Professional Corporation Tax: Everything You Need to Know
Professional Corporation Tax is the tax levied on corporations offering professional services such as health clinics, architectural practices, and others.3 min read
2. Tax Rate
3. Accumulated Earnings
4. Passive Activity Losses
5. Reallocating Income
6. C or S Corporation Taxation?
7. The Personal Service Corporation Issue
8. Requirements for Classification as a Professional Service Corporation
9. Tax Structure of a Professional Services Entity
Professional Corporation Tax is the tax levied on corporations offering professional services such as health clinics, dental offices, architectural practices, and others.
A professional corporation, also known as a personal service corporation, is a specialized business entity whose owners are professionals like doctors, attorneys, architects, and dentists who offer services for profit.
However, only licensed professionals may provide these services and be entitled to a proportion of the corporation's profits. If a group of professionals establishes a corporation, the liability of each professional is limited to their actions. A special form of taxation applies to professional corporations.
A professional corporation is subject to a flat tax rate of 35 percent, meaning it pays $35,000 as a tax on revenue of $100,000. Conversely, a non-professional corporation is taxed based on its income. For example, a non-professional corporation pays $61,250 in taxes on revenue of $200,000 and the tax rate increases as earnings rise.
A corporation pays 15 percent of accumulated income as tax. The accumulated income tax applies to professional corporations whose income exceeds $150,000. However, it is possible to avoid this tax if your corporation can prove it has realistic and concrete plans for the unused revenue.
Passive Activity Losses
Passive activity means businesses like a real estate asset, which the corporation is not directly involved in its management. It may not be possible for professional corporations to deduct losses from such business out of the earnings of their practice for the current year. These losses can only be deducted in the next year.
If the Internal Revenue Service discovers that you created your professional corporation to dodge taxes, the agency can reallocate the corporation's earnings as personal income for tax purposes. In the event of an income reallocation, you may not be able to deduct your operating expenses from the practice's revenue.
Also, you may lose the privileges of a corporation if your client is only one person or company. For instance, the IRS will not treat your practice as a corporation if, as a doctor, you work for a single hospital.
C or S Corporation Taxation?
Like every other corporation, a professional corporation can choose to be taxed as a C or S corporation. The default designation of state-incorporated businesses is a C Corporation. Your company must satisfy specific requirements of small business before it can change to an S corporation.
As a professional corporation, the business must have only individual shareholders to become an S corporation. When you become an S corporation, you start enjoying the tax benefits that come with that status.
The Personal Service Corporation Issue
The reason many licensed professionals prefer S corporation status is to enjoy the pass-through tax treatment of the corporations' earnings and avoid the Personal Service Corporations (PSC) designation, which subjects the business' income to a 35 percent flat federal tax rate.
Requirements for Classification as a Professional Service Corporation
The main requirements for classifying a corporation as a PSC include:
- Providing personal services in specialized fields such as architecture, health (including veterinary services), law, accounting, actuarial science, consulting, performing arts, and engineering.
- The corporation makes over 20 percent of its income from the services.
- Over 10 percent of the corporation's stock belongs to the employee-owners.
Tax Structure of a Professional Services Entity
Professionals such as physicians, dentists, and surgeons use the professional corporation entity because the business structure offers several benefits. Professionals in the same field can form a professional corporation with each individual's liability limited to his/her actions.
The default tax status of a professional corporation is a C corp. However, the entity can elect for S corporation status so that the IRS can treat it as a pass-through tax entity. However, the entity can elect for S corporation status so that the IRS can treat it as a pass-through tax entity.
It is essential to consider a wide range of factors before choosing between a C and S status. While an S corporation eliminates the 35 percent flat rate and double taxation, a C corporation provides employee-owners several employee benefits.
Additionally, S and C corporations treat payments made to employee-owners differently for tax purposes. C corps offer a favorable tax treatment for shareholders as it treats payments made to them as salary instead of dividends.
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