It is essential to understand who can be a shareholder of a California Professional Accountancy Corporation because California Accountancy Corporations are subjected to stringent regulations enforced by the California Department of Consumer Affairs, California Board of Accountancy.

This article will delve into the specific requirements and restrictions concerning the eligibility of individuals to become shareholders of Professional Accountancy Corporations in California to provide both current and prospective shareholders, as well as those advising accountants and their legal entities used for a public accountancy 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 Accountancy Corporation and thus exert influence over the operation and management of a public accountancy practice.

Permissible Shareholders of a California Professional Accountancy Corporation

Licensed Accountants May Be Shareholders of a California Professional Accountancy Corporation

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

It is worth noting that this law explicitly states that a “professional corporation” (including a Professional Accountancy 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 accountants, being authorized to render such professional accountancy services, fall under this category.

Certain Others May Be Minority Shareholders of a California Professional Accountancy Corporation

Per California Corporations Code Section 13401(b), (d), unless an exception exists, shareholders of California Professional Corporations are limited to licensed persons (as defined in Section 13401 of the California Corporations Code) and further is limited only to professionals holding a license to practice in the profession specified by the professional corporation.

Such exception is provided by California Business and Professions Code Section 5154, which confirms the restrictions of the Moscone-Knox Professional Corporations Act, but allows those persons described in California Business and Professions Code Section 5079 to be directors, shareholders, or officers of a California Professional Accountancy Corporation in addition to licensed accountants.

California Business and Professions Code Section 5079(a) allows a California Professional Accountancy Corporation lawfully engaged in the practice of public accountancy to have shareholders who are not licensed as certified public accountants or public accountants if the following conditions are met:

(1)       Nonlicensee owners shall be natural persons or entities, such as partnerships, professional corporations, or others, provided that each ultimate beneficial owner of an equity interest in that entity shall be a natural person materially participating in the business conducted by the firm or an entity controlled by the firm.

(2)       Nonlicensee owners shall materially participate in the business of the firm, or an entity controlled by the firm, and their ownership interest shall revert to the firm upon the cessation of any material participation.

(3)       Licensees shall in the aggregate, directly or beneficially, comprise a majority of owners, except that firms with two owners may have one owner who is a nonlicensee.

(4)       Licensees shall in the aggregate, directly or beneficially, hold more than half of the equity capital and possess majority voting rights.

(5)       Nonlicensee owners shall not hold themselves out as certified public accountants or public accountants and each licensed firm shall disclose actual or potential involvement of nonlicensee owners in the services provided.

(6)       There shall be a certified public accountant or public accountant who has ultimate responsibility for each financial statement attest and compilation service engagement.

(7)       Except as permitted by the board in the exercise of its discretion, a person may not become a nonlicensee owner or remain a nonlicensee owner if the person has done either of the following:

(A)      Been convicted of any crime, an element of which is dishonesty or fraud, under the laws of any state, of the United States, or of any other jurisdiction.

(B)       Had a professional license or the right to practice revoked or suspended for reasons other than nonpayment of dues or fees, or has voluntarily surrendered a license or right to practice with disciplinary charges or a disciplinary investigation pending, and not reinstated by a licensing or regulatory agency of any state, or of the United States, including, but not limited to, the Securities and Exchange Commission or Public Company Accounting Oversight Board, or of any other jurisdiction.

Per California Business and Professions Code Section 5079(b):

(1)       A nonlicensee owner of a licensed firm shall report to the board in writing of the occurrence of any of the events set forth in paragraph (7) of subdivision (a) within 30 days of the date the nonlicensee owner has knowledge of the event. A conviction includes the initial plea, verdict, or finding of guilt, pleas of no contest, or pronouncement of sentence by a trial court even though that conviction may not be final or sentence actually imposed until appeals are exhausted.

(2)       A California nonlicensee owner of a licensed firm shall report to the board in writing the occurrence of any of the following events occurring on or after January 1, 2006, within 30 days of the date the California nonlicensee owner has knowledge of the events:

(A)      Any notice of the opening or initiation of a formal investigation of the nonlicensee owner by the Securities and Exchange Commission or its designee, or any notice from the Securities and Exchange Commission to a nonlicensee owner requesting a Wells submission.

(B)       Any notice of the opening or initiation of an investigation of the nonlicensee owner by the Public Company Accounting Oversight Board or its designee.

(C)      Any notice of the opening or initiation of an investigation of the nonlicensee owner by another professional licensing agency.

(3)       The report required by paragraphs (1) and (2) shall be signed by the nonlicensee owner and set forth the facts that constitute the reportable event. If the reportable event involves the action of an administrative agency or court, the report shall identify the name of the agency or court, the title of the matter, and the date of occurrence of the event.

(4)       Notwithstanding any other provision of law, reports received by the board pursuant to paragraph (2) shall not be disclosed to the public pursuant to the California Public Records Act (Division 10 (commencing with Section 7920.000) of Title 1 of the Government Code) other than (A) in the course of any disciplinary proceeding by the board after the filing of a formal accusation, (B) in the course of any legal action to which the board is a party, (C) in response to an official inquiry from a state or federal agency, (D) in response to a subpoena or summons enforceable by order of a court, or (E) when otherwise specifically required by law.

(5)       Nothing in this subdivision shall impose a duty upon any licensee or nonlicensee owner to report to the board the occurrence of any events set forth in paragraph (7) of subdivision (a) or paragraph (2) of this subdivision either by or against any other nonlicensee owner.

Pursuant to California Business and Professions Code Section 5079(c), the following definitions apply:

(1)       “Licensee” means a certified public accountant or public accountant in this state or a certified public accountant in good standing in another state.

(2)       “Material participation” means an activity that is regular, continuous, and substantial.

Under California Business and Professions Code Section 5079(d), all firms with nonlicensee owners shall certify at the time of registration and renewal that the firm is in compliance with California Business and Professions Code Section 5079.

Permissible Directors of a California Professional Accountancy Corporation

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

Under California Business and Professions Code Section 5154, those persons described in California Business and Professions Code Section 5079 may serve as directors of a California Professional Accountancy Corporation.

Permissible Officers of a California Professional Accountancy Corporation

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

Under California Business and Professions Code Section 5154, those persons described in California Business and Professions Code Section 5079 may serve as officers of a California Professional Accountancy Corporation.

Permissible Business of a California Professional Accountancy 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 Accountancy Corporation, the purpose clause should read, “The purpose of the corporation is to engage in the profession of accountancy 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 Accountancy Corporation may engage in any other business permitted by the California Department of Consumer Affairs, California Board of Accountancy pursuant to California Corporations Code Sections 13401(b), 13404.

Tax Classifications of a California Professional Accountancy Corporation

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

S-Corp Taxation of a California Professional Accountancy Corporation

The most common tax classification for a California Professional Accountancy 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 Accountancy 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 Accountancy Corporation

A California Professional Accountancy 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 Accountancy 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 Accountancy Corporation

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

The Formation Process for a California Professional Accountancy Corporation

The formation process of a California Professional Accountancy 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 Accountancy 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 public accountancy practice as determined by the California Department of Consumer Affairs, California Board of Accountancy and specific language that must be included in the corporate documents to satisfy the requirements of the California Department of Consumer Affairs, California Board of Accountancy, 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 Accountancy Corporation

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

You would not suggest your clients attempt their own accounting or rely on information from a website for their accounting needs, so do not do the same when it comes to liability protection for your practice of public accountancy.

Handling the formation of a California Professional Accountancy 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 California Department of Consumer Affairs, California Board of Accountancy 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 Accountancy Corporation are adequately protected.

Let San Diego Corporate Law Form Your California Professional Accountancy Corporation

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

We understand that as an accountant, your time is precious. Let us handle the intricate legal complexities so you can focus on what truly matters – providing exceptional accountancy 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 Accountancy Corporation.