give favorabletreatment to fringe benefits for corporate employees.

The other reason to consider incorporation is the limitation on personal liability. It's no secret thatmalpractice verdicts against professionals continue to climb. Incorporating can't protect a professionalagainst liability for his or her negligence, but it can protect against liability for the negligence of anassociate.

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.)

Insurance is a better alternative for most professionals than is the limited liability offered byincorporation. But with malpractice rates soaring for many professionals, it's often hard to afford all youcould possibly need, and forming a professional corporation can be a useful backup.

As an alternative to incorporating, professionals wishing to limit their personal liability should considerforming a limited liability company (LLC) or professional limited liability company (PLLC).

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