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Editorial 8 MIN READ

Professional corporation, a 2021 year-end review

Twenty months after PPP, the PC balance sheet has a new line item called beneficial ownership and an old one called SSTB that still will not move

The Editors
Staff, Incorporator.org
8 min read Updated
Contents 6 sections
  1. What changed at the federal level in 2021
  2. The Section 199A problem has not moved
  3. Payroll math at the $142,800 wage base
  4. The state frame, which is where the form actually lives
  5. What to put on the 2022 list
  6. Sources

he professional corporation that carried a medical or legal practice through 2020 now carries three things into 2022 it did not carry in 2019: a Paycheck Protection Program forgiveness file, a Social Security wage base of $142,800, and a new federal reporting regime that treats the PC's shareholders as beneficial owners of a reporting company.

Twenty months after the 2020 field report, the entity form is still doing the same job. The environment around it has moved.

What changed at the federal level in 2021

The Corporate Transparency Act was enacted on January 1, 2021, when Congress overrode the presidential veto of the National Defense Authorization Act for Fiscal Year 2021 (Pub. L. 116-283). Title LXIV of that bill is the CTA, and it adds a new § 5336 to Title 31 of the U.S. Code. The operative sentence is that "each reporting company shall submit to FinCEN a report" identifying the company's beneficial owners. A reporting company is defined in 31 USC § 5336(a)(11) as a corporation, limited liability company, or "other similar entity" that is created by filing a document with a Secretary of State.

A California or New York professional corporation is created by filing articles of incorporation with the Secretary of State. It is therefore a reporting company. The exemptions listed at § 5336(a)(11)(B) run to twenty-three categories and cover things like SEC-registered issuers, banks, insurance companies, and tax-exempt entities. The "large operating company" exemption requires more than twenty full-time employees in the United States, more than $5 million in gross receipts reported on the prior year's federal return, and a physical office in the United States. Most PCs clear the office test and fail the headcount. A four-partner orthopedic group with nineteen staff is a reporting company.

FinCEN published a Notice of Proposed Rulemaking on December 8, 2021 (86 Fed. Reg. 69920), setting out what the beneficial-ownership filing will require and when it will be due. The proposal is not final as of this writing; the statute instructs FinCEN to issue final regulations by January 1, 2022, and the filing deadline for existing entities runs from the effective date of those regulations. Practitioners should read the NPRM but need not file anything in 2021. They should, however, know which of their shareholders will be named in 2022 and collect the identifying information on the way in rather than on the way out.

Beneficial owner is defined at § 5336(a)(3) as any individual who either exercises substantial control over the entity or owns or controls at least 25 percent of the ownership interests. For a four-shareholder PC with equal shares, all four are beneficial owners. For a medical group with a managing partner and eight junior shareholders each at a little under 11 percent, the managing partner qualifies on control; the junior shareholders only qualify if the governance documents push one of them into substantial-control territory. This is a fact question, and it will be worked out in the regulations rather than the statute.

The Section 199A problem has not moved

The professional corporation, if it is organized as an S-corp for tax purposes, still lives inside the specified service trade or business fence at IRC § 199A(d)(2). Health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and "any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners" are all SSTBs. The fence has been the same since the Tax Cuts and Jobs Act took effect in 2018, and the final regulations published at T.D. 9847 in August 2018 did not soften it.

The 2021 mechanics: a single filer whose taxable income exceeds $164,900 or a joint filer above $329,800 (those are the 2021 thresholds published in Rev. Proc. 2020-45) begins phasing out the 199A deduction if the income is from an SSTB. The phase-out runs over $50,000 for single filers and $100,000 for joint, and above the upper bound the SSTB gets no deduction at all. A two-physician PC whose owners each take $400,000 in W-2 wages plus $200,000 in K-1 income is fully phased out. The deduction is zero.

There was chatter during 2021 that the Build Back Better framework would expand or limit 199A in some direction. Nothing has been enacted. The House-passed version (H.R. 5376) contains a 3.8 percent net investment income tax extension to pass-through income for high earners, which would touch S-corp distributions that currently escape SECA and NIIT. The Senate has not voted. Read this in November and treat 199A as unchanged; read it in February and check whether the bill moved.

Payroll math at the $142,800 wage base

The Social Security Administration's 2021 wage base is $142,800, up from $137,700 in 2020 (SSA Fact Sheet, October 13, 2020). Medicare wages remain uncapped, with the additional 0.9 percent Medicare surtax on wages above $200,000 for a single filer. For a PC that has elected S-corp status, the shareholder-employee's reasonable-compensation W-2 runs payroll tax on the first $142,800 at the full 12.4 percent OASDI rate (split employer/employee) plus 2.9 percent Medicare. Above $142,800, only the 2.9 percent Medicare piece continues, plus the 0.9 percent surtax above $200,000.

Concretely: a surgeon on a $600,000 W-2 from her PC pays OASDI on the first $142,800 and Medicare on all $600,000. If the PC pays another $300,000 out as a K-1 distribution rather than wages, that $300,000 sees neither OASDI (she is over the wage base regardless) nor the employee Medicare (S-corp distributions are not SECA income). The payroll-tax saving on the distribution is 2.9 percent of $300,000, or $8,700, plus 0.9 percent of the piece above her $200,000 wage-surtax threshold. Call it roughly $11,000 in saved Medicare tax.

The IRS has not softened its reasonable-compensation posture in 2021. The auditable question is whether the W-2 matches what the shareholder would have been paid as a non-owner doing the same work. David E. Watson, P.C. v. United States, 668 F.3d 1008 (8th Cir. 2012) remains the controlling case for most practitioners; the Tax Court continues to recharacterize distributions as wages when the wage figure is implausibly low. A PC paying a radiologist-shareholder $60,000 on a $500,000 collection is still the kind of file an examiner opens first.

The state frame, which is where the form actually lives

California's Moscone-Knox Professional Corporation Act at Cal. Corp. Code §§ 13400-13410 requires a professional corporation to be organized for the single purpose of rendering professional services, and only persons licensed in the relevant profession (or exempt under the statute) may hold shares or serve as officers or directors (§§ 13401(b), 13406(a)). California's licensing boards each publish their own list of permissible name suffixes and share-ownership rules; the State Bar's Law Corporations Rules and the Medical Board's regulations at 16 CCR § 1343 run alongside the Corporations Code provisions. A medical PC incorporated in California must maintain a Certificate of Registration with the Medical Board and file biennially.

New York's analog is the professional service corporation statute at Article 15 of the Business Corporation Law, with the operative ownership rule at BCL § 1505(a): "No professional service corporation may issue any of its shares to anyone other than an individual who is authorized by law to practice in this state a profession which such corporation is authorized to practice." A PC formed in New York must file a certificate of good standing from the relevant licensing authority, and the shareholders must be licensed in New York specifically, not merely somewhere. Multi-state medical groups with New York offices usually form a separate New York PC to hold the New York practice, and that New York PC is a reporting company under the CTA in its own right.

A PLLC formed in a state that allows the form gets you the same shareholder-licensing constraint with LLC-style governance. California does not allow PLLCs for most licensed professions, which is why California keeps the PC in use at volumes other states have dropped. The 2021 choice between PC and PLLC is mostly a state-of-formation question layered on a tax-election question, and neither layer moved this year.

What to put on the 2022 list

The PC shareholder who read the original 2016 piece and has been running the form for five years now has three items to review before January: whether the reasonable-compensation split still makes sense at the 2022 wage base of $147,000 (SSA published this October 13, 2021), whether the 199A phase-out still writes off the deduction at current taxable income, and whether the governance documents name the right people as substantial-control parties for the beneficial-ownership filing that is coming.

The CTA is the new thing. The rest is bookkeeping that has been the same work for a decade. A PC that passed a 2020 PPP review and a 2019 199A review will pass the 2022 FinCEN review too, provided the partnership agreement and the stock ledger agree on who owns what and who runs what. That is the file to pull out of the drawer this month.

Sources

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