Navigating the complexities of business structures can be a significant challenge, especially in a state with regulations as specific as California. For certified public accountants, understanding the right way to incorporate is crucial. The California Professional Accountancy Corporation offers a unique structure designed to meet the legal and professional requirements for the practice of accountancy. However, the path to establishing and maintaining a California Professional Accountancy Corporation is lined with questions.

This article answers some of the most frequently asked questions about California Professional Accountancy Corporations. From what a California Professional Accountancy Corporation is, who can form one, the benefits it offers, and the specific rules that govern its operation under California law. By understanding these key details, California accountants can make an informed decision about whether a California Professional Accountancy Corporation is the right choice for an accounting practice and ensure compliance with the California Corporations Code and California Business and Professions Code.

What is a California Professional Accountancy Corporation?

A California Professional Accountancy Corporation is a special type of business entity created for certified public accountants who provide state-licensed accounting services. Under California law, these certified public accountants are often prohibited from forming a standard corporation, such as a California Corporation or California S-Corp, or a California Limited Liability Company (California LLC) for their accounting practice. Instead, they must form a California Professional Accountancy Corporation if they wish to practice accountancy in corporate form.

The primary purpose of a California Professional Accountancy Corporation is to allow accountants to gain the liability protections and tax advantages of a corporate structure while still being held personally accountable for their professional conduct. The California Professional Accountancy Corporation structure is governed by the Moscone-Knox Professional Corporation Act, which is part of the California Corporations Code as well as the California Business and Professions Code, which set out the specific rules for forming, owning, and operating a California Professional Accountancy Corporation.

Essentially, a California Professional Accountancy Corporation functions much like a traditional corporation but with key differences related to ownership and liability specifically tailored for California accountants.

Who is Required to Form a California Professional Accountancy Corporation?

In California, certain professions are mandated by law to form a California Professional Corporation if they wish to incorporate their practice. They cannot form a standard S Corporation, C Corporation, or LLC to render their professional services.

The list of professions required to use a California Professional Corporation structure is extensive, and includes accounting under California Business and Professions Code §§ 5150–5158.

Attempting to practice accountancy through an incorrect business entity can lead to disciplinary action from the California Board of Accountancy and other legal complications.

What are the Benefits of a California Professional Accountancy Corporation?

Choosing to form a California Professional Accountancy Corporation offers several significant advantages for an accounting practice. Some of these advantages are as follows.

Liability Protection of California Professional Accountancy Corporations

While a California Professional Accountancy Corporation does not shield a California accountant from malpractice claims related to their own professional negligence, it does protect them from the malpractice of their business partners or fellow shareholders. In a California General Partnership, each partner has joint and several personal liable for the business debts and the professional negligence of all other partners. A California Professional Accountancy Corporation creates a corporate shield, limiting the personal liability of a shareholder to their own actions or inactions. Personal assets are also protected from general business debts, liabilities, obligations, and legal judgments against the California Professional Accountancy Corporation itself.

Tax Efficiency of California Professional Accountancy Corporations

A California Professional Accountancy Corporation can elect to be taxed as an S Corporation. This “pass-through” taxation allows the profits and losses of the California Professional Accountancy Corporation to be passed directly to the personal income tax returns of shareholders, avoiding the double taxation that occurs with a standard C Corporation, for California Professional Accountancy Corporations referred to as personal service corporations or professional services corporations (where income is taxed at the corporate level and again when distributed as dividends). This can result in significant tax savings.

The primary advantage of an S-Corp election is the potential savings on self-employment taxes, which currently total 15.3% (12.4% for Social Security and 2.9% for Medicare).

Here is how it works: Say a California accounting practice generates $100,000 in net profit annually. As a Sole Proprietor or partner in a California General Partnership, the California accountant would pay self-employment taxes on the entire $100,000, or $15,300 in self-employment taxes. With an S-Corp election for a California Professional Accountancy Corporation, the California accountant might pay themself a reasonable salary of $50,000 (subject to employer and employee payroll taxes of 15.3% combined) and take the remaining $50,000 as a distribution (not subject to self-employment taxes or payroll taxes). This could potentially save the California accountant over $7,500 annually in self-employment taxes on these example numbers.

Credibility and Permanence

Operating as a California Professional Accountancy Corporation can enhance the credibility and professional image of an accounting practice. The corporate structure of a California Professional Accountancy Corporation suggests stability and permanence to clients, partners, employees, and financial institutions. Unlike a sole proprietorship, which dissolves upon the death of its owner, a California Professional Accountancy Corporation has a perpetual existence and can continue operating through changes in ownership.

What are the Naming Requirements for a California Professional Accountancy Corporation?

California has strict naming rules for California Professional Accountancy Corporations. The name of the California Professional Accountancy Corporation must comply with both the California Corporations Code and the regulations of the specific licensing board governing the profession.

Generally, the name restrictions are as follows:

The Articles of Incorporation must include the name of the California Professional Accountancy Corporation. California Corporations Code 202(a).

The Secretary of State shall not file articles setting forth a name in which “bank,” “trust,” “trustee,” or related words appear, unless the certificate of approval of the Commissioner of Financial Protection and Innovation is attached thereto. California Corporations Code Section 201(a).

The name of a California Professional Accountancy Corporation shall not be a name that the Secretary of State determines is likely to mislead the public and shall be distinguishable in the records of the Secretary of State. California Corporations Code Section 201(b). This requires that names are not likely to mislead the public and be distinguishable from all other corporations in the records of the California Secretary of State that are in good standing, including names of foreign corporations qualified to transact interstate business in California.

The name of a California Professional Accountancy Corporation shall not include the word “cooperative,” any abbreviation of it, or any related word. California Corporations Code 12311(b).

The name of a California Professional Accountancy Corporation shall not include the words “Olympic” or “Olympiad,” or related phrases. 36 USC §220506.

The name of a California Professional Accountancy Corporation shall not include the words “national,” “federal,” “United States,” “reserve,” or “deposit insurance,” and certain words and phrases referring to credit unions. 18 USC §709.

California Professional Accountancy Corporations also have profession-specific requirements in addition to the general name restrictions as follows:

“No person or firm may practice public accountancy under any name which is false or misleading.” California Business and Professions Code Section 5060(a).

“No person or firm may practice public accountancy under any name other than the name under which the person or firm holds a valid permit to practice issued by the board.” California Business and Professions Code Section 5060(b).

“Notwithstanding subdivision (b), a sole proprietor may practice under a name other than the name set forth on his or her permit to practice, provided the name is registered by the board, is in good standing, and complies with the requirements of subdivision (a).” California Business and Professions Code Section 5060(c).

“The board may adopt regulations to implement, interpret, and make specific the provisions of this section including, but not limited to, regulations designating particular forms of names as being false or misleading.” California Business and Professions Code Section 5060(d).

It is crucial to check the California Board of Accountancy for any additional naming restrictions or requirements. The proposed name must also be available and not be misleadingly similar to an existing corporation name on file with the California Secretary of State.

Who Can Be a Shareholder in a California Professional Accountancy Corporation?

Ownership in a California Professional Accountancy Corporation is tightly restricted. According to the California Corporations Code, shares can only be issued to individuals who are licensed to practice the specific profession for which the corporation was formed.

There are a few exceptions, including:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

However, notwithstanding California Corporations Code Section 13401.5 and the California Business and Professions Code, at least 51% of the shares must be owned by professionals in the primary field and the number of other professionals cannot outnumber the professionals in the primary field.

Can a California Professional Accountancy Corporation be an S Corp?

Yes, a California Professional Accountancy Corporation can elect to be taxed as an S Corporation. This is one of the most common and beneficial tax strategies for California Professional Accountancy Corporations.

By filing Internal Revenue Service Form 2553, “Election by a Small Business Corporation,” the California Professional Accountancy Corporation can opt for S-Corp tax status. This means the California Professional Accountancy Corporation itself does not pay federal income tax. Instead, the income, losses, deductions, and credits are “passed through” to the shareholders, who report them on their personal tax returns. This structure avoids the double taxation associated with C Corporations.

To qualify for S-Corp status, the California Professional Accountancy Corporation must meet certain IRS requirements, including:

Be a domestic corporation.

Have only allowable shareholders (individuals, certain trusts, and estates).

Have no more than 100 shareholders.

Have only one class of stock.

Choosing S-Corp status can provide significant tax advantages, but it also comes with complexities, such as the requirement to pay reasonable salaries to shareholder-employees. Consulting with a tax professional is essential to determine if this is the right choice for your practice.

Can a California LLC Register as a Professional Accountancy Corporation in California?

No, a California LLC cannot register to do business as a Professional Accountancy Corporation in California, nor may a California LLC provide the services of a California Professional Accountancy Corporation. The California Corporations Code has specific rules that prevent certified public accountants from using a California LLC structure for their accounting practice, most notably California Corporations Code Section 17701.04(e) which reads in full as follows:

“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.”

Certified pubic accountants cannot operate as a California LLC. Instead, they would typically need to form a California Professional Accountancy Corporation to conduct their professional practice in California in corporate form.

Can a Foreign LLC Register as a Professional Accountancy Corporation in California?

No, a foreign limited liability company (foreign LLC) cannot register to do business as a Professional Accountancy Corporation in California, nor may a foreign LLC provide the services of a California Professional Accountancy Corporation. The California Corporations Code has specific rules that prevent certified public accountants from using a foreign LLC structure for their accounting practice, most notably California Corporations Code Section 17701.04(e) which reads in full as follows:

“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.”

If a group of certified public accountants operate as an LLC or a similar entity in another state, they cannot simply register that entity in California to provide accounting services in California. Instead, they would typically need to form a new, separate California Professional Accountancy Corporation to conduct their professional practice in California in corporate form.

This area of California law can be complex, especially when dealing with multi-state practices. The rules are in place to ensure that all professionals practicing in California adhere to California’s strict liability and oversight standards, which are tied to the California Professional Accountancy Corporation structure. If a practice operates across state lines, seeking legal advice is critical to ensure compliance.

What Happens if a Shareholder Dies or Becomes Disqualified?

The California Corporations Code has specific provisions for what happens when a shareholder in a California Professional Accountancy Corporation passes away or loses their license (becomes “disqualified”).

Because ownership is restricted to certified public accountants and certain other persons, the shares of a deceased or disqualified shareholder of a California Professional Accountancy Corporation cannot be transferred to an unlicensed person, such as a family member or an heir. The California Professional Accountancy Corporation or its remaining shareholders are legally obligated to repurchase the shares from the deceased shareholder’s estate or from the disqualified individual, and California law sets a timeframe for this repurchase.

The price and terms are often negotiated after death or disqualification, but may be set forth in advance in a separate shareholder agreement such as a Buy-Sell Agreement. Having a clear, pre-negotiated Buy-Sell Agreement in place is vital to prevent disputes and ensure a smooth transition. Without one, the parties may have to rely on the default provisions of the law, which could lead to complications and significant legal expenses.

Make an Informed Decision for Your Practice

Forming and maintaining a California Professional Accountancy Corporation involves navigating a unique set of legal and regulatory requirements. While the structure offers significant benefits in terms of liability protection and tax flexibility, compliance with the California Corporations Code and the California Board of Accountancy is paramount.

From understanding who can be a shareholder to adhering to strict naming conventions, the details matter. Taking the time to get it right from the beginning can save you from potential legal issues, financial penalties, and even disciplinary action down the road.

If you have more questions or need guidance on setting up a California Professional Accountancy Corporation for your practice, the experienced corporate attorneys at San Diego Corporate Law are here to help. We can provide the clarity and support you need to build a solid legal foundation for your business.

Schedule a consultation today to discuss your specific needs and learn how we can assist you in navigating the complexities of California corporate law for California Professional Accountancy Corporations.