March 18, 2020
When professionals wish to incorporate their business, most states require they form what are called professional entities. A professional entity is a special type of incorporated business structure, similar to a traditional incorporated businesses but with important liability and regulatory differences. But first things first: what exactly is business incorporation?
Today’s businesses come in two forms: incorporated and non-incorporated entities. There are many disparities between these two classes of structures, but perhaps the biggest difference comes down to liability protections. Incorporated structures—such as limited liability companies (LLCs) and corporations—provide owners with a layer of liability protection that distinguishes the business’s dealings from their own personal assets. This means that the debts and legal obligations of the business generally can’t endanger the personal well-being of the owners. This isn’t the case with non-incorporated businesses, where a successful legal action can actually expose the owner’s personal possessions and bank accounts.
There’s no doubt that proper business incorporation is important, but not every type of business is able to form traditional LLCs and corporations. Notably, certain types of occupations—namely “professional” occupations—must form professional entities instead.
Importantly, the term “professional” is defined differently state-by-state. According to California’s Moscone-Knox Professional Corporation Act, services that require a license, registration, or certification per the Business and Professions Code, the Public Accountancy Act, or the Osteopathic Act are considered professional services. Therefore, occupations that fall into this category cannot form traditional incorporated entities and instead must form professional entities, which in California, means a Professional Corporation (PC) or a Registered Limited Liability Partnership (RLLP).
Types of Professional Entities Permitted in California
The two most popular types of incorporated entities throughout the country are LLCs and corporations. Accordingly, the two most common types of professional entities are Professional LLCs (PLLCs) and professional corporations (PCs). However, the Golden State is somewhat of an anomaly in that the California legislator disallows PLLCs of any kind. Thus, for California professionals, there are essentially two options: PCs and RLLPs.
PCs are akin to regular corporations, with the exception of a “limitation” on limited liability. While owners of PCs enjoy many of the same types of liability protections as regular corporations, they aren’t shielded when legal claims arise from their own mistakes. Said another way, a PC will shield an owner when a claim is made against their business, unless the claim is a result of their own malpractice or negligence. This is, in fact, the hallmark of all professional entities—they cannot shield an owner when claims arise from their own mistakes.
On the other hand, RLLPs are partnership-like structures, so they’re taxed and regulated similar to general partnerships. Of course, since they are indeed professional entitles, they also have the characteristic “limitation” on liability protections (just like the PCs above). Also important, as of 2019 only two types of occupations can form RLLPs in California: public accountants and attorneys. For other professionals, (such as psychologists, doctors, dentists, optometrists, and psychiatrists) a PC is generally the only option.
Specific Rules for California Professional Entities
As we’ve seen already, professional entities are quite similar to their non-professional counterparts, yet there are significant differences to be aware of. One thing to keep in mind is that rules and regulations regarding professional businesses are largely established at the state level. As such, it’s crucial to know your local regulations before making any important structural decisions regarding your business. Here are a few rules that California business owners should be cognizant of:
Stock Ownership and Professional Entities: In California, the only individuals allowed to own stock in a professional entity are the professionals that are licensed to do so, although the rules can vary depending on the particular occupation. This means that non-professional individuals typically cannot be shareholders or own stock in a professional company. In fact, most professional corporations throughout the country have restrictions on who can be an owner, shareholder, officer, or member of the Board.
Naming Restrictions: Owners of professional entities are generally limited in the names they’re allowed to choose for their business. For example, a PC must include the phrase “Professional Corporation” or “P.C.” within the business’s name. There are similar naming restrictions for RLLPs as well. Additionally, you can’t choose a name that’s already being used by an existing business.
The Single Purpose Requirement: in California—as is the case with most states—professional corporations can only provide the services that they’re formally registered to provide. For example, a PC that’s licensed to provide physical therapy services cannot legally offer psychiatric services. An entity must exclusively provide the services that it’s legally allowed to offer.
A qualified legal professional can be of great assistance when trying to form a professional entity. However, since the laws vary state-to-state, it’s important to ensure that your representative is familiar with any and all California-specific regulations. Although most professionals would advocate for incorporation, forming a professional entity is a big step for an owner and should certainly be made with both discretion and professional guidance.
