Whether you’re considering starting your own practice from scratch or buying into an existing business, one of the first decisions you will need to make is your practice structure. Choosing the right structure is important, as it dictates your legal liabilities and how your practice is taxed.
There are four main practice structures: sole proprietorships, partnerships, s corporations, and c corporations. We’ll introduce you to each one to help you decide which one might fit your needs best. If you are still struggling to decipher which entity is right for your situation, contact one of our team members.
Sole Proprietorships
Sole proprietorships are the simplest practice structure to start, with no formal filing requirements if you have no employees. Your practice will operate under your Social Security number and report all income or loss on Schedule C of your individual income tax return.
This structure makes sense when just starting out, as you can watch income levels and take advantage of the Qualified Business Income deduction, which is an automatic 20% reduction of your net income. In addition, sole proprietorships are generally more favorable if you plan on hiring family members, as there are payroll tax saving opportunities.
However, sole proprietorships can fall short when it comes to minimizing your tax liability, as all net income will be subject to payroll taxes, which include Social Security and Medicare. Since your practice is the employer, you will need to pay both the employee and employer’s share.
Additionally, one of the main drawbacks of sole proprietorships is limited continuity. In a sole proprietorship structure, you are the entire practice, meaning you can’t have other owners or partners. This can make retirement tricky, as it is costly and complex to transfer ownership in a sole proprietorship.
Partnerships
Partnerships are legally separate entities, filing a business tax return and passing all income down through Schedule K-1. This flow through taxation can potentially result in lower self-employment taxes; however, some distributions from the practice may be considered self-employment income.
Partnerships are great if you plan on opening a practice with other doctors or dentists, as there is a lot of flexibility to divvy up income between partners. Additionally, partnerships have the option to pay business pass-through entity taxes at the state level in many states (i.e. Illinois and Indiana). This can result in a lower tax liability, with the ability to claim a federal deduction for state taxes paid.
Like sole proprietorships, partnership owners can also claim the Qualified Business Income Deduction to reduce taxable income. Nevertheless, one of the top financial disadvantages is that all decisions need to be made according to the partnership agreement, such as taking equal distributions and making overall practice decisions.
S Corporations
S corporations also retain flow through taxation, issuing shareholders Schedule K-1 to report on their individual income tax returns. Unlike partnerships, s corporations shield practice owners from self-employment taxes on ordinary income and distributions. Distributions can become taxable if you exceed your basis in the practice, which comprises everything you’ve contributed, withdrawn, and earned.
S corporations can also leverage the Qualified Business Income Deduction and take advantage of pass-through entity taxes at the state level in Indiana and Illinois. With a corporate structure, medical and dental practices have greater tax planning options and can easily change owners or bring on new shareholders.
One of the main disadvantages associated with s corporations is the maintenance requirements. The IRS places more scrutiny on s corporation owners, especially when it comes to determining reasonable compensation and taxable fringe benefits. Moreover, s corporations can only issue one class of stock and have restrictions on the types of owners allowed.
It’s important to note that s corporations cannot be formed outright. You must first register as a limited liability company, limited liability partnership, or c corporation and elect s corporation status.
C Corporations
C corporations are not widely used by medical or dental practice owners, as they are expensive to maintain and don’t always maximize your tax savings. The c corporation is taxed at the corporate level on all earnings and shareholders are taxed on dividend income received from the company. This can result in a greater tax burden compared to other structures, like an s corporation.
Nevertheless, one of the main advantages associated with a c corporation is the ability to have different classes of stock. This could be helpful if you have other owners, but have different roles and responsibilities and want to delineate this by offering different classes of stock.
Which Structure Is Right For Your Medical Or Dental Practice?
Are you leaning toward a sole proprietorship, partnership, s corporation, or c corporation? Choosing the right structure for your practice is an important decision and relies on evaluating your operational and financial goals. Are you looking to lower self-employment taxes and enjoy flexibility in bringing on new doctors or dentists? If so, a partnership or s corporation might fit you the best.
On the contrary, if you are looking to keep operations small, are just starting out, or plan on hiring family members, a sole proprietorship structure might be right. Remember, the practice structure that you pursue should fit your needs now and in the future. If you plan on bringing on additional owners in two years, you don’t want to go through the hassle of switching your structure.
At the end of the day, there’s no one-size-fits-all approach to choosing your structure and this article over-simplifies for the sake of clarity and your circumstance may produce different answers based on your special circumstance. This means expert help is indispensable to making an informed decision. If you have questions about the financial implications of partnerships, s corps, or sole proprietorships, please contact us.
