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For most start-up businesses, however, this corporate tax planning strategy will be useful, at least in
the short term. In addition, entrepreneurs will find certain employee benefits are better offered in the
corporate form because they are deductible to employers, but excluded from income only for
employees. Since a sole proprietor or partner is not considered an employee, the value of benefits such
as group life insurance and disability insurance policies may be taxable income to them but tax-free to
the officers of a corporation.
Professional Corporations
There are two common variations of the corporate form. The first of these is the professional
corporation. Taxation played a major part in its invention. Originally, limitations on the amounts of
money that could be deducted as a contribution to a qualified retirement plan varied greatly,
depending on whether the business maintaining the plan was a corporation, a partnership, or a sole
proprietorship. The rules greatly favored the corporation. Partnerships and sole proprietorships were
required to adopt Keogh or HR-10 plans with their substantially lower limits on deductibility.
However, doctors, lawyers, architects, and other professionals, who often could afford large
contributions to retirement plans, were not allowed to incorporate under applicable state laws. The
states were offended by the notion that such professionals could be granted limited liability for the
harms caused by their businesses.
Eventually, a compromise was struck and the so-called professional corporation was formed. Using
that form, professionals could incorporate their businesses, thus qualifying for the higher retirement
plan deductions but giving up any claim to limited liability. As time went by, however, the Internal
Revenue Code was amended to eliminate most of the differences between the deductions available to
Keogh plans and those available to corporate pension and profit-sharing plans. Today, professional
corporations are subject to virtually all the same rules as other corporations, with the exception that
most are classified as personal service corporations and therefore taxed at a flat 35% rate on
undistributed profit.
As the tax incentive for forming professional corporations has decreased, many states, perhaps with
an eye toward maintaining the flow of fees from these corporations, have greatly liberalized the
availability of limited liability for these corporations. Today, in many states, professional corporations
now afford their stockholders protection from normal trade credit as well as tort liability arising from
the actions of their employees or other stockholders. Of course, even under the normal business
corporation form, a stockholder is personally liable for torts arising from his or her own actions.
Subchapter S Corporations
The second common variation is the subchapter S corporation, named for the sections of the Internal
Revenue Code that govern it. Although indistinguishable from the normal (or subchapter C)
corporation in all other ways, including limited liability for its stockholders, the subchapter S
corporation has affirmatively elected to be taxed similarly to a partnership. Thus, like the partnership,
it is not a separate taxable entity and files only an informational return. Profits appear on the tax