Chose the Best Entity Type for your Pratice – Part 3

By Andrew Schwartz, CPA

In the first two parts of this series, we covered the basic types of entity choices you have when setting up a practice and the benefits and pitfalls of S-Corporations.? Let’s wrap up by looking at deducting losses,?other considerations you should have, and a final scorecard.

Deducting Losses

It?s not uncommon for healthcare professionals to lose money in years that they open a practice from scratch, purchase an existing practice, or expand their current practice.? Assuming you borrow money to fund these transactions, the type of entity determines how much of these losses the you can claim each year.

To maximize the upfront losses you can claim, an S-Corp might not be the best choice.? If you set up your practice as an S-Corp, you can only claim losses to the extent of the money you invested into the practice.? Guaranteeing loans or other liabilities is not sufficient to allow you to claim these losses.

Running your practice as a LLC or a Sole Proprietorship allows you to claim larger losses up front.? The only catch is that you need to be personally liable for paying off these loans.

If you borrow money to purchase, open, or expand a practice, the S-Corp tends to be the better option with respect to managing the tax burden while repaying the loans.? Since the losses are not allowable up front for the S-Corp, those suspended losses are released as you generate profits to pay down the loans.? With a LLC or a Sole Proprietor, you?ll claim the losses in the early years which will not provide you with any tax shelter as you pay down your loans.

Other Considerations

Do you have children under the age of 18?? If so, going with the Single Member LLC or Sole Proprietor will let you take advantage of a quirky tax break.? While you get to deduct ?reasonable? wages paid to your child for services provided, neither you nor your child owes Social Security or Medicare taxes on wages paid. Plus, he or she does not owe any federal income taxes on the first $5,800 of wages earned (in 2011).?? (We wrote about this opportunity in our May 2007 Newsletter.)

This is true arbitrage.? You move money from your practice?s bank account to your child?s bank account, and the government gives you a tax break on that money.? You can also contribute money into a Roth IRA for your child based on the wages you report.? Assuming the Roth rules don’t change during your child’s lifetime, your child will benefit from decades of compounded growth within these tax-free investment accounts.

Caveat employer.? Keep in mind that you are only supposed to pay your child a fair wage for services actually performed.? You will also need to complete and file quarterly and annual payroll tax forms, as well as prepare a W-2 form for your child.

Flexibility of a LLC

LLCs?are very flexible entities.? With a LLC, you can start as a disregarded Entity, and your practice will be treated as a Sole Proprietorship for tax purposes.? When the time is right, you can then elect treat your LLC as an S-Corp by filing a Form 8832.? The beauty of this strategy is that you can continue to use same EIN and NPI, and don?t need to re-credential with any insurance companies you submit claims to.

Entity Selection Scorecard

Choosing the correct entity for your practice is a tough decision.? You should definitely reach out to a lawyer and an accountant who are familiar with your state?s rules and regulations prior to making your final decision.

Even so, here is an Entity Selection Scorecard to help you with your decision:

S.P.

S LLC

M LLC

S-Corp

Save Medicare Taxes on Earnings

X

Possibly avoid paying quarterly?estimates

X

Minimize accounting fees and state ? corporate taxes

X

X

Maximize deductible losses funded by debt

X

X

X

Manage taxes better? during loan repayment

X

Pay child under the age of 18 ? tax-free

X

X

Ability to deduct 100% of expenses? not paid by practice

X

X

X

Avoid doubling up on FICA Taxes

X

X

X

S.P. = Sole Proprietor, S LLC = Single Member LLC, M LLC – Multiple Member LLC

Chose the Best Type of Entity for your Practice – Part 2

By Andrew D. Schwartz, CPA

To read Part 1 of this series, click here.

In my previous article, we covered the basics of the most popular entity selections.? Let’s dig deeper into the benefits and pitfalls of S-Corps.? Remember: S-Corporations have the requirement of filing a separate tax return each year and are separate legal entities.

Benefits of S-Corporations

When your practice is set up as a sole proprietorship or LLC, you pay Social Security and Medicare taxes on 100 percent of the income that you report on your tax return.? By setting up your practice as an S-Corp, you have the option of taking a portion of the profits as an ?S-Corp Distribution? instead of as salary.? By doing so, you avoid paying these two taxes.? Currently, the maximum combined tax rate for these two taxes is 13.3%.? Take a salary of more than $110,100 (in 2012), and the rate drops to 2.9%.

Keep in mind that the rules require that you pay yourself no less than a ?reasonable salary? and then only take the excess income as S-Corp distributions.? Have the S-Corp issue you a distribution of $50k instead of a paycheck and you?ll save from between $1,450 and $6,650 in Social Security and Medicare taxes, depending on your total annual salary from the practice and other sources.

Pitfalls of an S-Corporation

There are some pitfalls with S-Corps to consider.? For starters, expect to pay higher accounting fees since the S-Corp needs to file its own tax return each year.? You should also look into the minimum tax that an S-Corp will need to pay in your home state as well as any other states where you operate your practice.

When it comes to deducting certain types of expenses, staying away from the S-Corp might be prudent.? It?s actually easier for people who operate their practice as a Sole Proprietor or LLC to claim the home office deduction or to deduct their automobile expenses.

If there are multiple owners to the practice, maintaining a LLC allows the owners to claim any professional expenses not run through the practice directly against their share of the practice income.? For practices set up as an S-Corp, each owner would need to claim these expenses as a miscellaneous itemized deduction, which are only allowable to the extent they exceed 2% of each owner?s income and then are capped for any owner subject to the Alternative Minimum Tax (AMT).

And you need to be careful if you earn a good salary working outside of your practice, and also own a profitable practice.? Since an S-Corp is required to pay its owners a reasonable salary, there is a chance that someone earning more than the FICA max might end up paying extra Social Security taxes if your salary from all sources exceeds $110,100.? Yes, you will get back the Social Security taxes withheld from your pay, but you don?t get back the Company match of 6.2%.? The cost of this tax could be as high as $6,93 ($110,100 * 6.2%).

In the last part of this series, I’ll discuss deducting losses and other considerations to think of when selecting an entity type.

Series: Choose the Best Entity Type for your Pratice – Part 1

By Andrew D. Schwartz, CPA

For doctors in practice, making a lot of decisions every day is just part of the deal.? While some practice management issues come with only one obvious solution, most require that you spend time researching a variety of options only to learn that there is more than one correct answer.? Selecting the best type of entity for your practice is one of those issues with multiple correct answers.

If you are in the process of opening or purchasing a practice, now is the time to determine which type of entity would work best for your practice over the long-term.? Or, if you have owned a practice for a number of years, why not take this opportunity to determine if you have selected the best type of entity for your situation.? Let?s take a look a pros and cons of the various entities available to healthcare professionals in practice.

Most Popular Entity Selection

Most healthcare professionals operate their practice as a Sole Proprietorship, a Limited Liability Company (LLC), or an S-Corporation.? Different rules apply to the different type of entity.? The first question, however, is why even bother to create an entity for your practice.? Why not just go with a sole proprietorship or a general partnership?

If you are involved with partners in your practice, setting up an entity is a must.? While asset protection laws vary by state, running your practice as an S-Corp or LLC should protect your personal assets from your business partner?s mistakes.? Without forming an entity, you would be running the practice as a General Partnership which offers no protection to that risk.

For practices with one owner, setting up an entity helps keep your practice separate from your personal finances.? Some people who own a practice and also own the real estate where their practice is located actually end up establishing two entities – one to hold the assets of the practice and a second to hold the real estate.

The Basics

Let?s start by looking at two major characteristics for these three options.? While Single Member LLCs and S-Corporations are separate legal entities, only an S-Corp comes with the requirement of filing a separate tax return each year.? Sole proprietors and Single Member LLCs report their income and expenses on a Schedule C filed as part of the owner?s individual income tax return.

Type of Entity

Separate Legal Entity

Files Own Tax Return

Sole Proprietorship

No

No

Single ? Member LLC

Yes

No

S-Corporation

Yes

Yes

For Part 2 of this series, we’ll discuss the Benefits and Pitfalls of S-Corps.? Stay tuned!

ENTITY SELECTION FOR YOUR PRACTICE – Part 2

To read Part 1 of this aticle, click here

So what are the comparative advantages of a Sole Proprietor vs an LLC vs an S Corporation?

Let?s start with a sole proprietor. A sole proprietor is not a separate legal entity and is not a separate taxable entity. Basically, it?s you, and you report the income and expenses from your practice to the IRS on a Schedule C attached to your federal tax return.

An S-Corporation, on the other hand, is a separate legal entity and files its own tax return, an 1120S. The S-corporation doesn?t pay its own taxes, however. Any income or allowable loss from the S-Corporation will flow through to your personal tax return and will be reported to you on a Schedule K-1.

An LLC is sort of a hybrid of a sole proprietor and an S-Corp. An LLC is a separate legal entity. If the LLC has only one owner, however, the LLC defaults to be treated as a “disregarded entity” for tax purposes, and you?ll report the income or expenses on a Schedule C attached to your tax return, just like you would as a sole proprietor.

Type of Entity

Separate
Legal
Entity

Files Own Tax
Return

Sole Proprietor

No

No

Single Member LLC

Yes

No

S-Corporation

Yes

Yes

An LLC with multiple owners would be treated as a partnership for tax purposes, and would therefore need to file a partnership tax return (Form 1065) each year.

Which type entity makes the most sense? It is usually easier for sole proprietors and LLCs to deduct losses ? especially in the early years of the practice. Sole proprietors and LLCs also have an easier time deducting personal-type expenses like automobile expenses and the home office deduction.

S-Corps, on the other hand, can help their shareholders save taxes once the practice becomes successful by letting them avoid paying Social Security and Medicare taxes on money paid out as ?S-Corp Distributions?. Plus, by paying yourself a salary through the practice’s payroll along with the other employees, you can avoid the headaches associated with remitting your personal income taxes through quarterly estimates.

Flexibility of an LLC:

One strategy we are seeing more often is for a person to open a practice as a Single Member LLC, and maintain their practice as an LLC until it makes sense to be treated as an S-Corp. At that time, the LLC will file a Form 8832 with the IRS to elect to have the LLC treated as a corporation, and then will elect S-Status by filing a Form 2553.

One huge benefit of this strategy is that you do not need to get a new Employer Identification Number for your practice if you decide to switch from being taxed as a Sole Proprietor to an S-Corporation. This will also allow you to continue to use the same NPI and avoid being required to re-credential with all the insurance companies.

To Incorporate or Not To Incorporate?

There are certain instances when incorporating your practice will most likely not make sense, and a Single LLC would be the preferable entity to select. We wrote about this in our July 2005 Newsletter in an article titled: To Incorporate or Not to Incorporate. Basically, if you earn a good salary each year, and then earn some extra money on the side by moonlighting or consulting, incorporating that practice might cost you a lot in extra taxes, state fees, and professional fees.

Which is Best for You?

Most of the practice clients we work with these days set up either an S-Corp or an LLC. There are pros and cons of each type entity, so you want to review your specific situation with your CPA and your lawyer to make sure you set up the correct entity based on the current set of facts and circumstances.