In most states, professionals such as dentists, engineers and architects can run their businesses as personal service corporations -- also referred to as professional service corporations -- or limited liability companies. California, for example, doesn’t allow professionals to operate LLCs. While both entities provide owners with similar personal liability protections, they have different taxation methods. Personal service corporations are taxed like regular C corporations while LLCs use the pass-through taxation method for taxation purposes. Each tax model has its advantages and disadvantages.
More Tax Deductions
Personal service corporations have more tax deductions than LLCs. Both entities can deduct operating costs, equipment purchases and fringe benefits for employees as business expenses on their tax returns. However, personal service corporations can deduct salaries and bonuses paid to owners and employees, while LLCs cannot. Also, fringe benefits given to personal service corporation owners are tax deductible, while the IRS taxes the value of the same benefits given to LLC owners.
Keep Profits Inside Company
The ability to retain profits is one of the corporate tax structure's main advantages over the pass-through taxation method used by LLCs. After corporate profits are taxed, professional corporations can keep up to $150,000 per year from being distributed to shareholders to pay for company improvements and other business transactions. Facility renovations and upgrades are some of the examples retained profits can be used for. The pass-through taxation method isn’t structured to retain profits because all profits are distributed to owners for taxation.
Avoid Double Taxation
One of the advantages to the pass-through taxation method used by LLCs is company profits aren't taxed at the company level like professional corporations. LLC profits are taxed once on the owners’ individual tax returns. However, profits from professional corporations are taxed twice. After being taxed at the corporate level, profits are taxed again on the shareholders’ individual tax returns.
Read More: LLC Pass Through Taxation
Higher Tax Rates
One of the disadvantages of operating professional corporations is they don’t get the favorable tax rates like regular corporations do. The IRS taxes profits from professional corporations at a flat rate of 35 percent regardless of the amount. For example, regular corporation are taxed just 15 percent on the first $50,000 in profits while professional corporations are taxed 20 percent more on the same amount. The 35 percent flat rate is generally higher than what LLC owners pay on their share of profits. In fact, as of 2012, LLC owners with $50,000 in income pay only 17 percent in federal income taxes.
- Thinkstock/Comstock/Getty Images