By Drew Hinrichs, CPA, CEO of Engage Advisors
When you imagined what it would be like to own a dental practice and work for yourself, the topic of business entities and tax classifications probably didn’t come to mind. While it’s not exactly a scintillating topic, it’s worth thinking about because what you choose can have a big impact on the financial side of your dental practice.
Whether you’re launching a new dental practice, or you’ve been a practice owner for a while, at some point, you selected – or will select – a business structure. This is simply an organizational framework that determines how you’ll be taxed, and how your company operates its finances.
Here’s a brief explanation of the most common options.
Description: This is a frequent choice when one person owns and controls a business. It’s favored for its simple structure wherein the owner pays all taxes and debts personally and reports profits and losses on Schedule C of their personal tax return.
Positives: Administratively it’s pretty easy, and you don’t have to file a separate tax return for the business.
You have full personal liability against all business debts and litigation, making it risky.
Description: Under this structure, two or more individuals share control and ownership of the business. Partners file their taxes for their own share of profits. Costs, debts, and losses pass through to them equally.
Positives: Allows flow through taxation and special allocation of income and expenses.
Negatives: There’s unlimited personal liability for general partnership unless it’s structured as an LLP. State law varies regarding the operation of partnerships, and a lawyer is essential to ensure the structure is set up correctly in the applicable state.
Limited Liability Company (LLC )
Description: An LLC is a legal business structure that protects the owner’s personal assets from the company’s debts and offers a more formal business structure than a sole proprietorship or partnership. Think of an LLC as a hybrid between a partnership and a corporation. Owners can choose whether they’re taxed as a corporation or as individuals on their personal taxes.
Positives: An LLC protects your personal assets from business liabilities and offers flexibility on the taxation of earnings.
Members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security unless they elect to be treated as an S corporation or C Corporation.
Description: Usually reserved for larger businesses, this entity type has become unusual in dentistry due to its unfavorable tax structure. You’ve probably heard of “double taxation” – that is significant because owners, or shareholders, are taxed separately from the entity, while C corporations are also subject to corporate income taxation – thus, “double taxation.”
Positives: Provides the strongest protection from personal liability and allows for unlimited shareholders.
Negatives: Requires extensive record keeping, operational processes and reporting, and double taxation.
Description: This is by far the most common entity type in dentistry. This tax classification is available to some small businesses. The defining characteristic of an S-corps is what’s referred to as its “pass-through” tax structure which exempts it from the federal corporate income tax. Instead, an owner or shareholder’s income is only taxed at the individual level.
Positives: Income is taxed at the shareholder level rather than the corporate level.
Negatives: It’s limited as to the number of shareholders you can have and has restrictions on the distribution of profits amongst partners.
Need to Change Structure?
To summarize, if you are practicing as a C corporation, all of your earnings are subject to double taxation through payroll taxes and income taxes. Most dentists operate as an S-corps because it allows them to shield a portion of earnings from self-employment and payroll taxes. Likewise, many dentists who are single member LLC’s, or sole proprietorships, make the necessary changes in order to be treated as an S corporation for tax purposes.
Keep in mind, you may start out with a structure that works, and eventually outgrow it. Or changes to the tax code could make a different tax classification more advantageous. Fortunately, your business entity is not set in stone. You always have the option to change it.
Consult Your Dental CPA
Always check with your dental CPA before changing your business structure to be sure you fully understand the potential tax implications of your decision.
If you have questions about whether your business structure is the best choice for your practice, or if you’d like help making a change, contact our team at Engage Advisors. We actually enjoy figuring out which tax classification and business entity is the best match for each client. It’s one of the ways we help dentists build financially thriving practices.