If you are an independent contractor offering services to other companies, it’s important to choose the right business structure that offers maximum benefits. Though a sole proprietorship is often seen as an ideal choice, its biggest downside is its unlimited liability, where your personal assets can be used to meet business debts. To avoid this downside, many independent contractors choose the Limited Liability Company (LLC) option, as it protects their personal assets. In this guide, we will help you understand between a standard LLC and a PLLC, what they mean, and how you can set up the right structure.
What Is an LLC?
The business structure has a big impact on the nature of your operations. Knowing the right structure is the key to a successful business. Let’s start by understanding what an LLC is and its pros and cons.
Basic Overview and Legal Framework
An LLC is a legal business structure recognized in all 50 states in the U.S. Its owners, also called members, have limited personal liability towards business debts and obligations. From a legal perspective, LLCs are formed under state law, and their operations follow a governed agreement. Note that every state has different regulations, and this is something to keep in mind.
Who Typically Forms an LLC?
Given the benefits of an LLC, it is a popular business structure among entrepreneurs and small business owners operating across multiple industries. Also, in an LLC, there’s no limit on the number of members. So, if you’re an individual, you can register as a single-member LLC. If you choose to have more partners, you can include individuals, corporations, LLCs, and other business structures as your partners.
However, a few types of businesses, like banks and insurance, cannot register themselves as LLCs. Also, there are special rules for foreign LLCs.
Pros and Cons for Independent Contractors
There are many advantages to forming an LLC for independent contractors. Firstly, they get personal liability protection, so their personal assets will not be used to clear business debts. Secondly, LLCs can be taxed as an S-Corp, thereby avoiding the double taxation of corporate and personal income taxes. Lastly, there are fewer formalities when compared to corporations, and at the same time, it builds trust and credibility among customers.
On the flip side, an LLC requires upfront money as you must pay the state filing fees while incorporating it. Also, LLCs cannot issue shares, and it is not allowed for certain businesses, like banking and insurance.
Next, let’s look at a variant of an LLC called a PLLC
What Is a PLLC (Professional LLC)?
A Professional Limited Liability Company (PLLC) is a business structure that offers liability protection in certain professions, such as law and medicine.
How It Differs from a Traditional LLC
A PLLC has the same liability protection and tax flexibility as a standard LLC. However, this option is available only for state-regulated licensed professionals, like legal, medical, accounting, or engineering services. In some states, individuals with only an active professional license can be members of a PLLC.
In some states, all members of a PLLC must be of the same licensed profession. You cannot mix different professions, like a chiropractor and a veterinarian, in a single PLLC. This restriction is logical, as the entity will be focused on a single line of work, and it is also easy for the state to monitor its activities when needed.
Additionally, you need approval from your state’s licensing board before you can register a PLLC. This additional step is not required for standard LLCs.
Professions That Typically Require a PLLC
Not all professions require a PLLC, so it’s important to know which ones require a PLLC in each state. Some common professions that require a PLLC to operate are:
- Doctors
- Dentists
- Lawyers
- Accountants
- Social workers
- Architects
- Engineers
- Veterinarians
- Chiropractors
- Psychologists
Note that some states, like Delaware and Oregon, do not recognize PLLCs. It is best that you check with your state authorities before deciding on the right structure.
State Licensing Board Requirements
Getting the approval of the state licensing board is one of the key processes in the registration of a PLLC. As mentioned before, this is not required for a standard LLC.
Typically, you need a letter from your state licensing board to confirm that:
- All the owners have a good professional standing.
- The business name follows the rules of the board.
- The proposed business activities must be in accordance with the licensed profession.
Once you get this letter, you can file your Articles of Incorporation with the Secretary of State to register your PLLC.
Some boards may also require additional documentation before they issue an approval letter. This documentation can include a notarized affidavit and proof of malpractice insurance.
All these additional steps make it cumbersome to form a PLLC. However, they are essential for certain professions.
PLLC vs LLC: Key Differences
Now that you have an idea of what an LLC and PLLC are, let’s dive into their major differences. Understanding these differences can help you make an informed decision.
Legal Formation & Ownership
Forming an LLC is simpler than a PLLC, as the latter requires an additional confirmation from the state licensing board before it can be incorporated. Also, there are ownership restrictions. An LLC can be owned by any individual in any profession, and it can also include professionals, LLCs, and corporations operating across diverse fields. Also, these LLCs can operate across different professions. For example, an LLC can offer digital marketing services, real estate brokerage, and corporate consulting. The only requirement is that the operations must be lawful.
A PLLC, on the other hand, is more restrictive regarding ownership. It can be owned only by members of the same profession and must operate only in the specified field. It cannot offer services unrelated to the registered service.
Overall, an LLC offers more flexibility in terms of ownership and business activities than a PLLC.
Personal Liability Protection
Both LLCs and PLLCs offer limited liability protection, so your personal assets are not liquidated for the business. A key difference is that in a PLLC, the liability protection does not extend to malpractice or professional negligence. For example, if you are a licensed professional and someone files a legal case against you for making a mistake, you can be held personally liable for it. The PLLC structure will not protect you from these claims. This is why many state licensing boards and states require malpractice insurance to protect you from these claims.
Tax Treatment
From a taxation standpoint, the IRS treats both LLC and PLLC in the same way. Both have pass-through taxation and can elect to be taxed as an S-Corp. Also, an LLC or a PLLC with only a single member is treated as a disregarded entity, which means the business income is treated as an individual’s personal income.
By default, a multi-member LLC is treated as a partnership and must file Form 1065 and Schedule K-1. However, if the partnership elects to be an S-Corp, it must file Form 2553.
Compliance, Licensing & Registration
To form an LLC, you must file the Articles of Organization with the Secretary of State and pay a registration fee. Once incorporated, you must regularly file forms and taxes based on your tax structure and the appropriate state laws.
PLLCs, on the other hand, have the additional step of going through the appropriate state licensing board and, in some cases, getting malpractice insurance. Once incorporated, a PLLC must also periodically renew its license with the board and follow the specifications laid down by the board.
Naming Conventions and Use of “PLLC” Suffix
Naming rules are another area where the two structures differ. In the case of a standard LLC, the company must include the word “LLC” or “Limited Liability Company”. Besides this requirement, owners have considerable freedom in choosing a name. It must not be misleading and should not be the same as the name of another business.
For PLLCs, the rules are stricter. Besides including the name “PLLC” or “Professional Limited Liability Company”, the name must clearly reflect the professional service that the firm is offering. In some cases, the name must be approved by the board.
Overall, a PLLC has stricter requirements and must follow more regulations than a standard LLC.
What States Require a PLLC?
Not every state requires licensed professionals to form a PLLC structure. Some states, like Delaware, don’t even recognize PLLCs. In general, there is considerable variation in the states’ PLLC requirements.
Let’s look at a few examples.
New York
In New York, professionals in licensed fields, like law, medicine, psychology, and engineering, must form a PLLC to offer their services. The state is very strict and does not allow licensed professionals to operate as a standard LLC. Also, the firm must get a Certificate of Authority from the relevant licensing body, often the New York State Education Department (NYSED), before submitting the documents for registration. Such a streamlined process helps maintain high standards of professionalism and service.
Florida
Florida is another state that requires professionals to form a PLLC to offer their services. Make sure to check if your profession falls in the required category before deciding between an LLC and PLLC. The state mandates that all professionals must hold a valid license before the firm can be incorporated. Also, the name must clearly reflect the professional nature of the business and must end with the word “PLLC.”
Texas
In Texas, professionals must register themselves as a PLLC or a Professional Corporation, depending on the industry. In general, a PC is a good choice if you’re planning to operate a large firm, but a PLLC is better for a small firm. Like other states, a permit is required from the state licensing board, and all members must be qualified individuals of the same profession.
California
California does not allow professionals to form a PLLC. Rather, they must register only as a Professional Corporation (PC). The state enforces this through the California Corporations Code, as it wants to have complete oversight of professional practices. Also, the state does not want professionals to get protection under the limited liability clause. Moreover, note that there are rigid rules regarding governance and shareholder requirements.
Georgia and Other Flexible States
Georgia is one of the most flexible states when it comes to forming a PLLC. In Georgia and other flexible states, professionals can choose to form a PLLC or an LLC. The state recognizes both LLC and PLLC, and it is up to the individual to decide the structure. The advantage of a PLLC structure is that it makes the firm look professional and offers greater protection. Other similar states are Colorado, Ohio, and Pennsylvania.
How to Know If You Need a PLLC or an LLC
Most states require you to register a PLLC if you’re offering professional services. However, in flexible states, you can decide on either of the two structures. Some factors to consider while making this decision are discussed below.
Are You in a Licensed Profession?
The first question to ask yourself is whether you are in a licensed profession, like doctors, lawyers, etc. Next, check if your state requires you to register a PLLC. On the other hand, if you’re in an unlicensed profession like a freelance graphic designer or contractor, a regular LLC should do, as this requires fewer steps.
Will You Be Practicing Under Your Name or a Brand?
Your marketing plan can also be a factor in deciding between an LLC and a PLLC. Many professionals believe that a PLLC firm can be a marketing channel by itself, as it reflects the firm’s credibility and trustworthiness because of the additional oversight from state authorities. In this sense, a PLLC can attract more clients.
However, if you’re operating in an unlicensed profession, you have more flexibility when it comes to choosing a name and branding your business.
Do You Need Malpractice Insurance Regardless?
Regardless of whether you register your firm as an LLC or PLLC, the liability protection does not include malpractice. This means your personal assets are liable for business losses that occur due to malpractice. This is why malpractice insurance is highly recommended for all professionals. For LLCs, malpractice is not a concern, so a general liability or an errors-and-omissions insurance can still come in handy.
Tax Implications for PLLC vs LLC
The tax implications are not very different between an LLC and a PLLC. But here are a few things to keep in mind:
Single-Member vs Multi-Member Taxation
By default, a single-member LLC or a PLLC is treated as a disregarded entity, which means the profits are taxed as a sole proprietorship. Though this setup simplifies business filings, it can increase self-employment taxes for the owner.
When there are two or more members, the LLC or PLLC is treated as a partnership by default. In this case, the business must file Form 1065 and a Schedule K-1 for each member to allocate loss or profit based on the agreement. As you can see, the tax implications are the same for both LLC and PLLC, as both are treated as pass-through entities.
Can a PLLC Elect S-Corp Tax Status?
Yes, both an LLC and a PLLC can elect S-Corp tax status by filing Form 2553. After this change, the firm can split the income as salary or distribution. Owners pay self-employment taxes only on their salary, not on the distributions they receive. This can reduce total tax liability. However, this requires additional payroll processing and tax filing for the business.
Self-Employment Tax & Deductions
Both LLC and PLLC owners must pay self-employment taxes, namely, Medicare and Social Security taxes. Together, they are taxed at 15.3%. Without an S-Corp, the profits are passed on to owners, and they must pay tax, in addition to federal and state income taxes. The good news is that they can deduct ordinary and business expenses required to run the business. Licensed professionals can also deduct the premiums of malpractice insurance, professional license renewal fees, and other expenses related to their practice.
Working Across States
If you are offering services across states, it’s important to understand the concept of a “nexus”, as it determines if you must pay the state tax of those states in which you operate. In simple words, a nexus is a legal connection that exists between a business and a state. This nexus varies between states, as some require you to conduct a certain amount of business, while others consider it a nexus if you have operations in the state. Know what a nexus is for each state, so you fulfill the tax obligations accordingly.
Costs & Paperwork Involved in Forming Each Structure
Each structure entails a certain amount of paperwork and costs. Let’s look at them in detail.
Secretary of State Filings
To form an LLC or a PLLC, you must file the Articles of Organization with the Secretary of State and pay the required fee. As mentioned earlier, for a PLLC, you must also get approval from the corresponding state licensing board. In both cases, though, you must have a registered agent who will receive legal documents on behalf of your business. Note that you will need a registered agent in every state in which you plan to operate.
Annual Reports and Franchise Taxes
Most states require LLCs and PLLCs to file an annual report to update the state on the name and address of the business, its registered agent, and details of its members. In general, this report must be filed within the first quarter of the following year, though the exact dates can vary. As late filing can lead to penalties and fines, make sure you stay on top of these dates.
Additionally, businesses will have to pay franchise taxes, which are a tax paid to the state government for operating in the state. It is not based on profits or income, and each state has a specific calculation for it.
State Licensing Board Approvals
The additional requirement of getting approval from state licensing boards increases the paperwork and timeframes for PLLCs. Approvals can also cost extra money for incorporating a PLLC. Note that the licensing board approvals are for PLLCs only.
Professional Liability Insurance Costs
Some licensing boards mandate professional liability insurance, also called malpractice insurance. However, it is highly recommended for professionals, as limited liability does not cover malpractice. The cost of this insurance varies across professions and states.
Can You Convert from LLC to PLLC (or Vice Versa)?
Now comes an important question: Can you move from LLC to PLLC and vice versa? The answer depends on the nature of your business.
When and Why You Might Need to Convert
It makes sense to convert from an LLC to a PLLC when you gain the necessary license to practice a regulated profession. For example, an individual offering business consulting services might become a certified CPA. In such a case, you must convert your LLC to a PLLC. On the other hand, if a professional moves to a different field or offers services that are not related to the profession, you can convert a PLLC to an LLC. However, in this case, you must not offer any services in the regulated sector.
What the Process Looks Like
The process varies from state to state, and it can also be complex, depending on the existing regulations. Staying on top of these varying processes across states can take focus away from your core business. This is where the experts at Manay CPA can help, as they are aware of the rules in every state and have experience working across states, and they can help you through this process.
Costs, Pitfalls, and Compliance Considerations
Conversions can increase costs, especially when converting to a PLLC. If you have to dissolve a firm and create one again, you will have to pay double the fees. There are also compliance pitfalls that come from skipping the steps. Some firms make the mistake of using an old agreement, and this can lead to penalties. Also, double taxation and filing errors are other aspects to consider.
When an LLC Might Be Better Than a PLLC (and Vice Versa)
An LLC is much better than a PLLC in many situations. However, knowing what works best for you requires an in-depth analysis of various factors, like the ones discussed below.
Freelancers Who Aren’t in Regulated Professions
Since an LLC has fewer requirements than a PLLC, freelancers who aren’t in regulated professions can benefit from these simpler requirements. Also, they may not have a licensing board for approval.
Professionals Operating Under Corporate Brands
If you are working for a company or a corporate brand and not as an independent entity, you don’t need a PLLC. Also, if the company you work for has malpractice insurance and meets the licensing requirements, an LLC may offer more flexibility for you.
Practitioners Operating in Multiple States
If you work in states that don’t mandate a PLLC, you can opt for a simpler LLC. But if you’re working across multiple states with varying requirements, the setup process can get complex, as each state has a different set of laws when it comes to PLLCs.
Need for Simplicity vs Liability Protection
Lastly, opt for LLCs if you’re in unregulated or low-risk professions, as the requirements are simpler. At the same time, make sure you opt for a general liability insurance to cover malpractice.
How Manay CPA Helps Independent Contractors Get Set Up Properly
Manay CPA is a leading firm that specializes in helping independent contractors set up the right business structure. It offers help in the following areas:
Choosing Between LLC, PLLC, S-Corp or Sole Prop
Manay CPA’s consultants work with independent contractors to understand their business, income level, risks, and future plans. Accordingly, they suggest the appropriate business structure.
EIN & ITIN Applications
To get started, you need an EIN for your firm and an ITIN if you’re a foreigner looking to start a business in the U.S. Manay CPA takes care of filing these applications for you.
State Filings and Licensing Coordination
All paperwork, licensing requirements, and filing processes are handled by Manay CPA, regardless of which state(s) you want to register. This flexibility allows you to focus on your business.
Multi-State Tax Compliance
Computing the state taxes and filing them gets complex when you operate across multiple states. Manay CPA can completely take over this paperwork for you to ensure you’re always compliant.
Ongoing Bookkeeping & Tax Filing Support
Regular bookkeeping and tax filing are necessary for business continuity. At the same time, they can be time-consuming. Since Manay CPA excels in this area, they can handle it all for you.
Book a Free Consultation
To better understand the differences between LLC and PLLC and to know which is the right one for you, book a free consultation and talk to an expert at Manay CPA today.
