A professional corporation (PC) is a type of corporation available to business entrepreneurs who offer professional services such as doctors, lawyers and engineers. PCs were formed to allow professionals to enjoy the tax advantages of a corporation without providing them with the benefit of limited liability. The main tax advantages of being a PC are tax breaks and tax deductions not available to unincorporated businesses.
Personal Service Corporations
PCs are generally created so a business can qualify as a personal service corporation (PSC). The Internal Revenue Service (IRS) will consider professional corporations as a PSC as long the business passes the function and ownership tests. The function test requires that 95 percent of the activities carried out by the business are services within the fields of health, law, accountancy, engineering, science, consulting or performing arts. The ownership test requires that the business' stock be owned by qualified people who either work or used to work for the corporation.
PSCs are taxed as a class C corporation with a flat rate of 35 percent. Salaries are considered tax deductible expenses. Professional corporations will usually pay all income as salaries to shareholders or other kinds of benefits, reducing taxable income to zero.
PCs can create retirement plans and 401(k) retirement saving plans with higher contribution limits than those available to sole owners and unincorporated businesses. These plans allow employees to save for their retirement and defer the income tax on the saved money and its interest until withdrawal.
PCs can organize a voluntary employees' beneficiary association (VEBA) for its stockholders and employees. This allows the corporation to provide its employees with health and life insurance as a tax-free benefit.
PCs are also eligible to apply for tax deductions for disability insurance, dependent care and other benefits supplied to its employees. In these cases the expenses are tax deductible to the corporation and are not considered taxable income to the employees.
Sale of Stock
Certain states, such as California, also provide tax incentives for the sale of stocks in professional corporations. For instance in California the sale of an individual's share in a partnership can be taxed at a rate as high as 39.6 percent while the sale of stock in a professional corporation is taxed at a maximum rate of 28 percent.