In California, certain professions that require a state license are prohibited from forming a limited liability company or a traditional corporation and instead must incorporate as a professional corporation.
1. Advantages To Electing To Being Taxed As An S Corporation.
If you do not elect to have your California professional corporation taxed as an S corporation, the default is for it to be taxed as a C corporation.
As a C corporation, your professional corporation would pay federal taxes on its profits and you would also pay individual taxes if you receive salary, bonuses, or dividends from the corporation.
By electing to be taxed as an S corporation, your professional corporation would instead be a pass-through tax entity, like an LLC or a partnership. Electing to be taxed as an S corporation may also allow you to pass losses from the business to your personal income tax return, where you can use the losses to offset income that you may have from other sources.
Finally, if the corporation pays you a “reasonable salary,” you may not be required to pay self-employment taxes on any additional corporate profits that are paid to you as dividends as a shareholder in addition to your reasonable salary.
2. Disadvantages To Electing To Be Taxed As An S Corporation.
A drawback of electing to have your professional corporation taxed as an S corporation rather than a C corporation is in a C corporation the cost of the premiums for shareholder benefits, such as insurance coverage, are deductible as a business expense. In addition, the shareholders may not be taxed on the value of the benefits.
Another drawback to electing to have your professional corporation taxed as an S corporation is there are restrictions on who can be a shareholder of an S corporation. For example, S corporation may not have shareholders who are non-resident aliens.
Finally, S corporations may only issue one class of stock whereas C corporations can have different classes of stock that have different rights and liquidation priorities.
You should consult with your CPA or tax professional to make sure being taxed as an S corporation is the best fit for your professional corporation, but for most California professional corporations electing to being taxed as an S corporation rather than a C corporation is likely to provide the most tax savings.
Disclaimer: This article discusses general legal issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Doug Bend expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.