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

Liability Protection in California Professional Accountancy Corporations

Licensed accountants often choose to practice public accountancy in a California Professional Accountancy Corporation to limit personal liability. Unlike sole proprietorships or partnerships, California Professional Accountancy Corporations offer a liability protection and personal asset protection by separating the personal assets of the licensed accountant shareholder from the business debts, liabilities, obligations, and legal judgments against the California Professional Accountancy Corporation.

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

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

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

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

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

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

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

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

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

Executive Summary: Putting the Conclusion First for Busy Accountants

A licensed accountant should form a California Professional Accountancy Corporation if they are either:

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

(ii) anticipate an immediate or future tax benefit.

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

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

Lower Net Income Practices without Employees or Independent Contractors

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

Lower Net Income Practices with Employees or Independent Contractors

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

Higher Net Income Practices Regardless of Liability Concerns

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

Starting a New Practice Without Certainty of Future Performance

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

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

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

Contact San Diego Corporate Law for Expert Guidance

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

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

Liability Protection for Licensed Accountants

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

General Liability

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

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

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

General Liability for Sole Proprietors and General Partnerships

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

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

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

General Liability for California Professional Accountancy Corporations

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

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

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

General Liability Conclusion

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

Employment Liability

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

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

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

Employment Liability for Sole Proprietors and General Partnerships

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

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

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

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

Employment Liability for California Professional Accountancy Corporations

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

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

It is important to recognize that a California Professional Accountancy Corporation holds liability for employee and independent contractor claims as well as third-party claims due to vicarious liability for the actions or inactions of employees and independent contractors. Although this is preferable to unlimited personal liability for licensed accountants, such liability can still significantly impact a California accountancy practice and business bank account for its own accountancy corporation, even as it protects the assets of the licensed accountant shareholders.

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

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

Employment Liability Conclusion

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

Malpractice Liability

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

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

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

Malpractice Liability for Sole Proprietors and General Partnerships

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

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

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

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

Malpractice Liability for California Professional Accountancy Corporations

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

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

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

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

Malpractice Liability Conclusion

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

Conclusions About Liability Protections

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

Tax Benefits for Licensed Accountants

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

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

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

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

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

FICA Tax Liability

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

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

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

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

FICA Tax Liability for Sole Proprietors and General Partners

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

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

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

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

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

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

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

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

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

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

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

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

FICA Tax Liability Conclusion

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

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

Medicare Tax Liability

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

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

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

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

Medicare Tax Liability for Sole Proprietors and General Partners

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

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

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

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

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

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

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

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

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

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

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

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

Medicare Tax Liability Conclusion

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

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

Additional Medicare Liability

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

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

Additional Medicare Tax Liability for Sole Proprietors and General Partners

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Additional Medicare Tax Liability Conclusion

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

Deductibility of Health Insurance Premiums and Other Fringe Benefits

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

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

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

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

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

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

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

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

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

Deductibility of Health Insurance Premiums and Other Fringe Benefits Conclusion

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

Additional Costs to Operating as a California Professional Accountancy Corporation

California Franchise Tax Board Minimum Annual Franchise Tax

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

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

Other Administrative Costs to Operate a California Professional Accountancy Corporation

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

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

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

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

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

Conclusions About Tax Benefits

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

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

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

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

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

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

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

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

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

Establishing a Business Structure for Anticipated Growth

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

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

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

If within the means of such a licensed accountant, the recommendation is to start with a California Professional Accountancy Corporation formed as a part of starting the accountancy practice.

A Quick Note on LLCs and PLLCs

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

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

This comes as a surprise to many licensed accountants, as professional limited liability companies (PLLCs) are commonly used to render professional services in other states, but in California a California Accountancy Corporation small business corporation must be used in place of a PLLC by accountancy firms to practice accountancy.