The information in this article is up to date through tax year 2019 (taxes filed in 2020).
If you are deciding whether to form a professional corporation (PC) or a limited liability company (LLC), there are several elements you should consider, as there are advantages and limitations to both. You want to choose a business structure that offers tax benefits but also protects you and your assets if something unexpected happens. Understanding your options will help you make the best, most informed decision about your business structure.
Professional Corporation (PC)
To set up a professional corporation, all shareholders in the business must be licensed to practice the same profession. For example, PC is the business structure commonly chosen by attorneys, doctors, architects, accountants, engineers, veterinarians, and others in similar fields.
Professional Corporations and Taxes
The IRS treats all personal corporations as qualified personal service corporations. This means that PCs pay the maximum 21% corporate tax on all business income.
A PC’s shareholders are responsible for reporting and paying individual income taxes. The PC itself is taxed independently of the shareholders. On one hand, this does limit a shareholder’s personal liability for corporate taxes. But for single owners, it also means they are being taxed twice: once on the business’s earnings and again on the dividends from those earnings.
Professional corporations get to choose whether they will use the cash method or the accrual method for accounting. The cash method means a business reports income for the tax year when they received cash payment for services. If a service was performed in 2018 but payment was received in 2019, the owner will wait until they file their 2019 taxes to report the income.
The Pros of a Forming PC
- Owners are not personally liable for malpractice actions brought against other owners.
- Ownership can easily be transferred if one member leaves the practice.
- Bigger contributions are allowed for retirement plans.
The Cons of Forming a PC
- Individual partners can still be held personally responsible for their own malpractice.
- High corporate tax rates
- Owners could be taxed twice: once on the business’s earnings, and again on the dividends from those earnings.
Limited Liability Company (LLC)
The limited liability company business structure is considered simpler and more flexible than other business structures. There is no limit to the number of members an LLC can have, and they are not required to hold annual meetings or record minutes the way other corporations are.
Limited Liability Companies and Taxes
Each member reports the business’s profits and losses on their personal income tax return. This means the LLC’s earnings are taxed at individual federal income tax rates, instead of the 21% corporate tax rate.
Because they do not have income withheld by an employer, most LLC members are liable for their own Social Security and Medicare payments during the year. This is also known as the self-employment tax.
The Pros of Forming an LLC
- Simple and straightforward to set up.
- Members’ personal assets are separate from their business assets. If the LLC is involved in a lawsuit, their liability is limited to the amount they invested in the business.
- An LLC can be taxed as a sole proprietorship if it has one member, as a partnership if it has more than one member, or as a corporation.
- You don’t have to be a U.S. citizen or permanent resident to form an LLC.
The Cons of Forming an LLC
- Some states require an LLC to have at least two members.
- Members may be required to pay state taxes, franchise tax, or a yearly registration fee, depending on the state in which the LLC is established.
- LLCs can expire in certain states and may have to be re-established.
If you have questions about starting a business, LegalSpark can help. LegalSpark connects you with a lawyer who can answer questions about how to start a business, how to comply with regulations, and how to file taxes as a business owner.
Looking for help filing your small business and self-employed taxes? E-File your return with TaxSlayer’s Self-Employed Edition, and get expert assistance with all your self-employment tax questions, plus tax tips and a deduction finder to make sure you’re getting all the tax breaks you deserve.