This year's tax law has reduced greatly the advantages to doctors, lawyers and other professionals of incorporating themselves. But lawyers who specialize in professional corporations believe it is unlikely that most doctors and lawyers will dissolve corporations as a result of the tax law changes.
"At this point there is no real reason to incorporate to gain special tax advantages of any major consequences," said Louis H. Diamond, a Washington partner in the law firm of Finley, Kumble, Wagner, Heine, Underburg & Casey.
"To my knowledge there is not a single professional corporation contemplating liquidation. We might merge some. And we are not setting up many more. But none are disolving."
Diamond, who himself is a private corporation within the partnership, might, however, find it better to dissolve his professional corporation. A special provision of the new tax code prohibits professional corporations which join a partnership to gain tax advantages, though the law does allow for the liquidation of such professional corporations -- known as PCs -- without the usual tax penalties, if it is done before 1984.
The ban on professional corporations within a partnership formed primarily for tax purposes was intended by Congress to overturn a 1981 tax court ruling, known as the Keller Case, which allowed Dr. Daniel F. Keller of Oklahoma City to form a one-man personal service corporation while a partner in a firm with 16 pathologists. The House-Senate conference on the tax bill said the corporation in the Keller Case "served no meaningful business purpose other that to secure tax benefits which would not otherwise be available."
After 1984, the new tax law will equalize the gap between the tax-deductible pension contributions allowed for corporations and the lesser amounts allowed for individual professionals and their partnerships. Diamond predicted that, at that point, most private corporations within partnerships will be dissolved.
"The small advantages will probably not be worth the aggravation, so after 1984 I don't think there will be many incorporated partners," he said.
The main reason for doctors, dentists, lawyers, athletes, artists, writers and other professionals to form corporations was to gain some of the same tax breaks from pension plans that long have been enjoyed by incorporated businesses. Without forming a corporation, an individual professional or a partnership was limited to a Keogh plan, which was far more restrictive than a corporate pension plan in the amount that could be contributed and the tax benefits that could be gained.
The new tax law, however, bowed to the long-time wishes of such professional organizations as the American Bar Association by narrowing the gap between corporations and individuals or partnerships. As of Jan. 1, the new law will begin raising the limits on tax-deductible pension contributions for individual professionals and lowering them for corporations.
By 1984, when these changes are fully phased in, said Washington tax attorney Arthur K. Mason, the gap will be completely erased, thus ending the major tax advantage for incorporating.
"It has put corporate and partnership people on parity," said Mason, a partner in the firm of Hydeman, Mason, Burzio & Lloyd. "If that had been done years ago we would not have had the distortion of a professional corporation."
He noted that special situations where it could be advantageous for a professional to incorporate will still exist. For example, a doctor earning $200,000 a year could, as a corporation, pay himself a salary, put money aside in a tax-favored pension and benefit plan and then keep the rest as accumulated income that would be taxed at a lower rate than if it were counted as personal income. If he liquidated his corporation, the accumulated income would be taxed as a capital gain, which also is taxed at a lower rate than personal income.
"It's sheltering income from the 50 percent [individual tax] bracket inside the low corporate rate," which is 15 percent on the first $25,000 and 18 percent on the next $25,000, said Mason. Thus, putting $50,000 into accumulated income means it is taxed at 16 1/2 percent instead of at a 50 percent rate.
Furthermore, incorporated professionals can gain small advantages in purchasing group life insurance and joining health care programs.
Diamond cited the example of a group of doctors who have formed a partnership but whose practices are so loosely related that they share only a small amount of income. Those doctors might still opt to incorporate, partially as a protection against a malpractice verdict being assessed against all of them even if most of the partners had nothing to do with the case. In a corporation, their liability is limited to the amount of their investment and does not extend to property held outside it.
Since the purpose of the partners each forming professional corporations has nothing to do with taxes, Diamond suggested it would be legal under the new law.
Other examples of members of a partnership who still might find it worthwhile to form individual professional corporations, Diamond said, are lawyers who earn money outside the partnership by writing or lecturing, or doctors who moonlight outside their partnerships, perhaps in hospital emergency rooms.
But the end of professional corporations as a tax-saving measure does not mean that high income professionals will sit still and hand over larger chunks of their earnings to Uncle Sam.
"There will be a lot of income tax planning but it won't include incorporating," said Diamond. "The same thing we did for incorporated people we will do for the unincorporated."