I was recently working with some doctors who co-owned their Sunnyvale medical office building. They were concerned about the liability of having the property in their own names, so we worked with their lender and transferred the property into an LLC. Then, I suggested forming a professional corporation to operate their medical practice. Although doctors cannot avoid personal liability for their own malpractice, the corporation will limit their vicarious liability for the acts of their professional partners.
The California Professional Corporations Act allows licensed professionals in the fields of law, medicine, dentistry and accountancy to conduct business in a corporation, through the licensed individual shareholders. The Articles of Incorporation must include special language about the professional corporation. In addition to registering with the California Secretary of State, the corporation must also follow the naming and registration rules of the professional agency. The shareholders must be licensed, and transfers may only be to other shareholders or back to the corporation.
If a shareholder dies, the shares must be transferred within six months. If a shareholder is no longer qualified to practice medicine, the shares must be transferred within 90 days. For these reasons, I always recommend a shareholder buy-sell agreement to give the corporation or the remaining shareholders time to pay for the shares so it does not create financial difficulties for the company. Ideally, the corporation will also obtain life insurance on the professionals to fund a cash buy-out of a deceased shareholder’s shares.
My clients were concerned because they had heard that professional corporations were taxed at a high flat rate. I explained that they were correct in understanding that professional corporations are taxed at a flat 35% tax rate on all of the income. However, taxable income can be avoided for the professional corporation by either paying out all of the gain in salaries, or by electing S corporation (“S-corp”) status. I also recommended they put special language in their agreements with patients to avoid being subject to the personal holding company rules.
Based on my advice and joint consultation with their accountant, the doctors now hold their medical office building in their limited liability company, and are operating as a professional corporation. In addition to their malpractice insurance, these planning measures took away a lot of their liability concerns.