It is essential to understand who can be a shareholder of a California Professional Law Corporation because California Law Corporations are subjected to stringent regulations enforced by the State Bar of California.

This article will delve into the specific requirements and restrictions concerning the eligibility of individuals to become shareholders of Professional Law Corporations in California to provide both current and prospective shareholders, as well as those advising attorneys and their legal entities used for a law practice, with an understanding of the applicable California laws and regulations.

A secondary goal is to clarify who can serve on the board of directors or as an officer of a California Professional Law Corporation and thus exert influence over the operation and management of a law practice.

Permissible Shareholders of a California Professional Law Corporation

Licensed Attorneys May Be Shareholders of a California Professional Law Corporation

In California, the law governing Professional Law Corporations and their shareholders is found in the California Corporations Code Section 13401.5. This statute establishes that licensed attorneys are allowed to be shareholders of a California Professional Law Corporation.

It is worth noting that this law explicitly states that a “professional corporation” (including a Professional Law Corporation) means a corporation that is organized under the Moscone-Knox Professional Corporation Act and that renders professional services that are lawfully rendered by the shareholders.

As such, licensed attorneys, being authorized to render such professional legal services, fall under this category.

Permissible Directors of a California Professional Law Corporation

Pursuant to California Corporations Code Section 13403, a California Law Corporation which has only one shareholder need have only one director who shall be such shareholder.

Also pursuant to California Corporations Code Section 13403, a California Law Corporation which has only two shareholders need have only two directors who shall be such shareholders.

Permissible Officers of a California Professional Law Corporation

Pursuant to California Corporations Code Section 13403, a California Law Corporation which has only one shareholder shall also require the sole shareholder to serve as the president and treasurer of the corporation. The other officers of the corporation in such situation need not be licensed persons.

Also pursuant to California Corporations Code Section 13403, a California Law Corporation which has only two shareholders shall also require such shareholders between them shall fill the offices of president, vice president, secretary and treasurer.

Permissible Business of a California Professional Law Corporation

California Corporations Code Sections 202(b)(1)(B), (b)(4), 13404, set forth the purpose clauses for California Professional Corporations.

For a California Professional Law Corporation, the purpose clause should read, “The purpose of the corporation is to engage in the profession of law and any other lawful activities (other than the banking or trust company business) not prohibited to a corporation engaging in such profession by applicable laws and regulations. This corporation is a professional corporation within the meaning of California Corporations Code section 13400 et seq.”

A California Professional Law Corporation may engage in any other business permitted by the State Bar of California pursuant to California Corporations Code Sections 13401(b), 13404.

Tax Classifications of a California Professional Law Corporation

A pivotal aspect to consider during the formation of a California Professional Law Corporation is its tax structure. California Law Corporations may choose to be taxed either as an S-Corp or as a Personal Service Corporation.

Each of these classifications carries distinct tax implications, so it is crucial to consult with your tax advisor when deciding whether your California Professional Law Corporation should be taxed as an S-Corp or as a Personal Service Corporation.

S-Corp Taxation of a California Professional Law Corporation

The most common tax classification for a California Professional Law Corporation is that of an S-Corp.

An S-Corp is a taxation type that elects to pass corporate income, losses, deductions, and credits through to shareholders for tax purposes. Shareholders of S-Corps report the flow-through of income and losses on their personal tax returns and are assessed at their individual income tax rates. This allows S-Corps to avoid double taxation on the corporate income and it is considered beneficial for a California Professional Law Corporation and its shareholders in most instances.

This election can be made by filing IRS Form 2553. Note that S Corporation status is subject to certain restrictions and regulations, as outlined by the Internal Revenue Service.

Personal Service Corporation Taxation of a California Professional Law Corporation

A California Professional Law Corporation taxed as a Personal Service Corporation under federal law carries a unique set of tax implications.

Federal Taxation of a Personal Service Corporation

The Internal Revenue Service defines a Personal Service Corporation as a corporation where more than 50% of its stock is owned by employees who provide personal services and said services constitute the principal activity of the corporation.

For these corporations, the IRS levies a flat tax rate of 35% on the taxable income.

This is different from the progressive tax system typical for other types of corporations. Personal Service Corporations are also subject to the Accumulated Earnings Tax if earnings and profits are accumulated beyond the reasonable needs of the business. It is important to note that a Personal Service Corporation may still exploit tax-planning strategies to minimize tax liabilities. For instance, the corporation could distribute the income among its shareholders-employees as salaries, which are tax-deductible for the corporation—but these salaries are subject to employment taxes.

California Taxation of a Personal Service Corporation

Under California law, a Professional Law Corporation that is taxed as a Personal Service Corporation is subject to the California state corporate income tax.

This tax is levied at a flat rate of 8.84% on the net taxable income of the corporation. The tax applies to both the corporation’s operating income and passive income.

Additionally, a Personal Service Corporation in California is subject to a minimum franchise tax of $800, which is due in the first quarter of each accounting period, including the first year.

It is worth noting that California does not conform to federal tax law for certain provisions related to Personal Service Corporations, so it is crucial to seek advice from a tax professional well-versed in California law when navigating the state’s taxation system.

Rely On Your Tax Advisor When Choosing a Tax Type California Professional Law Corporation

Consulting with a tax advisor is recommended to make informed decisions about the tax structure of your California Professional Law Corporation.

The Formation Process for a California Professional Law Corporation

The formation process of a California Professional Law Corporation follows the same procedures as the formation of general stock corporations in the State of California.

Initially, the incorporators must file the Articles of Incorporation with the California Secretary of State, establish bylaws, file a Statement of Information with the California Secretary of State, obtain an EIN from the IRS, issue stock to the initial shareholders in compliance with federal and California securities laws and regulations (and the securities laws and regulations of any other states, if applicable), and hold an organizational meeting of the Board of Directors, among other requirements. By default, the newly formed California Professional Law Corporations will be taxed as Personal Service Corporations unless an election to be taxed as an S-Corp is timely filed, so getting the S Election filed with the IRS on time is of the utmost importance unless your tax advisor determines taxation as a Personal Service Corporation, double taxation, 35% federal tax rate, and 8.84% California tax rate would be preferable.

Throughout the process, it’s essential to ensure compliance with the standards specific to law practice as determined by the State Bar of California and specific language that must be included in the corporate documents to satisfy the requirements of the State Bar of California, the California Corporations Code, and the California Business & Professions Code. Specific information must be included in the Articles of Incorporation and/or bylaws.

Work With a Professional for the Formation of Your California Professional Law Corporation

Potential Issues and Personal Liability When Forming a California Professional Law Corporation Yourself or With an Online Service

You would not suggest your clients represent themselves in court or rely on information from a website for their legal needs, so do not do the same when it comes to liability protection for your practice of law.

Handling the formation of a California Professional Law Corporation yourself or utilizing an online service comes with its own set of potential issues and risks. As the procedures are highly specialized, even a minor error in the formation process could result in delays, financial losses, or legal complications.

One of the most common issues is failing to adhere to the strict regulatory standards set by the State Bar of California and the California Corporations Code. Ensuring accurate and appropriate language in corporate documents is crucial to meet these standards. Without professional guidance, you may overlook these specific requirements, leading to non-compliance and potential legal scrutiny.

Another risk is the incorrect filing of tax forms or the failure to timely elect the preferred taxation status. An incorrect or late S-Corp election filing with the IRS can result in your corporation being taxed as a Personal Service Corporation by default, which may not be advantageous for your tax situation.

Importantly, if you form the corporation yourself, you risk losing liability protection caused by mistakes or oversights in the formation process. Personal liability could expose your personal assets to potential creditors of the corporation. Professional guidance can help you navigate these complexities and provide a shield against personal liability, ensuring that you and your California Professional Law Corporation are adequately protected.

Let San Diego Corporate Law Form Your California Professional Law Corporation

At San Diego Corporate Law, our experienced attorneys are well-versed in the complexities of forming a California Professional Law Corporation.

We understand that as an attorney, your time is precious. Let us handle the intricate legal and tax complexities so you can focus on what truly matters – providing exceptional representation and legal services to your clients. Do not leave such important matters to chance; trust the professionals.

Contact us today to begin the formation process of your California Professional Law Corporation.