Professional Corporations – Taxation
As described in Professional Corporations – Basics, Professional Corporations (PCs) are another form of corporations for businesses providing only professional services. The IRS treats PCs like any other corporation though there may be some additional professional corporation tax benefits.
Personal Service Corporation Designation Tax Benefits
Most PCs qualify as personal service corporations since the only qualification is that at least 95 percent of all outstanding stock is owned by employees who provide professional services. The advantage of being qualified as a personal service corporation is that the IRS will allow the PC to choose the cash method of accounting instead of the accrual method for calculating taxable business income. The IRS requires that regular Corporations use the accrual method.
Cash Method Accounting
Cash method accounting allows PCs to report income when the payment is received, not when it is invoiced. This means that a service that is invoiced in December 2016 but isn’t paid until February 2017 is not reportable as income until 2017 tax year, not 2016, which it would be reportable for regular Corporations.
Flat Tax Rate
If the PC is considered to be a personal service corporation by the IRS, there is a disadvantage. The IRS will impose a flat 35 percent tax rate on all corporate earnings. Regular Corporations are subject to a maximum tax rate of 35%. A regular corporation’s first $100,000 in income is subject to lower tax rates which go from 15% to 34%. Partnerships and LLCs use personal tax income rates to calculate income tax on business earnings; which can go from 10% to 35%. This is one of the reasons that forming PCs has become less favorable as the tax benefits of a regular corporation or LLC are reduced.
Professional corporations by default are taxed as C Corporations, however, there is still the option for them to elect to be taxed as an S Corporation. Please visit the sections on S Corporation – Taxation and C Corporation – Taxation for the differences in how these two kinds of corporations are taxed.