Choosing the right business structure is a crucial decision for solo psychologists in California. The choice of business entity determines how the psychology practice is taxed, the extent of personal liability protection and personal asset protection available to the psychologist, and the administrative requirements the psychologist will need to manage in operating the psychology practice.

A future article titled “What are the Business Structure Options for Two or More Psychologists in California?” will discuss the additional options available when two or more psychologists start practicing psychology together, however, for psychologists practicing psychology solo in California, the options are limited to sole proprietorships and California Professional Psychological Corporations.

This article provides an overview of the various business structure options available to psychologists practicing psychology solo in California, helping these psychologists to make an informed choice that aligns with their professional goals and liability concerns in the most tax efficient format possible.

Executive Summary: Putting the Conclusion First for Busy Psychologists

Summary of Practicing Psychology as a Sole Proprietor

The primary benefit of a sole proprietorship for psychologists is its simplicity. There are few legal formalities to establish a sole proprietorship and tax reporting is equally straightforward. However, a sole proprietorship is not a separate legal entity, which means that psychologist sole proprietors are personally liable for all business debts, liabilities, obligations, and legal judgments (including malpractice liability) against their psychology practice. The lack of a separate legal entity also means there is no distinction between personal and professional business assets for psychologist sole proprietors, so the business debts, liabilities, and legal judgments for which the psychologist sole proprietor is liable are satisfied from the personal assets of the psychologist.

Summary of Practicing Psychology with a California Professional Psychological Corporation

While inherently more complex than psychologist sole proprietorships, the complexity of a California Professional Psychological Corporation may be reduced by working with the experienced corporate attorneys at San Diego Corporate Law. As a separate legal entity, California Professional Psychological Corporations significantly reduce liability risks and are more tax efficient for most psychologists. For psychologists in high-liability practices, this reduction in risk can be substantial. The separate legal entity status of California Professional Psychological Corporations also means there is a distinction between personal and professional business assets for the psychologist, meaning the debts, liabilities, and legal judgments against the psychology practice are not generally satisfied from the personal assets of the psychologist.

Choosing Between a Sole Proprietorship and a California Professional Psychological Corporation

For most psychologists, the California Professional Psychological Corporation is the right chose because the tax benefits coupled with limited liability protection and ability to separate personal assets from professional business assets far outweighs the increased administrative complexity compared to practicing psychology as a sole proprietorship.

Contact San Diego Corporate Law for Assistance Selecting and Forming the Best Business Structure for Your Psychology Practice

Take the next step toward securing the ideal business structure for your psychology practice, whether that is a California Professional Psychological Corporation or another business structure. Contact the experienced corporate attorneys at San Diego Corporate Law today to schedule a consultation and receive personalized, expert guidance tailored to your needs. Our team is here to help you make informed decisions with confidence.

Practicing Psychology as a Sole Proprietor

Practicing psychology as a sole proprietor is the simplest and most straightforward business structure for solo psychologists in California. It requires minimal paperwork to set up compared to other business entity options and offers flexibility in managing the psychology practice. However, along with these advantages come distinct disadvantages that psychologists must consider carefully before considering sole proprietorship as the business structure for their psychology practice.

Administrative Requirements of Practicing Psychology as a Sole Proprietor

One of the primary benefits of a sole proprietorship for practicing psychology is the simplicity of establishing a sole proprietorship and the continued simplicity of operating as a sole proprietor.

Sole proprietorships require minimal effort to establish, with few legal formalities involved. Typically, the initial steps of setting up a sole proprietorship include obtaining a local business license to operate legally in the municipal jurisdiction in which the practice will operate and, if applicable, registering a fictitious business name (often referred to as a d/b/a).

Unlike other business structures, there is no need to file complex paperwork or create a formal business entity, which saves both time and money, but as discussed below, there are tradeoffs in exchange for this simplicity.

Taxation of Psychologist Sole Proprietors

Tax considerations are a critical aspect to be examined when planning to practice psychology as a sole proprietor. Sole proprietors are subject to business income taxation, self-employment taxation, and additional Medicare taxes. Understanding how these taxes apply to psychology practices is essential for psychologists when choosing a business structure in which to operate their psychology practice.

Business Income Taxation When Practicing Psychology as a Sole Proprietor

For psychologist sole proprietors, business income taxation is both simple and straightforward compared to that of other business entities. Sole proprietors report their business income and expenses on Schedule C (Profit or Loss from Business) to their personal income tax return, using Internal Revenue Service Form 1040. This allows psychologists to consolidate both personal and business income on a single tax form.

Self-Employment Tax When Practicing Psychology as a Sole Proprietor

While simple and straightforward, taxation of psychologist sole proprietors is not tax efficient. One significant consideration for psychologist sole proprietors is self-employment tax. Since a sole proprietor does not receive a salary from their business, they are responsible for paying self-employment taxes to cover Social Security and Medicare contributions. This self-employment tax is reported on Schedule SE, with the current rate at the time of this writing totaling 15.3% of net profit in addition to federal and state income taxes (however, a sole proprietor can deduct half of the self-employment tax paid as an adjustment on their tax return, which provides some financial relief).

Additional Medicare Tax When Practicing Psychology as a Sole Proprietor

High-earning psychologist sole proprietors may also be subject to the Additional Medicare Tax. This tax applies to individuals whose income exceeds certain thresholds, which are determined based on filing status. For psychologist sole proprietors filing as single, the threshold is $200,000, while it is $250,000 for psychologist sole proprietors filing a joint tax return with a spouse. The Additional Medicare Tax rate is 0.9% and applies only to the earnings above the specified threshold. Sole proprietors must calculate and report this tax on Form 8959, ensuring compliance with Internal Revenue Service requirements. It is important for high-earning psychologists to account for this additional tax in their financial planning to avoid unexpected liabilities.

Conclusions About Taxation of Psychologist Sole Proprietors

Understanding the tax implications of a sole proprietorship is integral when deciding which of the available business entities will be the most tax efficient, and understanding self-employment and the Additional Medicare Tax liabilities is the first step in planning and efficiently managing future tax liabilities.

Personal Liability Protection and Personal Asset Protection When Practicing Psychology as a Sole Proprietor

Practicing psychology as a sole proprietor, while simple, also comes with challenges regarding personal liability protection and asset protection because a sole proprietorship is not a separate legal entity, and thus does not offer a legal distinction between the psychologist and the psychology practice.

Personal Liability for Psychologists When Practicing Psychology as a Sole Proprietor

One of the primary risks faced by psychologist sole proprietors is personal liability. The lack of distinction between the psychologist and the psychology practice means that the psychologist sole proprietor is personally liable for all debts, liabilities, obligations, and legal judgments incurred by the psychology practice personally, including claims for professional negligence, better known as malpractice, for errors and omissions.

Personal Asset Protection for Psychologists When Practicing Psychology as Sole Proprietors

The lack of distinction between the psychologist and the psychology practice that makes personal liability a primary risk to psychologist sole proprietors also means that all assets of the psychologist, be they strictly personal assets or assets used in the psychology practice, are subject to claims by creditors and legal claimants against the personal assets of the psychologist (such as homes, bank accounts, investments, and other property).

Conclusions About Personal Liability and Asset Protection for Psychologist Sole Proprietors

The exposure to personal liability for debts, liabilities, obligations, and legal judgments (including those for professional negligence) coupled with the inability to separate personal assets from professional business assets underscores the importance for psychologists choosing a business structure for their psychology practice to understand liability risks and take proactive measures to safeguard their personal wealth and future earnings from such claims.

Conclusions About Practicing Psychology as a Sole Proprietor

When deciding whether to practice psychology as a sole proprietor, it is essential to weigh the benefits and drawbacks of this business structure. While psychologist sole proprietorships offer simplicity to psychologists, psychologist sole proprietorships come with significant risks and limitations. The advantages and disadvantages of practicing psychology as a sole proprietor are compared below together with a recommendation for when a sole proprietorship is the best legal structure for practicing psychology.

Advantages of Sole Proprietorship for Psychologists

The primary benefit of a sole proprietorship for practicing psychology is its simplicity. There are few legal formalities to establish a sole proprietorship and tax reporting is equally straightforward.

Disadvantages of Sole Proprietorship for Psychologists

While sole proprietorships are simple to establish, they carry significant risks and are not tax efficient for most psychologists.

A sole proprietorship is not a separate legal entity, which means that psychologist sole proprietors are personally liable for all debts, liabilities, obligations, and legal judgments (including malpractice liability). For psychologists in high-liability psychology practices, this risk can be substantial.

The lack of a separate legal entity also means there is no distinction between personal and professional business assets for psychologist sole proprietors, meaning the debts, liabilities, and legal judgments for which the psychologist sole proprietor is liable are satisfied from the personal assets of the psychologist.

When is a Sole Proprietorship the Right Business Structure for Practicing Psychology?

A sole proprietorship can be an ideal option for psychologists starting small-scale psychology practices with the expectation of low net profit and low liability risks. However, before choosing to practice psychology as a sole proprietor, it is essential to weigh the benefits of simplicity against the risks of personal liability and the future growth of the psychology practice. For psychologists in high-risk psychology practice areas or those who anticipate growth in their psychology practice may want to avoid practicing psychology as a sole proprietorship in favor of a business entity that is more tax efficient and provides limited liability protection together with the separation of personal assets from professional business assets.

For a more detailed understanding of the differences between professional sole proprietorships and California Professional Psychological Corporations and when a sole proprietorship is the best choice of business structure for psychology practices, see “When Not to Use a California Professional Psychological Corporation” for more information.

Practicing Psychology with a California Professional Psychological Corporation

Practicing psychology with a California Professional Psychological Corporation is not as simple or straightforward as practicing psychology as a sole proprietor, however, a California Professional Psychological Corporation provides the tax efficiency, limited liability protection, and separation of personal assets of the psychologist from the professional business assets of the psychology practice that psychologist sole proprietorships lack.

Administrative Requirements of Practicing Psychology with a California Professional Psychological Corporation

In order to enjoy the tax efficiency, limited liability protection, and separation of personal assets a California Professional Psychological Corporation provides, psychologists are faced with the complexity of establishing a California Professional Psychological Corporation. While this formation process is complex, psychologists may rely upon the experienced corporate attorneys at San Diego Corporate Law to draft and file all the required legal documents for the California Professional Psychological Corporation, leaving psychologists with essentially the same tasks they would undertake to establish a sole proprietorship. It is also worth noting that legal fees and costs of forming a California Professional Psychological Corporation are usually qualified business expenses that are tax deductible.

In addition to the initial formation of a California Professional Psychological Corporation, every year after the initial formation of a California Professional Psychological Corporation a Statement of Information must be filed with the California Secretary of State and a shareholder and board of directors meeting must be held. Just as with the formation of a California Professional Psychological Corporation, San Diego Corporate Law can assist in the annual requirements of practicing psychology with a California Professional Psychological Corporation.

Despite the additional administrative requirements of practicing psychology with a California Professional Psychological Corporation compared to practicing psychology as a sole proprietorship, an experienced corporate attorney can make the difference in requirements comparable.

For a more detailed understanding of the administrative requirements for forming and maintaining a California Corporation, see “The 7 Steps for Forming a California Professional Psychological Corporation” for more information.

Taxation of California Professional Psychological Corporations

As with psychologist sole proprietorships, tax considerations are a critical aspect to be examined when planning to practice psychology with a California Professional Psychological Corporation. While psychologists practicing psychology with a California Professional Psychological Corporation are subject to business income taxation, payroll taxes for wages, and franchise taxes paid to the California Franchise Tax Board, psychologists practicing psychology with a California Professional Psychological Corporation are not subject to self-employment taxation or additional Medicare taxes. Understanding how these taxes apply to psychology practices is essential for psychologists choosing a business structure in which to operate their psychology practices.

Business Income Taxation When Practicing Psychology with a California Professional Psychological Corporation

A California Professional Psychological Corporation is by default taxed as a personal service corporation (sometimes referred to as a professional service corporation), which is essentially a C Corporation (commonly referred to as a C-Corp) wherein corporate taxes applied to corporate profits are taxed directly at the federal and state levels at the corporate income tax rate, and any distributed dividends are subject to taxation again against the individuals receiving the dividends (referred to as “double taxation”). However, a California Professional Psychological Corporation may (and almost always should) elect to be treated as an S Corporation (commonly referred to as an S-Corp), which fundamentally changes how income is taxed. This article will focus on S Corporation taxation of California Professional Psychological Corporations.

Electing S Corporation status alters the tax treatment by enabling pass-through taxation. This means the profits and losses of the California Professional Psychological Corporation after payment of a reasonable salary to the psychologist are passed directly to the psychologist as the shareholder who in turn reports those profits on their personal income tax returns to pay federal income tax and state income tax on the net profit of the California Professional Psychological Corporation to pay taxes on the net profits of the psychology practice.

For more information about the election of S Corporation status for a California Professional Psychological Corporation, see “Can a California Professional Psychological Corporation Be an S-Corp?” for more information.

Self-Employment Tax When Practicing Psychology with a California Professional Psychological Corporation

Unlike psychologist sole proprietorships, which require the psychologist sole proprietor to pay self-employment tax on the entire net profit of the professional practice, the psychologist-shareholder of a California Professional Psychological Corporation is not subject to self-employment taxes.

Instead of self-employment taxes on the entire net profit of the psychology practice, with a California Professional Psychological Corporation employee and employer contributions to payroll tax are only paid on the reasonable salary of the psychologist. While the sum of the employee and employer contributions total 15.3% (the same percentage as self-employment tax), the calculation of the tax is based upon the reasonable salary of the psychologist only and not the net profit of the California Professional Psychological Corporation, which may result in significant annual tax savings compared to a sole proprietorship.

Additional Medicare Tax When Practicing Psychology with a California Professional Psychological Corporation

As discussed above for psychologist sole proprietorships, the Additional Medicare Tax is an extra 0.9% tax applied to earned income exceeding certain thresholds. However, because the Additional Medicare Tax is only applied to earned income and the net profit of a California Professional Psychological Corporation is not deemed to be “earned” income, the Additional Medicare Tax would only be applicable to psychologists practicing psychology with a California Professional Psychological Corporation if the reasonable salary of the psychologist exceeded the thresholds, meaning for all intents and purposes, practicing psychology with a California Professional Psychological Corporation does not subject psychologists to the Additional Medicare Tax.

Annual Franchise Tax for California Professional Psychological Corporations

California Professional Psychological Corporations must pay an annual franchise tax that psychologist sole proprietorships do not pay. The franchise tax paid by a California Professional Psychological Corporation taxed as an S Corporation is 1.5% of net profit with a minimum of $800 annually. While this is a tax not paid by psychologist sole proprietorships, the annual franchise tax is very small in comparison to self-employment taxes and the Additional Medicare Taxes paid by psychologist sole proprietors.

Conclusions About Taxation of California Professional Psychological Corporations

Understanding the tax benefits of a California Professional Psychological Corporation is integral when deciding which of the available business entities will be the most tax efficient, and understanding self-employment and the Additional Medicare Tax liabilities is the first step in planning and efficiently managing future tax liabilities.

For a more detailed understanding of the taxation of California Professional Psychological Corporations, see “What Tax Benefits Does a California Professional Psychological Corporation Provide?” for more information.

Personal Liability Protection and Personal Asset Protection When Practicing Psychology with a California Professional Psychological Corporation

Practicing psychology with a California Professional Psychological Corporation, while more complex than practicing psychology as a sole proprietorship, overcomes many of the personal liability protection and asset protection shortcomings of psychologist sole proprietorships. A California Professional Psychological Corporation is a separate legal entity distinct from the psychologist, thus offering a legal distinction between the psychologist and the psychology practice as well as personal and business assets of the psychologist.

Personal Liability Protection for Psychologists When Practicing Psychology with a California Professional Psychological Corporation

Practicing psychology with a California Professional Psychological Corporation resolves most of the risks faced by psychologist sole proprietors for personal liability. California Professional Psychological Corporations provide a separate legal entity distinct from the psychologist, meaning the psychologist is generally not personally liable for the debts, liabilities, obligations, and legal judgments incurred by the psychology practice.

Under California law, claims for professional negligence, better known as malpractice, for errors and omissions of psychologists are personal to the psychologists and not shielded by the existence of the California Professional Psychological Corporation, however, malpractice is an insurable risk and appropriately apportioned professional liability insurance may be used to indemnify the psychologist from this risk.

Personal Asset Protection for Psychologists When Practicing Psychology with a California Professional Psychological Corporation

The separate legal entity and distinction between the psychologist and the psychology practice provided by a California Professional Psychological Corporation means that, unlike a sole proprietorship, the California Professional Psychological Corporation separates the personal assets of the psychologist from professional business assets of the psychology practice. Therefore, claims by creditors and legal claimants against the California Professional Psychological Corporation are generally limited to the professional business assets of the California Professional Psychological Corporation and are not satisfied against the personal assets (such as homes, bank accounts, investments, and other property) of the psychologist.

Conclusions About Personal Liability and Asset Protection When Practicing Psychology with a California Professional Psychological Corporation

The limitation of personal liability for debts, liabilities, obligations, and legal judgments against the California Professional Psychological Corporation coupled with the ability to separate personal assets from professional business assets makes the use of a California Professional Psychological Corporation the choice for psychologists who wish to limit their personal liability and protect their personal wealth and future earnings from most claims arising out of their psychology practice.

For a more detailed understanding of the liability protection and asset protection of California Professional Psychological Corporations, see “What Liability Protection Does a California Professional Psychological Corporation Provide?” for more information.

Conclusions About Practicing Psychology with a California Professional Psychological Corporation

When deciding if practicing psychology as a California Professional Psychological Corporation is worth the additional cost and administrative requirements, it is essential to weigh the benefits and drawbacks of this business structure. While California Professional Psychological Corporations are more complex, California Professional Psychological Corporations resolve many of the significant risks and limitations inherent to practicing psychology as a sole proprietorship. The advantages and disadvantages of operating with a California Professional Psychological Corporation are compared below together with a recommendation for when a California Professional Psychological Corporation is the best legal structure for practicing psychology.

Advantages of California Professional Psychological Corporations

While practicing psychology as a sole proprietorship is simple to establish, doing so carries significant risks and is not tax efficient for most psychology. California Professional Psychological Corporations significantly reduce liability risks and are more tax efficient for most psychology.

A California Professional Psychological Corporation is a separate legal entity, which means the psychologist is generally shielded from personally liable for debts, liabilities, obligations, and legal judgments (other than the insurable risk of malpractice liability). For psychologists in high-liability psychology practices, this reduction in risk can be substantial.

The separate legal entity status also means there is a distinction between personal and professional business assets for psychologists, meaning the debts, liabilities, and legal judgments against their psychology practice are not generally satisfied from the personal assets of the psychologist.

Disadvantages of California Professional Psychological Corporations

The primary benefit of a sole proprietorship is its simplicity, and in turn the primary disadvantage of a California Professional Psychological Corporation is the relative complexity of formation and operation. However, psychologists may rely upon the experienced corporate attorneys at San Diego Corporate Law to draft and file all the required legal documents for establishing and maintaining the California Professional Psychological Corporation, leaving these psychologists with essentially the same tasks they would undertake to establish and maintain a sole proprietorship.

When is a California Professional Psychological Corporation the Right Business Structure for Practicing Psychology?

A California Professional Psychological Corporation can be an ideal option for psychologists starting psychology practices based upon the tax efficiency, limited liability protection, and separation of personal assets from professional business assets that California Professional Psychological Corporations provide. Small-scale psychology practices with the expectation of revenue growth can benefit from starting as a California Professional Psychological Corporation to avoid the future need to reestablish the psychology practice as revenue grows. Similarly, small-scale psychology practices in high-risk practice areas may benefit from the limited liability protection and separation of personal assets from professional business assets provided by a California Professional Psychological Corporation regardless of revenue or profitability.

For a more detailed understanding of the differences between psychologist sole proprietorships and California Professional Psychological Corporations, and when a California Professional Psychological Corporation is the best choice of business structure for a professional practice, see “When to Use a California Professional Psychological Corporation” and “Sole Proprietorship vs Professional Psychological Corporation in California” for more information.

Psychologists in California May Not Practice Psychology as a Limited Liability Company (LLC) or Professional Limited Liability Company (PLLC)

A The experienced corporate attorneys at San Diego Corporate Law are frequently asked about limited liability companies and professional limited liability companies, so this topic will be briefly discussed here.

California law explicitly prohibits a psychologists from operating the their practices as Limited Liability Companies (LLCs) or Professional Limited Liability Companies (PLLCs). This prohibition may be found in California Corporations Code Section 17701.04(e), which reads:

“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.”

Instead, California requires psychologists who wish to operate in corporate form to utilize other types of business entities, such as California Professional Psychological Corporations.

For a more detailed understanding of the prohibition on the use of LLCs for psychology practices in California, see “Can a Psychologist Practice Psychology Using a California LLC?” and “Can I Use a PLLC to Practice Psychology in California?” and for more information.

If an LLC or PLLC is currently being used by a business owner for a psychology practice in California, see “10 Steps to Convert LLC to Professional Psychological Corporation in California” and “Four Reasons Not to Convert LLC to Professional Psychological Corporation in California” or “12 Steps to Convert a PLLC to a California Professional Psychological Corporation” and “Four Reasons Not to Convert Foreign LLC or PLLC to a California Professional Psychology Corporation” for more information about bringing the professional practice into compliance with California law.