Can a Professional Corporation Be an S Corp: Everything You Need to Know
Can a professional corporation be an S corp? Small businesses often must minimize their tax burden to become profitable. 3 min read
2. Classification of Professional Corporations
3. Subchapter S Election Eligibility
4. Qualifying for S Status
5. Electing S Corporation Status
6. Limited Liability Considerations
Updated October 26, 2020:
S Corp Status for Professional Corporations
Can a professional corporation be an S corp? Small businesses often must minimize their tax burden to become profitable. If you have a professional corporation, you may qualify for pass-through taxation by electing to be treated as an S corporation by the IRS. If your business meets the qualifications, S corporation status allows you to avoid double taxation, thus increasing your net profits.
In many states, licensed professionals are not permitted to operate as regular corporations. However, a professional corporation is an alternative that provides limited liability. Depending on the state, this is the required business entity for physicians, attorneys, engineers, and other professionals. However, a professional corporation may be able to opt for S corp status.
Most states allow professionals to opt for an S corporation, professional corporation (PC), or limited liability company (LLC). The best choice for your entity depends on the individual circumstances of your business.
Classification of Professional Corporations
State laws govern the formation of a professional corporation. Depending on the individual state, shareholders in this type of corporation must be licensed in law, medicine, architecture, or another professional service. They are also governed by special liability laws.
The IRS categorizes professional corporations as C corporations. They are considered taxpayers and must pay income taxes at the corporate rate. In some states, physicians are not allowed to form professional corporations and must instead establish professional associations.
Subchapter S Election Eligibility
If a C corporation qualifies as a small business corporation, it can elect to be taxed as an S corporation by the IRS. This prevents double taxation profits by taxing income only at the individual level, not the corporation level. Each shareholder reports profits and losses on his or her individual tax return.
Qualifying for S Status
Requirements for your professional corporation to qualify for S taxation status are as follows:
- The corporation must have fewer than 100 shareholders
- Shareholders can only be individuals or certain estates and trusts that benefit individuals.
- Only U.S. citizens or permanent residents can be shareholders.
- Only one class of stock can be offered.
- The corporation must establish a tax year based on the calendar or get IRS approval of an alternate calendar.
Electing S Corporation Status
Individuals in high tax brackets who run high-profit professional corporations are subject to a flat 35 percent corporate tax, a savings over the individual tax rate. To minimize their personal taxes, corporate owners can disburse dividends. When a practice runs at a loss, owners who have substantial income can offset this income with the losses of the corporation.
When a professional corporation is close to breaking even and is owned by individuals with moderate income, taxation at the lower individual tax rate is often more beneficial, which is when S corp election makes sense.
To elect S status, all shareholders must be in agreement. The corporation must complete IRS Form 2553 and have it signed by all shareholders. When this form is submitted, the IRS will review your qualifications and if you are eligible, it will notify you in writing of the date of your successful S corp election.
After successful S corporation election, the corporation will still be required to file Form 1120S every year to report profits and losses, even though these are not taxed at the corporate level. Profits and losses are allocated to shareholders by filing a Schedule K-1. Each shareholder then reports these profits and losses on Form 1040.
Except for pass-through taxation, S corporations operate like other types of corporations. They are subject to the same requirements, including regular management meetings, even if they only have one shareholder.
Limited Liability Considerations
While both corporations and LLCs protect the owners' personal assets from business debts and obligations, some situations put this limited liability in jeopardy. This includes situations where an owner provides a personal guarantee for a loan or lease, injures someone, or does something illegal.
Owners of professional corporations are responsible for damages caused by the services they provide, even though liability for other business obligations is limited. For example, a physician found guilty of malpractice is personally responsible for damages awarded by the court.
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