Choosing the right business structure is a critical decision for physicians establishing their private practices in California. While California Limited Liability Companies (California LLCs) are popular for their flexibility and tax benefits, medical practices in California are expressly prohibited from operating as a California Limited Liability Company (California LLC).

While the question, “why is a medical practice not permitted to use a California LLC?” has been answered in previous articles cited and summarized below, the experienced corporate attorneys at San Diego Corporate Law inquiries on a weekly basis from physicians receiving mixed information from other attorneys or advisors leading them to believe that in certain circumstances it might be permissible to practice medicine in a California LLC.

This blog references and links to previous articles with regard to the business structures and business entities physicians may use to practice medicine in California, but the purpose of this article is to highlight and explore the specific provisions of the California Corporations Code that prohibits the use of a California LLC to render professional services as a physician in California.

California Corporations Code Section 13401

The Moscone-Knox Professional Corporations Act is found in California Corporations Code Sections 13400-13410. California Corporations Code Section 13401(b) provides the authority for licensed physicians to practice in California as California Professional Medical Corporations with the purpose of rendering professional services in their practice of medicine.

California Corporations Code Section 13401 also provides two definitions required to properly analyze the restrictions on the use of California LLCs by physicians practicing medicine in California.

California Corporations Code Section 13401(a)

California Corporations Code Section 13401(a) provides the definition of “Professional Services” as follows:

“‘Professional services’ means any type of professional services that may be lawfully rendered only pursuant to a license, certification, or registration authorized by the Business and Professions Code, the Chiropractic Act, or the Osteopathic Act.”

Thus, Professional Services under the definition provided by California Corporations Code Section 13401(a) encompasses many professions, including medicine under California Business and Professions Code Sections 2400–2417.5.

California Corporations Code Section 13401(d)

California Corporations Code Section 13401(d) provides the definition of “Licensed Person” as follows:

“‘Licensed person’ means any natural person who is duly licensed under the provisions of the Business and Professions Code, the Chiropractic Act, or the Osteopathic Act to render the same professional services as are or will be rendered by the professional corporation or foreign professional corporation of which the person is, or intends to become, an officer, director, shareholder, or employee.”

Thus, Licensed Person under the definition provided by California Corporations Code Section 13401(d) means those persons licensed in the professions listed above as providers of Professional Services under California Corporations Code Section 13401(a), which includes physicians in California.

California Corporations Code Section 17701.04

Two subsections of California Corporations Code Section 17701.04 explicitly outline restrictions on the use of a California LLC for the provision of medical services.

Professional Services, as defined under California Corporations Code Section 13401(a), refers to professional services, such as the practice of medicine, that require a license, certification, or registration by governmental agencies or other entities and regulatory boards such as the Medical Board of California. California Corporations Code Section 17701.04 establishes that individuals or entities practicing as a physician cannot form a California LLC for these purposes.

California Corporations Code Section 17701.04(b)

One of the primary legal barriers to medical practices utilizing a California LLC can be found in California Corporations Code Section 17701.04(b), which reads:

“A limited liability company may have any lawful purpose, regardless of whether for profit, except the banking business, the business of issuing policies of insurance and assuming insurance risks, or the trust company business. A domestic or foreign limited liability company may render services that may be lawfully rendered only pursuant to a license, certificate, or registration authorized by the Business and Professions Code, the Chiropractic Act, the Osteopathic Act, or the Yacht and Ship Brokers Act, if the applicable provisions of the Business and Professions Code, the Chiropractic Act, the Osteopathic Act, or the Yacht and Ship Brokers Act authorize a limited liability company or foreign limited liability company to hold that license, certificate, or registration.”

California Corporations Code Section 17701.04(b) is one of the more confusing sections in the analysis of restrictions on using a California LLC for a medical practice. While the first half of the second sentence of California Corporations Code Section 17701.04(b) does read:

“A domestic or foreign limited liability company may render services that may be lawfully rendered only pursuant to a license, certificate, or registration authorized by the Business and Professions Code, the Chiropractic Act, the Osteopathic Act, or the Yacht and Ship Brokers Act…”

the second half of that sentence requires there to be applicable provisions the California Business and Professions Code or other applicable Act to actually authorize the use of a California LLC, which authorizing provisions do not exist at the time of this writing for the practice of medicine.

California Corporations Code Section 17701.04(e)

Another of the legal barriers to a professional medical practice utilizing an LLC in California can 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.”

This section of the California Corporations Code explicitly prohibits LLCs from providing Professional Services in California under California Corporations Code 13401(a) by those Licensed Persons, including physicians, under the definition of California Corporations Code Section 13401(d).

Secretary of State Form LLC-1 Regarding a Medical Practice Using a California LLC

California Articles of Organization Form LLC-1 Screenshot of Professional Services Notice

As shown in the image above, in order to file California Secretary of State Form LLC-1, the filer must agree to the following provision:

“A California limited liability company may not provide professional services in California. (California Corporations Code sections 13401 and 7701.04(e).) If your business is required to be licensed, certified or registered, before submitting this filing to the California Secretary of State’s office, it is recommended that you contact the appropriate licensing authority in order to determine whether your services are considered professional. For licensing requirements in California, please refer to the CalGold website at http://www.calgold.ca.gov or the California Department of Consumer Affairs website at http://www.dca.ca.gov.

A filer may successfully file California LLC Articles of Organization despite the warning depicted and quoted above, however, acceptance of Articles of Organization by the Secretary of State does not constitute the consent of the California Secretary of State to practicing medicine with a California LLC under the California Corporations Code.

Reasons for Prohibition Against a California Limited Liability Company for California Physicians

The main reason for prohibiting the use of California LLCs by licensed physicians is to ensure compliance with professional regulations and protect the public from potential harm caused by unqualified or unethical individuals providing medical services by upholding public accountability standards specific to the practice of medicine. The State of California wants to ensure that only licensed physicians who have met certain education and training requirements are able to offer their expertise and advice in a professional capacity as a physician.

The reasoning behind this restriction stems from the nature of medical services, which requires specialized knowledge and experience, and is subject to stringent regulation by the State of California and the Medical Board of California. Professions such as medicine demand accountability not just to patients but also to their professional licensing boards.

The California LLC structure, known for its liability protections and manager/member flexibility, is deemed incompatible with the heightened accountability standards the State of California applies to physicians. Thus, physicians practicing in California must choose alternative structures that better align with the regulatory oversight and public protection goals of the State of California.

California Professional Medical Corporations require adherence to stricter regulations regarding ownership and governance. Licensed physician shareholders of a California Professional Medical Corporation must be licensed to practice medicine, certain other medical professionals, or certain other professionals permitted under California Corporations Code Section 13401.5 (see: “Who May Be a Shareholder of a California Professional Medical Corporation?“), ensuring that ethical standards and professional expertise guide the practice of medicine.

Permitted California Business Structures for Licensed Physicians

Licensed physicians in California are restricted in the types of business entities they may form due to California law in the California Corporations Code discussed above. These California laws are designed to ensure compliance with professional standards of practice and maintain accountability for practicing medicine in California.

A previous article titled “Can a Physician Practice Medicine Using a California LLC?” answered the question of whether a licensed physician could use a California LLC, discussed some of the possible consequences of practicing medicine in California as a California LLC, and explored the options available to licensed physicians who might already be practicing medicine as a California LLC.

This section will provide an overview of the permitted business structures that licensed physicians may utilize, including California Professional Medical Corporations, partnerships, and sole proprietorships, while providing links to articles containing more information about the specific requirements and considerations for each business entity structure.

Sole Proprietorships for California Licensed Physicians

A sole proprietorship is the simplest and most common business structure for licensed physicians looking to practice medicine in California. It is an unincorporated business owned and operated by the licensed physician personally, making it straightforward to set up and maintain. For licensed physicians in California, understanding how a sole proprietorship functions and the associated considerations is critical to ensuring compliance and achieving success.

Key Features of Sole Proprietorships for California Licensed Physicians

One of the primary advantages of a sole proprietorship is ease of formation. There are minimal regulatory requirements compared to other business structures, which reduces the time and cost of starting a practice. Sole proprietors simply need to obtain the appropriate professional licenses and any required local permits to begin operations.

Another notable feature of a sole proprietorship is that the licensed physician has complete control of the business. This autonomy allows licensed physicians to make decisions and manage their practice without needing approval from partners or shareholders.

However, sole proprietors are personally liable for all debts and obligations of their business. For California licensed physicians, this means that personal assets can be at risk if claims arise from medical services or other business activities. It is crucial for sole proprietors to consider obtaining adequate liability insurance to mitigate this risk.

Tax Considerations of Sole Proprietorship for Practicing Medicine

From a tax perspective, sole proprietorships are treated as “pass-through” entities. This means the business income is reported directly on the owner’s personal tax return, simplifying the tax filing process. However, sole proprietors are subject to self-employment taxes, which includes both the employer and employee portions of Social Security and Medicare taxes.

Is a Sole Proprietorship Right for You?

While a sole proprietorship may offer simplicity and independence, it is essential to weigh the potential risks and benefits relative to other business structures, such as California Professional Medical Corporations. Licensed professionals should assess their long-term business goals, liability exposure, and the administrative requirements when selecting a business entity. For more detailed guidance on sole proprietorships for licensed professionals in California, consult “Sole Proprietorship vs Professional Medical Corporation in California” and “What are the Business Structure Options for Solo Physicians in California?” or schedule a consultation with the experienced corporate attorneys at San Diego Corporate Law to ensure compliance and alignment with your professional objectives.

Partnerships for California Licensed Physicians

A partnership is one of the simplest business entity structures available for two or more licensed physicians looking to collaborate professionally. For California physicians, partnerships may offer a straightforward structure for operating a medical practice. However, it is essential to understand the benefits, limitations, and regulatory implications before forming a partnership for practicing medicine.

Key Features of Partnerships for California Licensed Physicians

A California General Partnership is formed when two or more individuals agree to engage in a business together for profit, without formally organizing another form of business entity. Partners share ownership, responsibilities, profits, and liabilities equally unless otherwise agreed upon through a written partnership agreement. Importantly, in California, general partnerships do not require registration with the state to be established, but they must comply with local licensing and regulatory requirements applicable to the practice of medicine. Partners of a California General Partnership have joint and several liability for all debts, liabilities, obligations, and legal judgments against the California General Partnership.

Tax Considerations of Partnerships for Practicing Medicine

One of the main considerations when choosing between these a partnership for a medical practice is the tax implications.

Partnerships are subject to pass-through taxation, a process that allows the income, deductions, and tax credits of the partnership to “pass through” to the individual partners rather than being taxed at the business entity level. This means that the partnership itself does not pay federal income taxes. Instead, each partner reports their share of the profits or losses of the partnership on their personal income tax return, based on their ownership interest.

In addition to income taxes, partners of a partnership are generally considered self-employed for tax purposes. This designation requires them to pay self-employment taxes, which cover Social Security and Medicare contributions. Unlike employees, who split these taxes with their employer, self-employed individuals are responsible for the full tax rate, currently 15.3% of net earnings. The self-employment tax liability of each partner is calculated based on their share of the net income of the partnership.

It is crucial for physicians considering a partnership business structure for their medical practice to understand the income tax and self-employment tax obligations of partnerships and plan accordingly, as these taxes can significantly impact personal income tax liability.

Is a Partnership Right for You?

While a partnership may offer simplicity and independence, it is essential to weigh the potential risks and benefits relative to other business structures, such as California Professional Medical Corporations. Licensed physicians should assess their long-term business goals, liability exposure, and the administrative requirements when selecting a business entity for their medical practice. For more detailed guidance on California General Partnerships for licensed professionals in California, consult “What are the Business Structure Options for Medical Group Practices in California?” or schedule a consultation with the experienced corporate attorneys at San Diego Corporate Law to ensure compliance and alignment with your professional objectives.

California Professional Medical Corporations for California Licensed Physicians

In California, licensed physicians have the option to form a California Professional Medical Corporation with the California Secretary of State as the business entity structure to practice medicine. A California Professional Medical Corporation is a specialized type of California Corporation that is specifically designed for licensed physicians.

Key Features of California Professional Medical Corporations for California Licensed Physicians

One of the main advantages of forming a California Professional Medical Corporation is that it offers personal liability protection for the licensed physician shareholders who own the California Professional Medical Corporation. This means that all debts, liabilities, obligations, and legal judgments against the medical practice that are not subject to a personal guaranty or based on malpractice or professional errors and omissions will stay with the California Professional Medical Corporation and no flow to the licensed physician shareholder (see: “What Liability Protection Does a California Professional Medical Corporation Provide?“).

However, there are certain restrictions on who can own and manage a California Professional Medical Corporation which require only licensed physicians to be shareholders (see: “Who May Be a Shareholder of a California Professional Medical Corporation?“).

Tax Considerations of California Professional Medical Corporations for Practicing Medicine

Forming a California Professional Medical Corporation can also provide tax benefits to licensed physician shareholders (see: “What Tax Benefits Does a California Professional Medical Corporation Provide?“). For example, a California Professional Medical Corporation can make an S Corporation election, which allows for pass-through taxation (see: “Can a California Professional Medical Corporation Be an S-Corp?“). Electing to be taxed as an S-Corp means that the profits and losses of a California Professional Medical Corporation are passed through to the personal tax returns of the individual shareholders rather than being subject to double taxation at both the corporate and individual level.

Additionally, California Professional Medical Corporations do not subject licensed physician shareholders to self-employment taxes, and licensed physician shareholders who also provide medicine services must only pay payroll taxes on that portion of their income from the California Professional Medical Corporation that are paid as W-2 wages.

It is important for physicians to consult with a tax advisor when considering forming a California Professional Medical Corporation, as both the personal financial situation of the licensed physician shareholder and pro forma professional practice financials of each licensed physician will be factors in determining if a California Professional Medical Corporation is the most tax efficient structure to use when practicing medicine.

Is a California Professional Medical Corporation Right for You?

Based upon limited liability protection and tax efficiency, a California Professional Medical Corporation is the best choice for most licensed physicians practicing medicine in California.

To assist in the decision about whether a California Professional Medical Corporation is the best business entity structure for your business, see “When to Use a California Professional Medical Corporation” and “When Not to Use a California Professional Medical Corporation” for more detailed information about choosing a business entity structure to practice medicine.

If you are already practicing medicine in a California LLC, see “10 Steps to Convert LLC to Professional Medical Corporation in California“, and “Four Reasons Not to Convert LLC to Professional Medical Corporation in California” for more detailed guidance on moving from a California LLC to a California Professional Medical Corporation.

If you are not already practicing medicine in a California LLC, see “Four Things to Know About Starting Your Medical California Professional Corporation“, “The 7 Steps for Forming a California Professional Medical Corporation“, “How Long Does It Take to Form a California Professional Medical Corporation?” for more detailed guidance on forming a California Professional Medical Corporation for your medical practice.

To speak with a corporate attorney knowledgeable in matters of forming California Professional Medical Corporations, schedule a consultation with the experienced corporate attorneys at San Diego Corporate Law.