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

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

This article provides an overview of the various business structure options available to accountants practicing accountancy solo in California, helping these accountants to make an informed choice that aligns with their professional goals and liability concerns in the most tax efficient format possible under state and federal government laws and regulations.

Executive Summary: Putting the Conclusion First for Busy Accountants

Summary of Practicing Accountancy as a Sole Proprietor

The primary benefit of a sole proprietorship for accountants 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 accountant sole proprietors are personally liable for all business debts, liabilities, obligations, and legal judgments (including malpractice liability) against their accounting practice. The lack of a separate legal entity also means there is no distinction between personal and professional business assets for accountant sole proprietors, so the debts, liabilities, and legal judgments for which the accountant sole proprietor is liable are satisfied from the personal assets of the accountant.

Summary of Practicing Accountancy with a California Professional Accountancy Corporation

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

Choosing Between a Sole Proprietorship and a California Professional Accountancy Corporation

For most accountants, the California Professional Accountancy 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 accountancy as a sole proprietorship.

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

Take the next step toward securing the ideal business structure for your accounting practice, whether that is a California Professional Accountancy 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 Accountancy as a Sole Proprietor

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

Administrative Requirements of Practicing Accountancy as a Sole Proprietor

One of the primary benefits of a sole proprietorship for practicing accountancy 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, obtaining an Employer Identification Number, 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 Account Sole Proprietors

Tax considerations are a critical aspect to be examined when planning to practice accountancy 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 accounting practices is essential for accountants when choosing a business structure in which to operate their accounting practice.

Business Income Taxation When Practicing Accountancy as a Sole Proprietor

For accountant 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 accountants to consolidate both personal and business income on a single tax form.

Self-Employment Tax When Practicing Accountancy as a Sole Proprietor

While simple and straightforward, taxation of accountant sole proprietors is not tax efficient. One significant consideration for accountant 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 Accountancy as a Sole Proprietor

High-earning accountant 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 accountant sole proprietors filing as single, the threshold is $200,000, while it is $250,000 for accountant 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 accountants to account for this additional tax in their financial planning to avoid unexpected liabilities.

Conclusions About Taxation of Accountancy 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 Accountancy as a Sole Proprietor

Practicing accountancy 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 accountant and the accounting practice.

Personal Liability for Professionals When Practicing Accountancy as a Sole Proprietor

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

Person Asset Protection for Accountants When Practicing Accountancy as Sole Proprietors

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

Conclusions About Personal Liability and Asset Protection for Accountancy 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 accountants choosing a business structure for their accounting practice to understand liability risks and take proactive measures to safeguard their personal wealth and future earnings from such claims.

Conclusions About Practicing Accountancy as a Sole Proprietor

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

Advantages of Sole Proprietorship for Accountants

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

Disadvantages of Sole Proprietorship for Accountants

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

A sole proprietorship is not a separate legal entity, which means that accountant sole proprietors are personally liable for all debts, liabilities, obligations, and legal judgments (including malpractice liability). For accountants in high-liability accounting 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 accountant sole proprietors, meaning the debts, liabilities, and legal judgments for which the accountant sole proprietor is liable are satisfied from the personal assets of the accountant.

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

A sole proprietorship can be an ideal option for accountants starting small-scale accounting practices with the expectation of low net profit and low liability risks. However, before choosing to practice accountancy 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 accounting practice. For accountants in high-risk accounting practice areas or those who anticipate growth in their accounting practice may want to avoid practicing accountancy 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 of California Professional Accountancy Corporations and when a sole proprietorship is the best choice of business structure for accounting practices, see “When Not to Use a California Professional Accountancy Corporation” for more information.

Practicing Accountancy with a California Professional Accountancy Corporation

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

Administrative Requirements of Practicing Accountancy with a California Professional Accountancy Corporation

In order to enjoy the tax efficiency, limited liability protection, and separation of personal assets a California Professional Accountancy Corporation provides, accountants are faced with the complexity of establishing a California Professional Accountancy Corporation. While this formation process is complex, accountants 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 Accountancy Corporation, leaving accountants 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 Accountancy Corporation are usually qualified business expenses that are tax deductible.

In addition to the initial formation of a California Professional Accountancy Corporation, every year after the initial formation of a California Professional Accountancy 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 Accountancy Corporation, San Diego Corporate Law can assist in the annual requirements of practicing accountancy with a California Professional Accountancy Corporation.

Despite the additional administrative requirements of practicing accountancy with a California Professional Accountancy Corporation compared to practicing accountancy 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 Accountancy Corporation” for more information.

Taxation of California Professional Accountancy Corporations

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

Business Income Taxation When Practicing Accountancy with a California Professional Accountancy Corporation

A California Professional Accountancy 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 Accountancy 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 Accountancy Corporations.

Electing S Corporation status alters the tax treatment by enabling pass-through taxation. This means the profits and losses of the California Professional Accountancy Corporation after payment of a reasonable salary to the accountant are passed directly to the accountant 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 Accountancy Corporation to pay personal income tax of the net profits of the accounting practice.

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

Self-Employment Tax When Practicing Accountancy with a California Professional Accountancy Corporation

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

Instead of self-employment taxes on the entire net profit of the accounting practice, with a California Professional Accountancy Corporation employee and employer contributions to payroll tax are only paid on the reasonable salary of the accountant. 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 accountant only and not the net profit of the California Professional Accountancy Corporation, which may result in significant annual tax savings compared to a sole proprietorship.

Additional Medicare Tax When Practicing Accountancy with a California Professional Accountancy Corporation

As discussed above for accountant 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 Accountancy Corporation is not deemed to be “earned” income, the Additional Medicare Tax would only be applicable to accountants practicing accountancy with a California Professional Accountancy Corporation if the reasonable salary of the accountant exceeded the thresholds, meaning for all intents and purposes, practicing accountancy with a California Professional Accountancy Corporation does not subject accountants to the Additional Medicare Tax.

Annual Franchise Tax for California Professional Accountancy Corporations

California Professional Accountancy Corporations must pay an annual franchise tax that accountant sole proprietorships do not pay. The franchise tax paid by a California Professional Accountancy 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 accountant sole proprietorships, the annual franchise tax is very small in comparison to self-employment taxes and the Additional Medicare Taxes paid by accountant sole proprietors.

Conclusions About Taxation of California Professional Accountancy Corporations

Understanding the tax benefits of a California Professional Accountancy 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 Accountancy Corporations, see “What Tax Benefits Does a California Professional Accountancy Corporation Provide?” for more information.

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

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

Personal Liability Protection for Accountants When Practicing Accountancy with a California Professional Accountancy Corporation

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

Under California law, claims for professional negligence, better known as malpractice, for errors and omissions of accountants are personal to accountants and not shielded by the existence of the California Professional Accountancy Corporation, however, malpractice is an insurable risk and appropriately apportioned professional liability insurance in conjunction with other business insurance may be used to indemnify the accountant from this risk.

Person Asset Protection for Accountants When Practicing Accountancy with a California Professional Accountancy Corporation

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

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

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

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

Conclusions About Practicing Accountancy with a California Professional Accountancy Corporation

When deciding if practicing accountancy as a California Professional Accountancy 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 Accountancy Corporations are more complex, California Professional Accountancy Corporations resolve many of the significant risks and limitations inherent to practicing accountancy as a sole proprietorship. The advantages and disadvantages of operating with a California Professional Accountancy Corporation are compared below together with a recommendation for when a California Professional Accountancy Corporation is the best legal structure for practicing accountancy.

Advantages of California Professional Accountancy Corporations

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

A California Professional Accountancy Corporation is a separate legal entity, which means the accountant is generally shielded from personally liable for debts, liabilities, obligations, and legal judgments (other than the insurable risk of malpractice liability). For accountants in high-liability accounting 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 accountants, meaning the debts, liabilities, and legal judgments against their accounting practice are not generally satisfied from the personal assets of the accountant.

Disadvantages of California Professional Accountancy Corporations

The primary benefit of a sole proprietorship is its simplicity, and in turn the primary disadvantage of a California Professional Accountancy Corporation is the relative complexity of formation and operation. However, accountants 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 Accountancy Corporation, leaving these accountants with essentially the same tasks they would undertake to establish and maintain a sole proprietorship.

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

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

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

Accountants in California May Not Practice Accountancy 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 accountants from operating 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 accountants who wish to operate in corporate form to utilize other types of business entities, such as California Accountancy Corporations.

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

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