Professionals in regulated industries in Minnesota have various options for the type of business form in which to operate a business providing professional services. These options include sole proprietorship, partnership variations, corporation, and limited liability company. This article provides an overview of options for professionals and discusses the obligations a professional may have under the Minnesota Professional Firms Act.
Two primary factors ought be considered before moving forward with the start-up of a professional firm. First, consider the professional’s need for limited liability on claims and debts related to the business. While a professional will always be liable for the professional’s own actions or inactions, a professional that foresees doing business with other professionals, or hiring employees, is better protected by the liability shield afforded by a properly organized and administered entity.
Second, consider the tax implications and framework for the chosen business form. Tax implications are based on factors that include anticipated and expected compensation of owners, anticipated return of capital (profits), health care requirements of owners, and number of owners. Since all business entities except sole proprietorships and general partnerships provide for limited liability under Minnesota law, and insurance often provides significant protection for non-entity business forms, the key issue for most professionals in selecting a business form is tax considerations.
Sole Proprietorship and General Partnership
A sole proprietorship in the case of a single professional, or a general partnership in the case of two or more professionals, is a business form in which the professional operates without creating a formal organized entity under Minnesota statute. Sole proprietorships and general partnerships are inexpensive and easy to administer, in part, because there is no need to make any entity-qualification filing with the Minnesota Secretary of State or, in most cases, with any other professional board.
Under either of these business forms, professionals do not benefit from statutory or common law limited liability. Importantly, in the case of a general partnership, a partner may have liability for the contracts, torts, and business obligations of other partners. For this reason, general partnerships are disfavored and not a recommended business form in Minnesota.
While there is no statutory or common law limited liability under these business forms, sole proprietors and general partners typically protect themselves with adequate insurance. Be cautioned, however, that a professional working as a sole proprietor may be treated as a general partner for tax and legal purposes if the professional shares the entity’s profits with other professionals.
Professionals working under a sole proprietor or general partnership model are not subject to corporate payroll taxes or withholding because the sole proprietorship or partnership is not a legal entity separate and distinct from the owner. Tax reporting in either of these business forms is fairly straightforward, as income and losses are reported on Schedule C of Form 1040, an individual’s return.
A corporation is an entity distinct from its owners created under a state statute. In Minnesota, corporations are governed by the Minnesota Business Corporation Act.
Limited liability for owner-shareholders is a hallmark of doing business under the corporate form. However, in Minnesota, a professional firm providing professional services, as that term is defined under Minn. Stat. sec. 319B.02(19), must make an initial filing and pay a filing fee to the appropriate regulatory board in order to benefit from the limited liability shield. Examples of a few of these regulatory boards include the Lawyers Professional Responsibility Board, the Board of Marriage and Family Therapy, and the Board of Dentistry. A professional considering the formation of a professional corporation must include specific language provided for in the Professional Firms Act in the corporation’s Articles of Incorporation filed with the Minnesota Secretary of State.
A decision for the professional considering the corporation form is whether or not the shareholders should elect to be taxed as a Subchapter S corporation. By this election, the corporate entity is not taxed separately from its shareholders, which may be the case in a C corporation if the entity does not distribute all net income to its owners. Additionally, in certain circumstances, professionals may be able to receive a return on invested capital in the form of a dividend. This dividend return can result in a favorable tax treatment compared to taking all profit distributions in the form of wage compensation. Complying with requirements as to compensation and profit distributions in a corporation electing Subchapter S status should be undertaken with the counsel of both an accountant and business attorney.
Limited Liability Company
While the limited liability company (LLC) is a newer entity form under Minnesota statute, it is now well established and increasingly used by professionals, especially in multi-owner professional firms. An LLC, like a corporation, is an entity distinct from its owners created under a state statute. In Minnesota, LLCs are governed by the Minnesota Limited Liability Company Act.
An LLC is treated as a partnership for tax purposes unless an alternative election is made by the LLC members. Member-owners of the LLC are not treated as employees and, therefore must make estimated tax payments. Any non-owner employees of the LLC, however, must have taxes withheld and submitted on a quarterly or monthly basis, depending on total payroll.
An LLC has the advantage of providing limited liability, so long as the Professional Firms Act requirements are met, along with a pass-through tax framework and a flexibility that allows multiple classes of membership interests. This flexibility, permitting the separation of financial rights from governance rights, may be attractive where the firm’s founder wishes to retain voting control of the entity.
The documents necessary to form and administer an LLC follow in many ways the corporate framework. Most importantly, Articles of Organization are filed with the Minnesota Secretary of State. For a professional firm regulated by the Professional Firms Act, particular language described in the Act must be included.
For both corporations and limited liability companies, ownership rights are assignable or transferrable only to other professionals licensed to practice for the purpose in which the professional firm is qualified. This is because the Professional Firms Act requires that all members of a professional firm be licensed to practice in the State of Minnesota in their particular area.
While the simplicity of a professional practicing as a sole proprietor remains attractive, the limited liability and possible tax advantages of operating as a corporation or limited liability company mean these entity forms are well-suited for professionals establishing a new business. Professionals considering formation of a new business should consult with both an accountant and a business attorney to determine the appropriate entity form, and to ensure that the entity complies with post-formation requirements to retain limited liability and tax advantages.
For more information about business form choices available for professional firms, please contact any of the Trepanier MacGillis Battina P.A. business attorneys.
About the Author:
Minnesota business attorney James C. MacGillis practices extensively in the field of business and commercial litigation, including business organizations and management, shareholder disputes, and commercial real estate transactions. Jim may be reached at 612.455.0503 or firstname.lastname@example.org. Trepanier MacGillis Battina P.A. is a Minnesota business start-up firm located in Minneapolis, Minnesota.