In California, establishing a California Professional Architecture Corporation to establish architectural firms is a favored option for licensed architects providing architectural services in California. We recently published an article titled When Not to Use a California Professional Architecture Corporation outlining when this legal structure may not be suitable for a California architectural firm. This article is intended to outline the strengths that most often make the California Professional Architecture Corporation the business entity of choice for California licensed architects rendering architectural services in California.

Liability Protection in California Professional Architecture Corporations

Licensed architects often choose to establish architecture firms in a California Professional Architecture Corporation to limit personal liability. Unlike sole proprietorships or partnerships, California Professional Architecture Corporations offer a liability protection and personal asset protection by separating the personal assets of the licensed architect shareholder from the architecture firm business debts, liabilities, obligations, and legal judgments against the California Professional Architecture Corporation.

Limited liability protection is vital for licensed architects who employ other licensed individuals as employees or independent contractors to render professional services, especially when there is a significant risk of malpractice claims. By forming a California Professional Architecture Corporation, architects can safeguard their personal assets and future earnings while adhering to state regulatory requirements and complying with agencies which govern rendering professional services in California, such as the California Architects Board.

Tax Benefits when Rendering Professional Service in a California Professional Architecture Corporation Taxed as an S-Corp

Selecting the ideal business structure to render professional service requires a deep understanding of tax implications. A California Professional Architecture Corporation that opts for S Corporation status can provide substantial tax benefits, especially in relation to self-employment and payroll taxes.

Self-employed architects are responsible for covering the full Social Security and Medicare taxes, totaling 15.3% of net profit up to the statutory cap, which is $168,600 as of 2024. Beyond this cap, they must pay 2.9% on all net profit. Additionally, there is a 0.9% Medicare tax for single taxpayers earning $200,000 or more and for married taxpayers filing jointly with incomes of $250,000 or above, added to the 2.9%.

A California Professional Architecture Corporation taxed as an S-Corp offers a strategic way to minimize self-employment taxes. By providing a market-rate salary to licensed architect shareholders, the salary becomes subject to payroll taxes of 15.3% up to the statutory cap ($168,600 in 2024) and 2.9% for earnings above this limit. The remaining profits can then be distributed as shareholder distributions, which are not subject to payroll or self-employment taxes. This approach can result in significant tax savings for licensed architects who balance their salary for architectural services with the distributions on their shares of stock based upon ownership of their California Professional Architecture Corporation.

When do the California Professional Corporation Benefits Make Sense for a Licensed Architect?

Most licensed architects would benefit from practicing with a California Professional Architecture Corporation in California, with the exceptions being very low revenue architectural practices without employees and with no plans for future growth of the architectural practice.

This article examines why forming a California Professional Architecture Corporation is advantageous for a licensed architect, whether practicing solo or with other licensed professionals. This article addresses relevant considerations to weigh when choosing the best business entity in which to practice architecture, namely, federal income taxes, California corporate taxes, self-employment taxes, personal income tax, liability protection, asset protection, and ownership issues.

The goal of this article is to equip licensed architects with the information needed to make informed decisions. It is crucial to ensure that the chosen business entity aligns with the business goals of the licensed architect while adhering to California law, including the California Corporations Code, the Moscone-Knox Professional Corporations Act, the California Business and Professions Code, and other relevant regulations, as well as the rules of government agencies overseeing the practice of architecture, such as the California Architects Board.

Executive Summary: Putting the Conclusion First for Busy Architects

A licensed architect should form a California Professional Architecture Corporation if they are either:

(i) concerned about liability protection or the separation of personal and business assets; or

(ii) anticipate an immediate or future tax benefit.

Some licensed architects establish California Professional Architecture Corporations solely for liability protection, while many other licensed architects do so exclusively for the tax benefits of practicing architecture using a California Professional Architecture Corporation. When either liability protection or tax benefits justify the creation of a California Professional Architecture Corporation, a licensed architect should consider using a California Professional Architecture Corporation, even if only one of liability protection or tax benefits are sought by the licensed architect.

For most licensed architects in most architectural practices, the experienced corporate attorneys at San Diego Corporate Law recommend the use of a California Professional Corporation for the limited liability protections and tax benefits a California Professional Architecture Corporation provides.

Lower Net Income Practices without Employees or Independent Contractors

If a licensed architect works alone, has no employees or independent contractors, is fully insured, and runs a practice with an annual net income below $50,000 to $60,000 without the intention to grow the architectural practice in the future, operating as a sole proprietorship in California may be suitable for that licensed architect.

Lower Net Income Practices with Employees or Independent Contractors

For licensed architects earning less than $50,000 to $60,000 in net income annually without plans to grow their architectural practice in the future, establishing a California Professional Architecture Corporation is still recommended if the licensed architect has or plans to have employees or independent contractors at any point in time, because California Professional Architecture Corporations offer protection to the licensed Architecture shareholder from liabilities related to their employees and independent contractors, including vicarious liability and malpractice liability claims.

Higher Net Income Practices Regardless of Liability Concerns

A licensed architect earning (or planning to earn) over $60,000 in net income annually should seriously consider practicing architecture in a California Professional Architecture Corporation regardless of liability concerns because the tax savings of a California Professional Architecture Corporation can outweigh the additional administrative costs associated with practicing architecture in a California Professional Architecture Corporation, and these tax savings can be significant.

Starting a New Practice Without Certainty of Future Performance

Licensed architects planning to start practicing architecture small and grow their architectural practice over time should carefully consider the administrative challenges of initially operating as a sole proprietor or general partnership with plans to later convert to a California Professional Architecture Corporation. It is best to schedule a consultation with an experienced corporate attorney for advice on the challenges for converting a thriving architectural practice from a sole proprietorship or general partnership to a California Professional Architecture Corporation versus forming the California Professional Architecture Corporation as a part of starting their architectural practice.

California Professionals are Prohibited from Practicing in a Limited Liability Company (LLC) or Professional Limited Liability Company (PLLC)

It is worth noting that LLCs and PLLCs are not permitted for use with architectural practices in California.

Contact San Diego Corporate Law for Expert Guidance

Choosing the right business structure for your architectural practice can be a complex task. For tailored advice that considers your specific circumstances, schedule a consultation with the experienced attorneys at San Diego Corporate Law. Our team is committed to assisting licensed architects in determining whether a California Professional Architecture Corporation or another business structure best suits their needs, maximizing tax benefits while minimizing liability risks.

Schedule a consultation today to ensure your architectural practice is structured for success.

Liability Protection for Licensed Architects

Licensed architects often opt to practice architecture as a California Professional Architecture Corporation to shield themselves from personal liability and to keep their personal assets separate and protected from business debts, liabilities, obligations, and legal judgments related to their architectural practice. It is essential for licensed architects to understand the liability protection differences between sole proprietorships and general partnerships compared to those offered by a California Professional Architecture Corporation when deciding on the ideal business structure for their architectural practice.

General Liability

Licensed architects selecting a business structure for their architectural practice should understand the distinctions in general liability protection between sole proprietorships and general partnerships compared to California Professional Architecture Corporations.

In this section, “general liability” refers to liabilities arising from contracts with vendors, claims of bodily injury, property damage, and other liabilities not related to employment relationships, malpractice, or professional errors and omissions.

For instance, consider scenarios such as a long-term lease of office space or specialized equipment, a bodily injury resulting from a visitor slipping and falling in the office of a licensed architect, property damage to leased premises or neighboring properties due to the architectural practice, or claims of libel, slander, and other reputational harm stemming from professional advertising.

General Liability for Sole Proprietors and General Partnerships

Sole proprietors and general partners practicing architecture encounter substantial liability risks due to the absence of a distinction between personal and business assets. In a sole proprietorship, the architect owner is personally liable for all business debts, liabilities, obligations, and legal judgments related to general liability claims against the architectural practice.

Similarly, in general partnerships, all general partners share joint and several liability. Each individual general partner is personally responsible for all business debts, liabilities, obligations, and legal judgments arising from general liability against the partnership. This means that each licensed architect acting as a general partner for a California architectural practice operating as a general partnership is personally liable for all liabilities of the architectural practice.

If a visitor is injured on the premises or if the architectural practice causes damage to property of a third-party property, the personal assets of a California architect sole proprietor or each architect general partner in a general partnership bear unlimited liability for these claims. This unlimited personal liability imposes a significant burden on a California architect sole proprietor or individual architect general partners of a general partnership, especially if the architectural practice lacks sufficient insurance or fails to effectively manage risks. It is essential for architect sole proprietors and architect general partners to be aware of these risks and consider protective measures, such as comprehensive insurance policies or restructuring the architectural practice to limit personal liability exposure.

General Liability for California Professional Architecture Corporations

A California Professional Architecture Corporation offers significant protection against personal liability for licensed architects. Unlike architect sole proprietors and architect general partners of a general partnership, who face unlimited personal liability for business debts, liabilities, obligations, and legal judgments, licensed architect shareholders of a California Professional Architecture Corporation generally enjoy protection from such business liabilities. This protection means the personal assets of licensed architect shareholders, such as homes and personal bank accounts, are typically shielded from claims related to the debts, liabilities, obligations, and legal judgments of the California Professional Architecture Corporation. As a distinct legal entity, the California Professional Architecture Corporation is accountable for its own debts, liabilities, obligations, and legal judgments, thereby insulating the personal financial exposure of its licensed architect shareholders.

It is important to recognize that the liability protection offered by a California Professional Architecture Corporation has its limitations. Licensed architect shareholders may still be personally liable for their own negligent or wrongful actions. Additionally, this protection does not cover liabilities backed by the personal guarantee of the licensed architect shareholder. To ensure limited liability protection for its licensed architect shareholders, the California Professional Architecture Corporation must be operated diligently and in compliance with California laws and regulations.

Despite the limitations mentioned above, the general liability protections afforded to licensed architect shareholders of California Professional Architecture Corporations are significant. These protections enable licensed architects to manage their architectural practices confidently with the maximum liability protection available under applicable law.

General Liability Conclusion

Some general liabilities for a California architectural practice, whether it is structured as a sole proprietorship, general partnership, or California Professional Architecture Corporation, are insurable risks. However, if an incident occurs that is not covered by insurance, if the insurer denies coverage, or if the liability exceeds the insurance limits, the limited liability features of a California Professional Architecture Corporation may protect a licensed architect shareholder whereas a California architect sole proprietor or architect general partner or a general partnership would be personally liable for the same claim. The limited liability of a California Professional Architecture Corporation offers protection compared to the unlimited personal liability faced by a California architect sole proprietor or architect general partner.

Employment Liability

Licensed professionals choosing a business structure for their practice should understand the differences in employment liability protection among sole proprietorships, general partnerships, and California Professional Architecture Corporations.

In this section, the term “employment liability” refers to both the responsibility owed to employees and independent contractors and the vicarious liability to third parties arising from the actions or inactions of employees and independent contractors.

Employment liability to employees encompasses issues such as wage and hour law, sexual harassment, hostile work environment claims, privacy and information privacy claims, discrimination, wrongful termination, and a host of other potential liabilities. In contrast, vicarious liability to third parties might involve a business being held accountable for an injury to a third party arising from an auto accident caused by an employee during company time or some similar claim.

Employment Liability for Sole Proprietors and General Partnerships

Much like general liability issues, architect sole proprietors and architect general partners of general partnerships are significantly exposed to liability due to the absence of a clear divide between personal and business assets. In a California architectural sole proprietorship, the licensed architect owner bears full responsibility and unlimited liability for employment-related claims made by employees or independent contractors, as well as for third-party claims concerning employee or independent contractor actions or inactions for which the architect practice is vicariously liable.

In general partnerships, architect general partners share joint and several liability. Each architect general partner has unlimited personal liability for all employee-related claims against the architectural practice and for all third-party claims of vicarious liability resulting from employee or independent contractor actions or inactions.

If an employee or independent contractor files a claim for a meal break violation, wrongful termination, or other common workplace issues, the personal assets of a California architect sole proprietor or each architect general partner in a general partnership is subject to unlimited liability. Similarly, if an employee or independent contractor assaults or injures a third party, or damages third-party property, the architect sole proprietor or each architect general partner faces unlimited liability for these claims under the legal principle of vicarious liability.

Unlimited personal liability places a heavy burden on architect sole proprietors and individual architect general partners of general partnerships, particularly when the architectural practice is underinsured or poorly manages risks. It is crucial for architect sole proprietors and individual architect general partners to recognize these risks and explore protective measures. Options such as employment practices liability insurance can guard against employee claims, while comprehensive general liability insurance addresses vicarious liability from employee and independent contractor actions or inactions. Alternatively, restructuring the architectural practice can help mitigate personal liability exposure.

Employment Liability for California Professional Architecture Corporations

A California Professional Architecture Corporation provides significant protection against personal liability for licensed architect shareholders, shielding them from employee-related claims. Unlike architect sole proprietors and architect general partners of general partnerships, who face unlimited personal liability for employee and independent contractor claims and incidents caused by employees and independent contractors, licensed architect shareholders in a California Professional Architecture Corporation typically enjoy protection from both types of employment liability.

The liability protection provided by a California Professional Architecture Corporation ensures that the personal assets of licensed architect shareholders, such as their homes and bank accounts, are generally shielded from claims arising from employment liability related to the architectural practice. As a separate legal entity, the California Professional Architecture Corporation assumes responsibility for employee and independent contractor claims and third-party claims based on employee and independent contractor actions or inactions under the legal theory of vicarious liability, thereby significantly reducing the personal financial exposure of licensed architect shareholders of a California Professional Architecture Corporation.

It is important to recognize that a California Professional Architecture Corporation holds liability for employee and independent contractor claims as well as third-party claims due to vicarious liability for the actions or inactions of employees and independent contractors. Although this is preferable to unlimited personal liability for licensed architects, such liability can still significantly impact a California architectural practice, even as it protects the assets of the licensed architect shareholders.

Similar to general liability, a California Professional Architecture Corporation must operate diligently and comply with California laws and regulations to ensure its licensed architect shareholders receive limited liability protection. This protection extends to both employee claims and third-party vicarious liability claims.

Despite the previously mentioned limitations, licensed architect shareholders enjoy significant employment liability protections with California Professional Architecture Corporations, and the safeguards provided allow them to conduct their practices with confidence with the maximum liability protection available under applicable law.

Employment Liability Conclusion

Employment practices liability insurance can cover many, but not all, liabilities related to employee and independent contractor liabilities. Similarly, many general liabilities are insurable risks for a California practice whose employees may expose it to third-party claims under vicarious liability. Whether operating as a sole proprietorship, general partnership, or California Professional Architecture Corporation, having comprehensive insurance is crucial. However, if an incident is not covered by insurance, if a claim is denied by an insurer, or if liability exceeds the limits of insurance coverage, the limited liability status of a California Professional Architecture Corporation can protect a licensed architect shareholder from personal liability. This stands in contrast to a California architect sole proprietor or architect general partner of a general partnership who would face unlimited personal liability for the same claim.

Malpractice Liability

Licensed architects selecting a business structure for their architectural practice should understand the differences in malpractice and errors and omissions liability protection offered by sole proprietorships, general partnerships, and California Professional Architecture Corporations.

In this section, “malpractice” is defined as the professional errors and omissions that occur when an individual architect fails to meet the accepted standards of architectural practice, resulting in harm or damage. Malpractice liability pertains to the legal accountability architects may incur for not adhering to these standards, which can lead to claims and lawsuits.

For architects selecting a business entity in which to practice architecture in California, understanding the assignment of malpractice liability is vital. In a California architectural practice, the consequences of malpractice can be significant. This section explores the intricacies of malpractice liability, focusing on the risks associated with professional errors and omissions, and examines the liability of architectural practice owners in sole proprietorships, general partnerships, and California Professional Architecture Corporations.

Malpractice Liability for Sole Proprietors and General Partnerships

California architect sole proprietors and architect general partners of general partnerships bear unlimited liability for their own malpractice, errors, and omissions. Consequently, these architects are personally liable for any malpractice claims filed against them by their clients.

In a general partnership, each of the architect general partners not only bear unlimited liability for the malpractice and errors and omissions claims against them personally, but they also have unlimited liability for the malpractice and errors and omissions of all other architect general partners in the general partnership, giving each architect general partner unlimited personal liability for the malpractice and errors and omissions of each other architect general partner.

Furthermore, as previously mentioned regarding vicarious liability for employees and independent contractors, architect sole proprietors and architect general partners of general partnerships bear unlimited liability for malpractice claims of the professional employees and professional independent contractors who practice for the sole proprietorship or general partnership. This liability stems from the alleged malpractice or errors and omissions of their professional employees under the legal theory of vicarious liability.

The unlimited personal liability associated with malpractice claims for all other professional general partners, employees, and independent contractors makes sole proprietorships and general partnerships less appealing for architectural practices because these business entities expose the personal assets of architect owners to unlimited liability for the alleged malpractice of other professionals.

Malpractice Liability for California Professional Architecture Corporations

Similar to architect sole proprietors and architect general partners in a general partnership, licensed architect shareholders of a California Professional Architecture Corporation face unlimited liability for their own malpractice and professional errors and omissions. This means that licensed architect shareholders remain personally liable for their own acts of malpractice and errors and omissions due to their own negligence.

However, licensed architect shareholders of a California Professional Architecture Corporation do enjoy protection from liability related to malpractice and errors and omissions allegedly made by employees, independent contractors, and other professional shareholders. A California Professional Architecture Corporations function as a legal entity separate and apart from its shareholders, safeguarding individual shareholders and their personal assets from malpractice liability, except for their own acts of malpractice and their own errors and omissions. In essence, while licensed architect shareholders of a California Professional Corporation are accountable for their own professional negligence, they are not held personally liable for the malpractice or errors and omissions of employees, independent contractors, or fellow architect shareholders within the California Professional Architecture Corporation.

This protection exists because the California Professional Architecture Corporation, not the individual licensed architect shareholder, is considered the employer of any employee, independent contractor, or other professional shareholder accused of malpractice. As a result, vicarious liability for malpractice falls on the California Professional Architecture Corporation rather than the individual architect shareholder. Consequently, while the professional alleged to have committed malpractice or an error or omission and a California Professional Architecture Corporation may face lawsuits for malpractice claims due to the actions of employees, independent contractors, or other professional shareholders, the personal assets of licensed architect shareholders not alleged to have personally committed an act of malpractice or an error or omission are typically protected.

As with general liability and employment liability, the limited liability framework for malpractice and errors and omissions relies upon the diligent operation of the California Professional Architecture Corporation in compliance with California laws and regulations.

Malpractice Liability Conclusion

Licensed architects, regardless of their chosen business structure, are personally liable for their own acts of malpractice and their own errors and omissions. However, operating as a sole proprietorship or general partnership in California exposes licensed architects to unlimited liability for malpractice and errors and omissions committed by employees, independent contractors, and professional co-owners. In contrast, forming a California Professional Architecture Corporation provides protection from personal liability for professional negligence committed by employees, independent contractors, or fellow professional shareholders. While malpractice insurance can cover errors and omissions, its limitations and the possibility of claim denial make malpractice liability a significant concern for licensed architects and California Professional Architecture Corporations provide the maximum legal protection available under applicable law.

Conclusions About Liability Protections

Choosing the right business entity for a California architectural practice requires careful consideration and consultation with legal experts, such as the experienced corporate attorneys at San Diego Corporate Law. It is crucial to have adequate insurance coverage, including general liability insurance, employment practices liability insurance, and malpractice liability insurance, to protect against claims regardless of the chosen professional business entity. However, insurance is limited in coverage and coverage amounts, and insurers deny claims when possible, so understanding professional liability and selecting an appropriate business structure, such as a California Professional Architecture Corporation, can offer further peace of mind for architects and safeguard both their personal and professional assets in ways even the best insurance policies cannot.

Tax Benefits for Licensed Architects

The organizational structure of a California Professional Architecture Corporation offers significant liability protection for licensed architects. However, it is essential to also consider its tax implications. Establishing a California Professional Architecture Corporation may also lead to favorable tax results. By understanding the tax benefits of California Professional Architecture Corporations compared to the taxation of sole proprietorships and general partnerships, licensed architects can make more informed decisions when selecting a business entity for their practice of architecture.

The tax benefits of a professional business entity are influenced by several factors: the net income of the practice before distributing funds to owners, additional income earned by the owners, and their overall tax strategy.

Certain tax situations can diminish the usual benefits of forming a California Professional Architecture Corporation from a tax perspective. This is especially true when the net income of the architectural practice before compensation to the architect owner is relatively low or when other income of the architect owner already meets the FICA cap. In such cases, the tax advantages of a California Professional Architecture Corporation may be diminished.

California Professional Architecture Corporations are by default C Corporations (C-Corps) and typically face double taxation at personal service corporation rates (sometimes referred to as professional service corporation rates). However, California Professional Architecture Corporations have the option to elect S Corporation status, which is advantageous for most architectural practices. This article will concentrate on the benefits of S Corporation taxation, omitting detailed discussions on professional C Corporation (C Corp) taxation and the issue of double taxation generally.

This section examines tax concerns for licensed architects, helping them assess whether establishing a California Professional Architecture Corporation aligns with their financial objectives and tax efficiency strategies.

FICA Tax Liability

The FICA tax is a mandatory payroll tax in the United States that funds Social Security. Both employees and employers share the responsibility of paying FICA taxes.

The FICA tax is directly deducted from the wages or salaries of employees at a rate of 6.2% of their gross income. Employers must match this contribution with an additional 6.2%, resulting in a total contribution of 12.4% per employee.

For self-employed individuals, such as architect sole proprietors and architect general partners in general partnerships, the FICA tax is calculated differently. Instead of being based on wages or salaries, it is assessed at 12.4% of the net income attributed to the self-employed person (whether a sole proprietor or general partner) from their architectural practice.

The FICA tax is applied solely to income or net income up to a specified limit, which is annually adjusted for inflation. As of 2024, this cap is set at the first $168,600 earned.

FICA Tax Liability for Sole Proprietors and General Partners

Licensed architect sole proprietors and licensed architect general partners in general partnerships shoulder the entire FICA tax burden on the net income of a California architectural practice, each up to their individual FICA cap. Unlike professional employees who split this tax with their employers, self-employed architects must cover both the employer and employee portions, resulting in a total FICA rate of 12.4% for architect sole proprietors and architect general partners in general partnerships.

The following are some examples of FICA tax liability for a licensed architect with various net income:

$50,000 net income x 12.4% = $6,200 FICA tax liability

$150,000 net income x 12.4% = $18,600 FICA tax liability

$300,000 net income x 12.4% = $20,906 FICA tax liability (limited by $168,600 FICA cap for 2024)

FICA Tax Liability for California Professional Architecture Corporations Taxed as S Corporations

When a California Professional Architecture Corporation opts for S Corporation status for tax purposes, it modifies the approach to handling FICA tax liability for its licensed architect shareholders. Unlike architect sole proprietors or architect general partners of general partnerships, who pay FICA taxes on their entire net income, California Professional Architecture Corporations taxed as S Corporations offer a potential reduction in FICA tax liability by distributing a portion of business profits as shareholders distributions rather than wages. However, licensed architect shareholders actively participating in the daily operations of the California Professional Architecture Corporation must still receive reasonable compensation which is subject to FICA taxes. This reasonable salary is taxed at the 12.4% FICA rate up to the annual wage base limit, with a 6.2% contribution deducted from the wages of the licensed architect shareholder as an employee and a matching 6.2% paid by the California Professional Architecture Corporation.

Licensed architect shareholders may receive distributions from any profits beyond their reasonable salary exempt from FICA taxes. This allows licensed architects in California Professional Architecture Corporations electing S Corporation taxation to strategically organize their income to reduce FICA tax liabilities as long as they adhere to Internal Revenue Service guidelines for determining reasonable compensation.

Here is an example of FICA tax liability for a licensed architect earning a minimum fair market value salary as determined by Internal Revenue Service guidelines:

$50,000 salary x 12.4% = $6,200 FICA tax liability

This applies regardless of whether the licensed architect shareholder also receives $100,000, $250,000, or any other amount as a distribution through shares of stock in the California Professional Architecture Corporation.

This approach requires planning and documentation, as non-compliance with reasonable compensation standards could lead to the reclassification of distributions as wages, incurring additional FICA tax liabilities and penalties. Nonetheless, a $50,000 salary can be considered reasonable according to Internal Revenue Service standards, regardless of the total net income of the California Professional Architecture Corporation.

FICA Tax Liability Conclusion

When comparing FICA tax liability, architect sole proprietors and architect general partners of general partnerships are taxed on the total net income of their architectural practice. In contrast, a California Professional Architecture Corporation that elects S Corporation taxation can divide its income into that which is paid to a licensed architect shareholder as salary subject to the FICA tax and shareholder distributions paid to the licensed architect shareholder through the shares of the stock of the California Professional Architecture Corporation, which distributions are not subject to the FICA tax.

Based upon the examples above, a California Professional Architecture Corporation taxed as an S Corporation that pays a $50,000 fair market salary to a licensed architect shareholder as an employee could save that licensed architect shareholder up to $14,706 per year based on the 2024 FICA tax cap of $168,600 compared that same net income being paid to a California architect sole proprietor or architect general partner.

Medicare Tax Liability

The Medicare tax is a mandatory payroll tax in the United States, supporting the federal Medicare insurance program. Responsibility for paying these taxes is shared between employees and employers.

For employees, the Medicare tax is deducted directly from their wages or salaries at a rate of 1.45% of their gross income. Employers must also contribute an additional 1.45% on behalf of the employee, resulting in a total contribution of 2.9% per employee.

For self-employed individuals, including architect sole proprietors and architect general partners in general partnerships, the Medicare tax is calculated not on wages or salaries, but rather as 2.9% of the net income of the architectural practice attributed to the licensed architect owner.

Unlike the FICA tax, which is imposed only on income up to a certain threshold, the Medicare tax has no cap on the amount owed by an employee, architect sole proprietor, or architect general partner.

Medicare Tax Liability for Sole Proprietors and General Partners

As architect sole proprietors or architect general partners of a general partnership, these licensed architects shoulder the entire Medicare tax burden on their net income. Unlike employees who share this responsibility with their employers, self-employed architects must cover both the employer and employee portions of the tax, resulting in a total Medicare tax rate of 2.9%.

The following are some examples of Medicare tax liability for a licensed architect with various net income:

$50,000 net income x 2.9% = $1,450 Medicare tax liability

$150,000 net income x 2.9% = $4,350 Medicare tax liability

$300,000 net income x 2.9% = $8,700 Medicare tax liability

Medicare Tax Liability for California Professional Architecture Corporations Taxed as S Corporations

When a California Professional Architecture Corporation opts for S Corporation status for tax purposes, it changes how Medicare tax obligations are managed for its licensed architect shareholders. Unlike architect sole proprietors or architect general partners of a general partnership who pay Medicare taxes on their entire net income, California Professional Architecture Corporations taxed as S Corporations offer a way to potentially reduce Medicare tax liability by classifying a portion of business profits as distributions on shares of stock instead of wages. Licensed architect shareholders actively engaged in the daily operations of the architectural practice must still receive reasonable compensation, which is subject to Medicare taxes. The Medicare tax responsibility is split, with a 1.45% contribution from the wages of the licensed architect shareholder as an employee and a matching 1.45% paid by the California Professional Architecture Corporation.

Licensed architect shareholders must receive a reasonable salary, but any additional profits can be paid as shareholder distributions to the licensed architect shareholder not subject to Medicare taxes. This allows licensed architects with California Professional Architecture Corporations taxed as S Corporations to strategically manage their income and reduce Medicare tax liabilities. It is essential, however, to adhere strictly to Internal Revenue Service guidelines when determining reasonable compensation.

Here is an example of Medicare tax liability for a licensed architect earning a minimum fair market value salary as determined by the Internal Revenue Service:

$50,000 salary x 2.9% = $1,450 Medicare tax liability

This applies regardless of whether the licensed architect shareholder receives $100,000, $250,000, or any other amount as shareholder distributions through shares of stock in the California Professional Architecture Corporation.

This approach requires planning and documentation, as non-compliance with reasonable compensation standards may lead to shareholder distributions being reclassified as wages, resulting in additional Medicare tax liabilities and penalties. Nonetheless, a $50,000 salary can be considered reasonable under Internal Revenue Service standards, regardless of the total net income of the California Professional Architecture Corporation.

Medicare Tax Liability Conclusion

When examining Medicare tax liability, architect sole proprietors and architect general partners of general partnerships are taxed on the entire net income of their architectural practice. In contrast, a California Professional Architecture Corporation that chooses S Corporation taxation can bifurcate its income to pay a reasonable salary to a licensed architect shareholder as an employee, which is subject to the Medicare tax, while distributing the remaining income to the licensed architect shareholder through the shares of stock of the California Professional Architecture Corporation, which is not subject to the Medicare tax.

Based upon the examples above, a California Professional Architecture Corporation taxed as an S Corporation that pays a $50,000 fair market salary to a licensed architect shareholder as an employee could save that licensed architect shareholder $2,900 per year based on a $150,000 annual income or $7,250 per year based on a $300,000 annual income compared to the Medicare tax liability for a California architect sole proprietor or architect general partner of a general partnership.

Additional Medicare Liability

The Additional Medicare Tax, introduced under the Affordable Care Act, targets high-income earners with increased taxation. Unlike the standard Medicare tax, this additional levy applies only to individuals and couples who surpass specific income thresholds. Specifically, it imposes a 0.9% tax rate on wages and self-employment income exceeding these limits, affecting only the income that surpasses the threshold.

The threshold for the Additional Medicare Tax is $200,000 for single taxpayers, $250,000 for married couples filing jointly, and $125,000 for married individuals filing separately.

Additional Medicare Tax Liability for Sole Proprietors and General Partners

As architect sole proprietors and architect general partners in general partnerships, individuals bear the full burden of the Additional Medicare tax obligation on their entire net income in excess of the thresholds.

The following are some examples of Additional Medicare tax liability for a single licensed architect with various net income:

$50,000 net income x 0.9% = $0 Additional Medicare tax liability (below threshold)

$150,000 net income x 0.9% = $0 Additional Medicare tax liability (below threshold)

$300,000 net income x 0.9% = $900 Additional Medicare tax liability ($100,000 above threshold)

The following are some examples of Additional Medicare tax liability for a married licensed architect filing jointly with various net income:

$50,000 net income x 0.9% = $0 Additional Medicare tax liability (below threshold)

$150,000 net income x 0.9% = $0 Additional Medicare tax liability (below threshold)

$300,000 net income x 0.9% = $450 Additional Medicare tax liability ($50,000 above threshold)

The following are some examples of Additional Medicare tax liability for a married licensed architect filing separately with various net income:

$50,000 net income x 0.9% = $0 Additional Medicare tax liability (below threshold)

$150,000 net income x 0.9% = $225 Additional Medicare tax liability ($25,000 above threshold)

$300,000 net income x 0.9% = $1,575 Additional Medicare tax liability ($175,000 above threshold)

Additional Medicare Tax Liability for California Professional Architecture Corporations Taxed as S Corporations

While the Additional Medicare tax applies to wages, including wages earned by licensed architect shareholders involved in the day-to-day operations of a California Professional Architecture Corporation, the fair market value wages required by the Internal Revenue Service are unlikely to come close to the thresholds for the Additional Medicare tax, regardless of marital status or tax filing status, with proper tax planning as follows:

$50,000 salary x 0.9% = $0 Additional Medicare tax liability (below threshold)

Additional Medicare Tax Liability Conclusion

While not as large as the FICA and Medicare tax examples at the net income rates used as examples above, the Additional Medicare tax is not nominal and can become quite large for the owners of large practice groups or owners of architectural practices with high net income.

Deductibility of Health Insurance Premiums and Other Fringe Benefits

Deducting health insurance premiums and other fringe benefits for licensed architect shareholders is another consideration in tax planning when selecting a business entity for a California architectural practice. This section will detail the tax implications and advantages of providing health insurance and other fringe benefits to licensed architect shareholders and employees. By grasping these deductions, one can engage in more strategic financial planning, significantly affecting overall tax liabilities.

Deductibility of Health Insurance Premiums and Other Fringe Benefits for Sole Proprietors and General Partners

For architect sole proprietors and architect general partners of general partnerships, the ability to deduct health insurance premiums and other fringe benefits can offer a tax advantage. Sole proprietors can deduct the health insurance premiums they pay for themselves as an above-the-line deduction, thereby reducing their adjusted gross income.

This deduction is available even if the sole proprietorship does not show a profit, though it cannot surpass the net profit of the architectural practice. It is important to remember that these deductions do not reduce Medicare or Social Security taxes. For architect general partners in general partnerships, similar provisions apply if the premiums are paid by the general partnership and classified as guaranteed payments.

These deductions not only reduce taxable income but also serve as incentives within the tax code, encouraging smaller business structures to offer health-related benefits.

Deductibility of Health Insurance Premiums and Other Fringe Benefits for California Professional Architecture Corporations Taxed as S Corporations

For California Professional Architecture Corporations taxed as S Corporations, understanding the deductibility of health insurance premiums and other fringe benefits for licensed architect shareholders is important to creating an effective tax strategy.

Shareholders who own more than 2% of the California Professional Architecture Corporation can deduct health insurance premiums and other fringe benefits for their benefit paid on their behalf by the California Professional Architecture Corporation, however, these premiums are treated as compensation to the licensed architect shareholders and are reported as such on their W-2 forms, underlining their inclusion in taxable income.

Proper handling of these deductions ensures that the California Professional Architecture Corporation remains compliant with tax regulations.

Deductibility of Health Insurance Premiums and Other Fringe Benefits Conclusion

Grasping these deductions is crucial for selecting the right business structure and optimizing tax responsibilities. For sole proprietorships, general partnerships, and California Professional Architecture Corporations taxed as S Corporations, health insurance premiums can qualify as business expenses. However, licensed architect shareholders of California Professional Architecture Corporations must include these premiums and other fringe benefits in their income tax calculations, although they are exempt from FICA and Medicare tax liabilities.

Additional Costs to Operating as a California Professional Architecture Corporation

California Franchise Tax Board Minimum Annual Franchise Tax

California Professional Architecture Corporations, when taxed as S Corporations, must pay the minimum annual franchise tax mandated by the California Franchise Tax Board. The minimum franchise tax is the greater amount between an annual $800 or 1.5% of net income.

Sole proprietorships and general partnerships are exempt from franchise taxation in California, allowing them to bypass the annual minimum tax. This exemption provides a slight financial benefit; however, the tax efficiency of California Professional Architecture Corporations far exceeds the California minimum franchise tax requirement.

Other Administrative Costs to Operate a California Professional Architecture Corporation

Operating a California Professional Architecture Corporation involves additional administrative costs beyond the minimum annual franchise tax compared to sole proprietorships and general partnerships.

For example, a California Professional Architecture Corporation will have expenses related to maintaining state and federal compliance for keeping its FinCEN Beneficial Ownership Information Report up to date, filing an annual statement of information, and the drafting of meeting minutes for its annual meetings of shareholders and its board of directors that sole proprietorships and unregistered general partnerships do not require.

For both general partnerships and California Professional Architecture Corporations, additional administrative costs for bookkeeping, legal consultation to ensure adherence to corporate governance requirements, and tax preparation are likely higher than equivalent costs for a sole proprietorship.

Sole proprietorships and general partnerships without employees will generally not incur payroll costs, but California Professional Architecture Corporations will require payroll services even if the licensed architect shareholder is the only employee of the California Professional Architecture Corporation, which is an added expense. However, sole proprietorships and general partnerships with employees will incur equivalent payroll costs that are comparable to those of California Professional Architecture Corporations.

The additional financial obligations of a California Professional Architecture Corporation can add up to a few thousand dollars per year depending upon the costs of tax preparation and payroll services, but these costs are often outweighed by the tax benefits provided by a California Professional Architecture Corporation taxed as an S Corporation.

Conclusions About Tax Benefits

The additional costs associated with operation as a California Professional Architecture Corporation vary but are generally a few thousand dollars per year compared to a sole proprietorship or general partnership that does not pay an annual franchise tax to the California Franchise Tax Board and does not have employees requiring payroll. In addition, sole proprietorships may enjoy lower tax preparation costs than general partnerships or California Professional Architecture Corporations.

However, depending upon the net income of the professional practice, these additional expenses may be paid for by the FICA, Medicare, and Additional Medicare tax savings possible with a California Professional Architecture Corporation.

For $50,000 of allocated net income, a California architect sole proprietor or architect general partner would expect to pay $7,650 in self-employment taxes ($6,200 FICA + $1,450 Medicare), equivalent to that which would be paid by a licensed professional shareholder of a California Professional Architecture Corporation.

For $150,000 of allocated net income, a California architect sole proprietor or architect general partner would expect to pay $22,950 in self-employment taxes ($18,600 FICA + $4,350 Medicare), compared to $7,650 in payroll taxes (employee and employer contributions combined of ($6,200 FICA + $1,450 Medicare) for a $50,000 salary from a California Professional Architecture Corporation, a tax savings of $15,300.

For $300,000 of allocated net income, a California architect sole proprietor or architect general partner would expect to pay $30,506 in self-employment taxes ($20,906 FICA + $8,700 Medicare + $900 Additional Medicare), compared to $7,650 in payroll taxes (employee and employer contributions combined of ($6,200 FICA + $1,450 Medicare) for a $50,000 salary from a California Professional Architecture Corporation, a tax savings of $122,856.

Thus, for lower net income, say $50,000 or below, a California Professional Architecture Corporation will likely cost more in additional administrative expenses than the tax savings realized.

At around $60,000 of net income per year, the tax savings versus additional expense of operating a California architectural practice as a California Professional Architecture Corporation starts to break even depending on the costs of the additional expenses incurred.

Above the $60,000 of net income per year, the tax savings begins to exceed the additional expense of operating a California architectural practice as a California Professional Architecture Corporation, resulting in the licensed architect shareholder keeping more of the net income earned after taxes.

The experienced corporate attorneys at San Diego Corporate Law are available to assist with the analysis of net income versus administrative expense budgeting when deciding whether or not a licensed architect should form a California Professional Architecture Corporation or choose another business structure for a California architectural practice.

Establishing a Business Structure for Anticipated Growth

Establishing a business structure conducive to anticipated growth involves selecting a formation that not only accommodates current operations but also facilitates future expansion.

For licensed architects foreseeing growth of their professional practice, choosing to start as a California Professional Architecture Corporation is advantageous because it allows these architects to establish their practice once, avoiding the establishment of a practice as a sole proprietorship or general partnership for a year or two before facing the need to establish the architectural practice a second time to after net income grows and the self-employment tax burden becomes expensive.

Additionally, even when net income remains lower, the California Professional Architecture Corporation is still valuable to a licensed architect because it provides legal protection by separating personal assets from business liabilities, a critical consideration for risk management.

If within the means of such a licensed architect, the recommendation is to start with a California Professional Architecture Corporation formed as a part of starting the architectural practice.

A Quick Note on LLCs and PLLCs

A licensed architect may not use a foreign or California limited liability company (LLC), nor may a foreign professional limited liability company (PLLC) be used to practice architecture in California. Pursuant to California Corporations Code Section 17701.04(e):

“Nothing in this title shall be construed to permit a domestic or foreign limited liability company to render professional services, as defined in subdivision (a) of Section 13401 and in Section 13401.3, in this state.”

This comes as a surprise to many licensed architects, as professional limited liability companies (PLLCs) are commonly used to render professional services in other states, however architecture firms may register with the California Secretary of State and use a general stock corporation or California Professional Architectural Corporation in California.