SECTION-BY-SECTION ANALYSIS OF PRINCIPAL PROVISIONS OF H.R. 3121

SECTION 1.

29-1102.-Defines the general coverage of the Act.

29-1103.-Makes it clear that professionals are not required to incorporate. 29-1104.-Sets forth the inter-relationships between the Act, the existing rules governing the professions, and the Bussiness Corporation Act.

29-1105.-Provides that the major activity of a PC will be the rendering of professional services. However, the PC may employ non-professionals, may invest its surplus funds, and may enter into partnership agreements with individuals or firms in other jurisdictions.

29-1106.-The form of articles of incorporation differs somewhat from the requirements of the Business Corporation Act.

29-1107.-In order to avoid artificialities and to afford flexibility in the management of the small PCs, the number of directors may be one or more.

29-1108.-Shareholders, officers and directors of PCs must be licensed professionals, but shareholders need not be active. Thus, retired or disabled partners can continue to have an interest in the firm.

29-1109. The names permitted to be used by PCs will distinguish them from commercial businesses.

29-1110.-This section, and sections 1112, 1113, 1115, 1116, and 1117, establish control relationships within the PC which recognize that PCs are close corporations which must have great latitude in placing restrictions on the transfer and voting of shares.

29-1111.-Establishes that corporate identity will not protect the individual professional from liability for his own malpractice, and will not diminish the confidentiality of the relationship between the professional and the client/patient. However, malpractice by one or more professionals in a PC will not subject any other professional to personal liability. The PC is liable up to the full value of its assets for negligent or wrongful acts of officers, shareholders, directors, agents in rendering professional services on behalf of the PC.

29-1112.-Permits PCs to place restrictions on the transfer of shares. Recognizing that stock of PCs will be owned by professionals and cannot be made available to the public, the section also exempts the issuance and transfer of stock of PCs from the D.C. Securities law and from the federal Securities Act of 1933. Subsection (4) is intended to minimize the disruptive effect of PC shares falling into the hands of an individual creditor of a stockholder.

29-1113.-This section recognizes that the rendering of professional services in D.C. should be conducted as a separate activity and not intermixed with other businesses. Out-of-state arrangements with other professionals are adequately provided for by section 29-1105. This provision is consistent with most state laws, which would also prohibit mergers of domestic and foreign PCs. The section implicitly recognizes that a single PC may conduct two or more professional activities (for example, architect-engineers) when such combinations are not prohibited by rules regulating the professions.

29-1114.-Foreign professional corporations licensed in a jurisdiction other than the District of Columbia may perform professional services in the District of Columbia if they meet certain requirements by obtaining a certificate of authority under this provision.

29-1115; 29-1116; 29-1117.-These sections provide a method for retiring stock of deceased, disabled or disqualified shareholders.

29-1118; 29-1119.-These are essentially administrative provisions.

29-1120.-This section provides penalties for failure to comply with the provisions of this Act.

29-1121.-This section delegates authority to the District of Columbia government to administer this Act.

SECTION 2

This section amends the District of Columbia Income and Franchise Tax Act of 1947 in order to maintain for unincorporated professional associations the unincorporated business tax exemption which these associations presently have under that Act.

Mr. HUNGATE. Congressman Fuqua of Florida is the author of of this act. He has advised that he has other hearings this morning and

regrets that he can't be present. He is filing with the Committee a statement of his position and the reasons that he seeks to have this adopted.

Unless there is objection, we will make Congressman Fuqua's statement a part of the record.

(The document referred to follows:)

STATEMENT OF HON. DON FUQUA, A REPRESENTATIVE IN

CONGRESS FROM THE STATE OF FLORIDA

Mr. Chairman, I welcome this opportunity to appear before your subcommittee.

H.R. 3121, 92d Congress, first session, would amend the corporation code of the District of Columbia by adding a new chapter 11 thereto to authorize doctors, lawyers, and other professional practitioners to organize "professional corporations" for the conduct and dispensation of their professional business and services.

Its most significant immediate contribution upon enactment is the substantial encouragement it gives to the realization of the highly desired "group professional practice" which is extolled by many as the most direct and effective means of supplying needed professional services to the economically disadvantaged at a cost within their income and means.

Permitting professional persons to incorporate would endow their association with the corporate characteristics of centralized management and continuity. The formal attributes of incorporation are lacking in the sole proprietorship and partnership forms of doing business that are currently employed by persons actively engaged in a professional practice.

These attributes of a corporation are vital to the stimulation of professional group practice on a large scale; and this fact can best be illustrated by noting the difficulties inherent in the partnership form currently utilized by group practitioners. As the partnership group practice grows in size, its management becomes cumbersome because of the general necessity for the partners' consent to various details of the management and business of the group. Likewise, partnership continuity is constantly interrupted by the death or resignation of old members and the addition of new ones. An additional problem attendant upon this frequent dissolution and reorganization of the partnership is that of attracting young professional men to the partnership group. That is, as the partnership size and business increases, the capital contributions required to purchase interests in the partnership also becomes increasingly larger and out of the financial reach of the young professional who is just embarking on the practice of his life's profession.

Additional stimulus to the effectuation of group practice is embodied in the liability provisions of the bill. Under the partnership form of group practice, each partner is personally liable for the negligent acts and omissions of his partners. Under the bill, shareholders would continue to be personally responsible for their own negligence and misconduct, as well as that of corporate employees under their supervision and control; but, the theory of liability in a partnership could not be invoked to impose a like liability on the remaining or other shareholders of the corporation.

At this time, I would like to suggest to the subcommittee that the bill contains a gross oversight manifested in the absence of optometrists from section 29-1102. Definitions. Certainly, this was a most unintentional omission and I would like to recommend to the committee that this be rectified by the following amendment:

On page 2, line 16, strike out, "and" and insert in lieu thereof "optometrists and".

Thus, if enacted, H.R. 3121 would allow professional persons to associate themselves in a business form that enjoys continuity, centralized management, and limited liability, thereby encouraging "group practice" to increase the availablity of their services to all the residents of the District at an affordable cost. For these reasons, I respectfully urge your favorable consideration of the bill.

Mr. HUNGATE. Mr. Middlekauff, this is your busy day and Mr. Corey, please come forward, gentlemen, and we will be glad to hear from you.

Proceed, please.

STATEMENT OF ROGER D. MIDDLEKAUFF AND WILLIAM S. COREY, ON BEHALF OF THE BAR ASSOCIATION OF THE DISTRICT OF COLUMBIA

Mr. MIDDLEKAUFF. Mr. Chairman, Mr. Corey and I have submitted a written statement on behalf of the Bar Association which we would like to have incorporated into the record.

Mr. HUNGATE. Without objection it will be made a part of the record at this point.

(The prepared statement follows:)

STATEMENT ON BEHALF OF THE BAR ASSOCIATION OF THE DISTRICT OF COLUMBIA BY ROGER D. MIDDLEKAUFF AND WILLIAM S. COREY

Mr. Chairman, my name is Roger D. Middlekauff, and I am a practicing attorney in the District of Columbia and Chairman of the Subcommittee on Corporations and Business Organizations of the District of Columbia Bar Association. William S. Corey, Chairman of the Tax Committee of the Bar Association and I were designated by the Bar Association to testify on its behalf before you this morning regarding H.R. 3121, the proposed District of Columbia Professional Corporation Act.

In this testimony we will first review the advantages which accrue to a professional having available to him the authority to incorporate. Then, we will review the highlights of the proposed act and the tax considerations with respect to incorporation of professionals. Finally, we would like to suggest a few technical changes to the proposed Act. In this regard, we would like to mention that the proposed Act is the work of many of the District's outstanding attorneys, who drew upon the best provisions of similar acts in the other states, and submitted it to the House District Committee for its consideration. We are all beneficiaries of the extraordinary efforts of those many esteemed attorneys who volunteered their energies and talents. Mr. Corey and myself are privileged to be chosen to appear on behalf of the Bar Association to submit to you these comments.

I. ADVANTAGES OF A CORPORATE STRUCTURE

Professionals are now authorized to incorporate in every state of these United States. Through the encouragement of the doctors, dentists, lawyers, architects, accountants, engineers and other professionals, all the 50 state legislative bodies adopted legislation authorizing their incorporation. Prior to this authorization, professionals had to resort to partnerships as their vehicles of combination. In a number of respects, partnerships, as compared to corporations, are ungainly and complicated.

Several basic attributes of professional corporations give them value over a partnership structure.* A corporation has a greater degree of centralization of management. A corporation limits the liability of a stockholder when an officer of the corporation properly acts within the authority given him by the Board of Directors. (However, in a professional corporation the professional still bears the responsibility for his own malpractice.) A professional corporation has perpetual existence; whereas, a partnership comes to an end upon the death of any partner. Finally, a professional corporation has greater flexibility with respect to transfer of interests than does a partnership.

As a general matter, the laws regarding corporations are much more clearly defined than as to the partnerships. The guidelines for corporate activities, responsibilities, and relationships are well-known. Partnership agreements by necessity become long and cumbersome because the partners are unable to resort to the large body of statutory and case law which define the coporate concept. I would like to emphasize that the proposed Act does not require professionals to incorporate. It simply provides them with the opportunity to incorporate and defines the structure which results from that incorporation. We believe that professionals should be given the privilege now accorded all businessmen, the right to incorporate.

II. A REVIEW OF THE HIGHLIGHTS OF H.R. 3121

Section 1 describes the details of the corporate process:

29-1102.-Defines the general coverage of the Act. Shareholders are limited to those who are licensed to render the same professional service as the corporation. Permits incorporation for those who were previously unable to do so. 29-1103-Makes it clear that professionals are not required to incorporate. 29-1104.-Sets forth the inter-relationships between the Act, the existing rules governing the professions, and the D.C. Business Corporation Act.

29-1105.-Provides that the major activity of a professional corporation will be the rendering of professional services. However, the professional corporation may employ non-professionals, may invest its surplus funds, and may enter into partnership agreements with individuals or firms in the District of Columbia and in other jurisdictions.

29-1106.-The form of articles of incorporation differs somewhat from the requirements of the Business Corporation Act. One or more persons may incorporate, provided that they are duly licensed.

29-1107.-In order to avoid artificialities and to afford flexibility in the management of small professional corporations, the number of directors may be one or

more.

29-1108.-Shareholders, officers and directors of professional corporations must be licensed professionals, but shareholders need not be active. Thus, retired or disabled partners can continue to have an interest in the firm.

29-1109.-The names permitted to be used by professional corporations will distinguish them from commercial businesses. The corporate name shall contain the words "Professional Corporation", the abbreviation "P.C.", or the word "Chartered."

29-1110.-This section, and sections 1112, 1113, 1115, 1116 and 1117, establish control relationships within the professional corporation which recognize that professional corporations are close corporations which must have great latitude in placing restrictions on the transfer and voting of shares.

29-1111.-Establishes that corporate identity will not protect the individual professional from liability for his own malpractice, and will not diminish the confidentiality of the relationship between the professional and the client/patient. However, malpractice by one or more professionals in a professional corporation will not subject any other professional to personal liability. The professional corporation is liable up to the full value of its assets for negligent or wrongful acts of officers, shareholders, directors, agents in rendering professional services on behalf of the professional corporation.

29-1112.-Permits professional corporations to place restrictions on the transfer of shares. Recognizing that stock of professional corporations will be owned by professionals and cannot be made available to the public, the section also exempts the issuance and transfer of stock of professional corporations from the D.C.

These attributes are elaborated further in "Factors That Go Into Decision of Whether to Operate as a Professional Corporation," G. E. Ray, The Journal of Taxation, 130–32 March 1971).

62-864 071-4

Securities law and from the Federal Securities Act of 1933. Subsection (4) is intended to minimize the disruptive effect of professional corporation shares falling into the hands of an individual creditor of a stockholder.

29-1113. This section recognizes that the rendering of professional services in the District of Columbia should be conducted as a separate activity and not intermixed with other businesses. Out-of-state arrangements with other professionals are adequately provided for by section 29-1105. This provision is consistent with most state laws, which would also prohibit mergers of domestic and foreign corporations. The section implicitly recognizes that a single professional corporation may conduct two or more professional activities (for example, architect-engineers) when such combinations are not prohibited by rules regulating the professions.

29-1114.-Foreign professional corporations licensed in a jurisdiction other than the District of Columbia may perform professional services in the District of Columbia if they meet certain requirements by obtaining a certificate of authority under this provision. A certificate of authority would be granted only if the foreign jurisdiction authorizes reciprocal admission rights.

29-1115.-If an individual is disqualified from rendering the professional services, he shall sever employment relationships with the professional corporation. 29-1116.-Provides for the sale or redemption of stock of a disqualified, deceased, or legally incompetent shareholder.

29-1117.-Unless the shareholders have previously agreed otherwise, the redemption price for shares or a disqualified, deceased, legally incompetent, retired or expelled shareholder shall be book value.

29-1118.-A professional corporation shall have perpetual existence, and provides an administrative procedure in the event professional services are no longer rendered.

29-1119.-An administrative requirement for the filing of annual report with the D.C. Recorder of Deeds.

29-1120.-This section deals with penalties for failure to comply with the provisions of the Act.

29-1121.-This section delegates authority to the District of Columbia government to administer this Act.

Section 2 amends the District of Columbia Income and Franchise Tax Act of 1947 in order to maintain for unincorporated professional associations the unincorporated business tax exemption which these associations presently have under the Act.

III. DISTRICT OF COLUMBIA AND FEDERAL TAX CONSIDERATIONS

Much has been written and said regarding the Federal tax advantages of professional individuals operating in the corporate form. While there are a number of these tax advantages, probably the most significant advantages at the present time stem from the disparities in the Federal tax treatments of qualified retirement plans of corporate employees and of qualified retirement plans for selfemployed individuals. Broadly speaking the Federal income tax treatment of all such qualified plans consists of a deferral of the Federal income tax with respect to contributions made on behalf of employees, including self-employed individuals, until distribution of the employees' benefits and the deferral, for the same period, of the Federal income tax on the earnings from investment of all contributions made under the plan.

As indicated above, the benefits under qualified retirement plans for selfemployed individuals, or so-called "H.R. 10 plans", are not nearly so broad as those under corporate plans. One of the most significant differences concerns the maximum limitation on contributions on behalf of self-employed individuals who have a more than 10% interest in the business (so-called "owner-employees"). Under the Federal Internal Revenue Code such contributions are limited to the lesser of 10% of the individual's "earned income" from the business of $2,500 per year. On the other hand, in the case of corporate retirement plans, contributions up to 25% of an employee's compensation are premitted where the employer has both a pension plan and a profit sharing plan and there is no ceiling on the dollar amount which may be contributed. Similarly, the benefits from voluntary additional contributions, i.e., the contributions by the employee or by self-employed individuals for which no deduction is allowable, are greater under corporate retirement plans. Specifically, under corporate plans an employee may contribute up to 10% of his compensation without regard to the dollar amount thereof, with the result that such contributions will then accumulate tax-free income until the distribution of the employee's benefits upon his retirement. On