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Legal Blotter
Legal Blotter AN OVERVIEW
II II
Professional Service CorporationsBy APhA Legal Division
Prof ional service corporations w re conceived as a form of business organization which would allow member of a profession (lawyers, physicians, pharmacists, etc.) to obtain the advantages of corporate status, particularly corporate tax status. Despite vigorous tax challenges by the Internal Revenue Service, the professional service corporation has survived and has begun to flourish throughout the United States. Today virtually every tate recognizes some form of professional corporation. (Notable exceptions include New York, Iowa and the Di trict of Columbia ). Thirty-four states allow pharmacists to incorporate under the statutes. After a series of nine U.S. D istrict Court decisions and three U .S. Circuit Court of Appeals decisions, all of which found the IRS highl y restrictive professional corporation regulations (Kintner Regulations) discrim inatory and unreasonable and therefore invalid, IRS has acquiesced in the corporate status of these professional corporations for tax purposes. Existing under such n ames as "Professional Service Corporations," "Professional Corporations" and "Professional Associations" this form of business organization is truly a hybrid. It achieves favored corporate status for tax purposes while at the same time retaining elements of control found in sol e proprietorships or partnerships. Creation of professional service corporations was not possible before the advent of specific enabling statutes. A corporation could not practice a profession since it could not satisfy professional licensing requirements, e.g., "attend school or pass a licensing examination." Also, many were concerned that incorporation would allow professionals to limit their liability for acts of negligence including malpractice. On the other hand, members of the professions felt they were being unfairly discriminated against because they could not enjoy many of the special advantages such as qualified pension plans, annuity and profit-sharing plans and other tax-advantaged devices available to corporate employees. The problem has been remedied as earlier indicated by state professional 86
service corporation statutes. Many of these enabling statutes allow even a single pharmacist (as opposed to a minimum of three shareholders for general business corporation) to set up business organizations which will have corporate status and which will be taxed as a corporation. At the same time, the organization will retain many of the characteristics of a professional p artnership or sole proprietorship. State statutes generally establish many of the corporate characteristics required by IRS to achieve corporate tax status . These characteristics, first noted in the case of United States vs. Kintner in 1954 and later adopted as formal tax regulations by IRS in early 1965, are-( 1) associates, (2) an objective to carryon a profession and divide the income therefrom, (3) limited liability, ( 4) continuity of life (perpetual existence), (5) free transferability of interest and (6) centralized management. While general business corporations easily fit this mold, IRS argued that professional service corporations do not. But, as noted earlier, in the face of a series of challenges by IRS, the courts have upheld the validity of corporaJte status for professional service corporations for Federal income tax purposes. While state professional seTvice corporation-enabling statutes grant corporate life, they also retain certain charO acteristics which will assure clients or patients the same degree of professional responsibility and performance they now receive. For example, the 34 states which now allow pharmacists to form professional service corporations require that the shareholders of the corporation be licensed practitioners. All 34 states limit the activities of the corporation to rendering the specific type of professional service for which it was organized, although most allow the corporation to own real and personal property necessary for rendering its professional services and to make investments. In 33 of the 34 states, the officers, directors, agents and professional employees all must be licensed practitioners. Thirty-two of the 34 states prohibit sale of shares to anyone but another licensed practi-
Journal of the AMERICAN PHARMACEUTICAL ASSOCIATION
tioner and the same number require a professional shareholder who severs his relationship with the corporation to sell his shares. A shareholder who loses his right to practice his profession must immediately terminate employment with the corporation. . Finally, 19 of the 34 states do not alter legal liability of professionals who incorporate-that is, legal liability is considered as though no corporation ever existed. Thus, in these states, a professional who is a member of a professional service corporation would not be able to limit his liability for contracts, debts, claims against the corporation or professional practice (especially malpractice suits) . Fifteen of the 34 states alter legal liability in some manner, with 12 of these limiting liability only for debts and claims against the corporation. Some of these states only isolate the professional shareholder from claims against the corporation in which he was not personally involved. Four states limit professional liability. Pennsylvania, Oregon and Maine expand all legal liability and appear to make a professional person more vulnerable than if he did not incorporate. At first glance, it would seem that the professional service corporation offers the professional person an opportunity to receive benefits long enjoyed by his corporate counterparts while maintaining the required standard of care to clients or patients. However, while professional service corporations do have certain advantages they should be considered in comparison with other business forms. On the basis of such a comparison, the pharmacist, as a professional with the guidance of his attorney, and in light of his own individualized needs, may conclude that the professional service corporation is advantageous. Pharmacists and their attorneys should be aware that further challenges of the tax status of professional service corporations by the gov1e rnment can be expected, possibly through new legislation. However, other considerations may still make the professional service corporation a desirable business structure for pharmacists.
II II
Professional Service CorporationsBy APhA Legal Division
Prof ional service corporations w re conceived as a form of business organization which would allow member of a profession (lawyers, physicians, pharmacists, etc.) to obtain the advantages of corporate status, particularly corporate tax status. Despite vigorous tax challenges by the Internal Revenue Service, the professional service corporation has survived and has begun to flourish throughout the United States. Today virtually every tate recognizes some form of professional corporation. (Notable exceptions include New York, Iowa and the Di trict of Columbia ). Thirty-four states allow pharmacists to incorporate under the statutes. After a series of nine U.S. D istrict Court decisions and three U .S. Circuit Court of Appeals decisions, all of which found the IRS highl y restrictive professional corporation regulations (Kintner Regulations) discrim inatory and unreasonable and therefore invalid, IRS has acquiesced in the corporate status of these professional corporations for tax purposes. Existing under such n ames as "Professional Service Corporations," "Professional Corporations" and "Professional Associations" this form of business organization is truly a hybrid. It achieves favored corporate status for tax purposes while at the same time retaining elements of control found in sol e proprietorships or partnerships. Creation of professional service corporations was not possible before the advent of specific enabling statutes. A corporation could not practice a profession since it could not satisfy professional licensing requirements, e.g., "attend school or pass a licensing examination." Also, many were concerned that incorporation would allow professionals to limit their liability for acts of negligence including malpractice. On the other hand, members of the professions felt they were being unfairly discriminated against because they could not enjoy many of the special advantages such as qualified pension plans, annuity and profit-sharing plans and other tax-advantaged devices available to corporate employees. The problem has been remedied as earlier indicated by state professional 86
service corporation statutes. Many of these enabling statutes allow even a single pharmacist (as opposed to a minimum of three shareholders for general business corporation) to set up business organizations which will have corporate status and which will be taxed as a corporation. At the same time, the organization will retain many of the characteristics of a professional p artnership or sole proprietorship. State statutes generally establish many of the corporate characteristics required by IRS to achieve corporate tax status . These characteristics, first noted in the case of United States vs. Kintner in 1954 and later adopted as formal tax regulations by IRS in early 1965, are-( 1) associates, (2) an objective to carryon a profession and divide the income therefrom, (3) limited liability, ( 4) continuity of life (perpetual existence), (5) free transferability of interest and (6) centralized management. While general business corporations easily fit this mold, IRS argued that professional service corporations do not. But, as noted earlier, in the face of a series of challenges by IRS, the courts have upheld the validity of corporaJte status for professional service corporations for Federal income tax purposes. While state professional seTvice corporation-enabling statutes grant corporate life, they also retain certain charO acteristics which will assure clients or patients the same degree of professional responsibility and performance they now receive. For example, the 34 states which now allow pharmacists to form professional service corporations require that the shareholders of the corporation be licensed practitioners. All 34 states limit the activities of the corporation to rendering the specific type of professional service for which it was organized, although most allow the corporation to own real and personal property necessary for rendering its professional services and to make investments. In 33 of the 34 states, the officers, directors, agents and professional employees all must be licensed practitioners. Thirty-two of the 34 states prohibit sale of shares to anyone but another licensed practi-
Journal of the AMERICAN PHARMACEUTICAL ASSOCIATION
tioner and the same number require a professional shareholder who severs his relationship with the corporation to sell his shares. A shareholder who loses his right to practice his profession must immediately terminate employment with the corporation. . Finally, 19 of the 34 states do not alter legal liability of professionals who incorporate-that is, legal liability is considered as though no corporation ever existed. Thus, in these states, a professional who is a member of a professional service corporation would not be able to limit his liability for contracts, debts, claims against the corporation or professional practice (especially malpractice suits) . Fifteen of the 34 states alter legal liability in some manner, with 12 of these limiting liability only for debts and claims against the corporation. Some of these states only isolate the professional shareholder from claims against the corporation in which he was not personally involved. Four states limit professional liability. Pennsylvania, Oregon and Maine expand all legal liability and appear to make a professional person more vulnerable than if he did not incorporate. At first glance, it would seem that the professional service corporation offers the professional person an opportunity to receive benefits long enjoyed by his corporate counterparts while maintaining the required standard of care to clients or patients. However, while professional service corporations do have certain advantages they should be considered in comparison with other business forms. On the basis of such a comparison, the pharmacist, as a professional with the guidance of his attorney, and in light of his own individualized needs, may conclude that the professional service corporation is advantageous. Pharmacists and their attorneys should be aware that further challenges of the tax status of professional service corporations by the gov1e rnment can be expected, possibly through new legislation. However, other considerations may still make the professional service corporation a desirable business structure for pharmacists.