You’ve worked hard to become a professional. Now, it’s time to understand how the system of professional corporation tax in California works in order for you to get the most out of your earnings and save money where possible.
This article provides an easy-to-follow guide on everything from understanding the basics of a professional corporation to its taxation rules – How are professional corporations taxed? What tax form does a professional corporation file? Can a professional corporation be taxed as an S Corp?
Ready? Let’s dive right into the world of professional corporations!
Key Takeaways
- A professional corporation can help you save money on taxes.
- These corporations have options for tax treatment: the “C” or “S” model.
- Various types of taxes you should be aware of include federal income, state income, property, franchise, and sales and use.
- The owners of the company enjoy limited liability protection, safeguarding them from personal risk in the event of losses.
- There are steps to follow when you want a professional corporation. Be sure it is done right so you can take advantage of these benefits!
Understanding Professional Corporations
As your first step towards forming a professional corporation, it’s crucial to understand the legal requirements involved and the potential limitations on liability this corporate structure allows.
Creating a professional corporation
In general, starting a professional corporation requires specific steps:
- Decide the type of professional service you will offer.
- Check with your state’s laws to ensure that your professional service fits within the list of permitted professions.
- Pick a name for the corporation following your state’s rules.
- The SOS will file, review, and approve the articles of incorporation. This will mean you are now a corporation.
- If you started as an outside, or foreign corporation, you will be required to show the California Franchise Tax Board proof from your home state or country that you are in good standing there.
- File the Statement and Designation by Foreign Corporation.
- Be ready to spend some money – at least $800 -to keep active with taxes in California as this is keyed in as franchise tax.
Legal requirements of a professional corporation
Setting up a professional corporation requires several steps. These include:
- You need to file Articles of Incorporation with the California Secretary of State.
- Pay the annual California Franchise Tax; the amounts vary on whether you have a C corporation or an S corporation.
- You must file corporate tax returns annually. If you file the tax returns late, you will be required to pay late filing penalties and interest.
- A suspended professional corporation must follow certain steps to get back its status.
- Your firm may owe taxes if it sells goods or offers services in California or uses intangibles there.
Limits on liability of Professional Corporations compared to General Stock Corporations
General Stock Corporation (GSC)
Nature of Business: A GSC can be formed for any lawful business activity and is the most common type of corporation in California.
Liability Protection: Shareholders of a GSC are generally not personally liable for the debts and obligations of the corporation. Their liability is typically limited to the amount they invested in the corporation (i.e., the value of their shares).
Operational Flexibility: GSCs have more flexibility in terms of management and operations compared to professional stock corporations.
Professional Stock Corporation (PSC)
Nature of Business: A PSC is specifically designed for licensed professionals, such as doctors, lawyers, accountants, architects, and others. It can only be formed to provide a single type of professional service.
Liability Protection: While shareholders of a PSC are protected from the general debts and obligations of the corporation (similar to a GSC), they are not shielded from liability arising from their own professional malpractice or the malpractice of those under their direct supervision.
Operational Restrictions: PSCs have specific operational requirements. For instance, all shareholders, directors, and officers typically must be licensed to practice the specific profession for which the corporation was formed.
In Summary…
Both general stock corporations and professional stock corporations offer liability protection to their shareholders. However, while GSCs provide broad protection against corporate debts and obligations, PSCs do not protect individual professionals from their own acts of malpractice or those of professionals directly supervised by them.
Professional Corporation Tax in California: How are Professional Corporations Taxed?
So, how are professional corporations taxed? Understanding the tax obligations of professional corporations is a key part to maintaining its operational legality. From federal and state corporate income taxes, and property taxes to franchise taxes, every facet plays an important role.
For federal and state tax purposes, the entity can be taxed as either a C corporation or an S corporation. In a C Corporation, the corporation pays tax on all the money made by the entity before it is taxed a second time upon distribution to the shareholders.
In an S corporation, the corporation does not pay tax at the entity level. Instead, the income flows through to the shareholders where they will each pay tax on their share of money made by the company.
The tax advantages could position you for significant savings. Each form of taxation carries its own intricate details that provide opportunities and challenges in managing your business finances efficiently.
Furthermore, sales and use tax laws can vary greatly from one location to another making it vital for professionals to stay informed.
Federal corporate income tax
A professional corporation taxed under subchapter C of the Internal Revenue Code must pay an entity-level tax on its income annually.
The tax can come as a result from services performed for your clients or patients as well as property the corporation owns and sells at a gain The IRS currently subjects the same flat tax rate of 21 percent on ordinary income as well as capital gain income.
Alternatively, in an S corporation, the income earned by the corporation generally bypasses entity-level taxation and flows directly to each shareholder. The amount that flows to each shareholder is based on their proportionate share of the company’s earnings. Any taxes owed will be paid by the shareholder on their personal tax returns.
State corporate income tax
Companies are required to pay state income tax based on the income that the corporation earns. The state tax rate varies by each state. They can range between 1% and 12%. California has an 8.84% corporate income tax rate.
Meanwhile, professional corporation tax in California and some other states have minimum franchise tax for all active corporations.
If your company is a C corporation, you must pay the $800 minimum franchise tax to the California Franchise Tax Board annually.
If your company is an S corporation, you must pay the greater of the $800 minimum franchise tax OR the 1.5% income tax on net income to the California Franchise Tax Board annually.
Even if your company did not make any profit or lost money during the year, you still owe this fee!
But there are exceptions to the minimum franchise tax that you should keep in mind:
- With regard to professional corporation tax in California, in their first taxable year, new California professional corporations do not have to pay the $800.00 franchise tax. However, S corporations are still required to pay the 1.5% tax if there was any earned income. For example, if your S corporation earned $10,000 net income in its first year, California will still require you to pay $150 franchise tax, as opposed to the minimum $800.
- For corporations that were formed within the last 15 days of the tax year and did no business in California during those 15 days are free from the minimum franchise tax for that year AND the following year too!
Property tax
Property tax is another cost to keep in mind. This tax is applied to land or buildings owned by the professional corporation. The amount owed will depend on where these assets are located. In California, the legislature decides this rate and many other states follow suit.
Paying property tax on time supports local utilities like schools and parks.
Sales and use tax
The money you earn from selling goods or services may have sales tax. This is a cost the buyer pays at the time of the transaction. You collect and give it to your state government. Not all states do this, however.
Use tax is for items bought in other states but are used where you live. You pay use tax on these items if your state charges sales tax but you didn’t pay tax when buying them.
What Tax Form Does a Professional Corporation File?
A professional corporation typically files IRS Form 1120, the U.S. Corporation Income Tax Return. This form is used by corporate entities to report their income, gains, losses, deductions, credits, and to calculate their federal income tax liability.
The form requires detailed financial information, including gross income, dividends, interest, and other types of income, as well as allowable deductions such as operating expenses, employee compensation, and taxes. Professional corporations must adhere to specific tax regulations, and it’s advisable that you seek guidance from an expert in professional corporation tax in California to ensure compliance and optimize their tax strategy.
Can a Professional Corporation Be Taxed as an S Corp?
Yes, a professional corporation (PC) can elect to be taxed as an S corporation. This election is made by filing IRS Form 2553, “Election by a Small Business Corporation.” The S corporation status allows the corporation’s income, losses, deductions, and credits to pass through to its shareholders’ personal tax returns. This means that the corporation itself is not subject to federal income tax; instead, the shareholders are taxed on their individual tax returns for their respective shares of the corporation’s income or loss.
There are specific eligibility criteria for a corporation to elect S corporation status, including:
- It must be a domestic corporation.
- It can have only allowable shareholders, which include individuals, certain trusts, and estates but not partnerships, corporations, or non-resident alien shareholders.
- It can have no more than 100 shareholders.
- It can have only one class of stock.
- It cannot be an ineligible corporation, such as certain financial institutions, insurance companies, and domestic international sales corporations.
Professional corporations considering an S corporation election should carefully evaluate their situation, as there are tax implications and legal requirements involved. It’s often advisable to consult with a tax professional or a legal advisor to understand the benefits and limitations of this election and to ensure compliance with all regulatory requirements.
Is There a Special Tax Rate for Professionals If They Filed Their Taxes as a C Corporation?
As of 2023, there is no special federal tax rate specifically for professionals who file their taxes as a C corporation. C corporations, whether owned by professionals or not, are generally taxed at the same federal corporate income tax rate. The Tax Cuts and Jobs Act of 2017 set a flat corporate tax rate of 21%, which applies to all C corporations regardless of their income level.
However, it’s important to note a few things:
State Taxes
The rates of professional corporation tax in California can vary, and some states may have different rates or rules that apply to professional corporations.
Deductions and Credits
While the tax rate is flat, professionals can take advantage of various business deductions and tax credits available to C corporations, which can effectively reduce the amount of taxable income.
Alternative Minimum Tax (AMT)
The corporate AMT was eliminated by the Tax Cuts and Jobs Act, simplifying tax calculations for many corporations, including those owned by professionals.
Tax Planning
When it comes to professional corporation tax in California, Professionals should engage in careful tax planning, considering factors like income splitting, salary versus dividend distribution, and other strategies to optimize their tax situation.
Double Taxation
As mentioned earlier, one of the key considerations for a C corporation is the issue of double taxation, where income is taxed at the corporate level and again at the individual level when profits are distributed as dividends.
Updates to Tax Laws
Laws on professional corporation tax in California are subject to change, and it is advisable to consult with a tax professional or accountant for the latest information and for personalized advice based on specific circumstances.
In summary, while there isn’t a special tax rate for professionals in C corporations at the federal level, the overall tax situation for such entities can be complex and depends on a variety of factors, including state tax laws and individual business circumstances.
Advantages and Disadvantages of Professional Corporations
The advantages and disadvantages of professional corporation tax in California vary. Discover the numerous tax benefits and liability limits that come along with having a professional corporation, as well as understand vital corporate formalities.
Tax benefits
Having a professional corporation can save you money at tax time. You might get to pay less due to special tax rules. For instance, C corporations only have taxes on their income. S corporations are similar but include an extra step.
With these, the group pays its own share and each part-owner must also pay out what they owe for their piece of the profit. Not all states will make you pay so much either!
Limits on Liability
While shareholders of a PSC are protected from the general debts and obligations of the corporation (similar to a GSC), they are not shielded from liability arising from their own professional malpractice or the malpractice of those under their direct supervision. You can easily plug this gap with an insurance policy for errors and omissions (i.e. “malpractice” insurance).
Professional Corporation Tax in California and Other Frequently Asked Questions
1. What are some benefits of having a California Professional Corporation?
The benefit of this type of business model includes less personal liability compared to partnership and also has special treatment under state law.
2. Why would professionals want to incorporate their practice?
Professionals may want to create or form a professional corporation because they can limit risks, get better taxes, and follow state laws.
3. With regard to professional corporation tax in California, will I encounter double taxation if I establish my practice as a professional service corporation?
The potential for double taxation is not inherently determined by whether your practice is established as a regular or a professional corporation. Instead, it hinges on the specific entity classification you choose when submitting your tax details to the IRS (as a C or an S corporation). It’s essential to strategically select the right classification to align with your tax planning objectives.
4. Can anyone form a Professional Service Corporation?
No! This type only suits business owners who are licensed professionals such as doctors or lawyers. If they meet certain terms under the US Internal Revenue Code, then State Law allows them to form a professional corporation.
Learn About Professional Corporation Tax in California So You Can Make The Most Out of It
There is a lot to learn about professional corporation tax in California. Learning about it will give you an advantage. If you are a licensed professional, consider forming a professional corporation. It can help cut down your tax bill and shield you from legal issues. Make sure to understand how taxes work for these firms before setting one up.
Be sure to check with an expert when unsure about any tax issue or law.
Incorporation Attorney can guide you through the ins and outs of professional corporation tax in California. We will make sure you understand each type of tax that you need to settle and help you make the most out of it. Aside from this, we can offer legal assistance in different facets of your business including the incorporation process.
Call us today at 714-634-4838 and know more about our other legal services that can help launch or grow your business!
