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Friday, June 29, 2012
Selecting the Best Entity for Your Practice

Selecting the Best Entity for Your Practice

 

By Andrew Schwartz, CPA

 

Making daily decisions is part of being an audiologist in practice. Some practice management issues have only one solution, but most require research on a variety of options. Selecting the best type of entity for your practice is one of those issues that has multiple possibilities. Now is the time to determine which type of entity works best if you are in the process of opening or purchasing a practice; you can also take this opportunity to revisit your entity selection if you already own a practice.

 

Most Popular Entity Selection

Most audiology practices operate as a sole proprietorship, a limited liability company (LLC), or an S-Corporation (S-Corp). Different rules apply to each entity. Why bother to create an entity for your practice? Why not just go with a sole proprietorship or a general partnership?

Setting up an entity is a must if you are a partner in your practice. Asset protection laws vary by state, but running your practice as an S-Corp or LLC should protect your personal assets from your business partner’s mistakes. Running the practice as a general partnership without forming an entity offers no protection from that risk.

Setting up an entity for single-owner practices helps keep the practice separate from your personal finances, and some people may own the property and establish two entities — one to hold the practice’s assets and a second to hold the real estate.

 

The Basics

These three options have two major characteristics. Single-member LLCs and S-Corps are separate legal entities, but only S-Corps are required to file a separate tax return each year. Sole proprietorships and single-member LLCs report their income and expenses on a Schedule C form 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

 

Benefits of S-Corps

You will pay Social Security and Medicare taxes on 100 percent of your reported income in a sole proprietorship or LLC. The option of taking a portion of the profits as an S-Corp distribution as opposed to a salary is possible in an S-Corp, which allows you to avoid having to pay these two taxes. Currently the maximum combined tax rate for these two taxes is 13.3 percent. Take a salary of more than $110,100 in 2012, and the rate drops to 2.9 percent. 

Keep in mind you are required to pay yourself a reasonable salary, taking the excess income as S-Corp distributions. You will save between $1,450 and $6,650 in Social Security and Medicare taxes if the S-Corp issues you a distribution of $50,000, depending on your total annual salary from the practice and other sources.

 

Pitfalls of an S-Corp

S-Corps do have some drawbacks, however. Expect to pay higher accounting fees because the S-Corp needs to file its own annual tax return. You should also look into the minimum tax that an S-Corp will need to pay in your home state and in as any other states where your practice operates. 

An S-Corp might not be the right choice for your practice when it comes to deducting certain expenses. It is easier for sole proprietorship or LLC practices to claim home office or automobile deductions. Maintaining an LLC allows the owners to claim professional expenses not run through the practice directly against their share of the practice’s income if there are multiple practice owners. S-Corp owners would need to claim these expenses as a miscellaneous itemized deduction, which are only allowable if they exceed two percent of each owner’s income and are capped for any owner subject to the alternative minimum tax.

Be careful if you earn a good salary working outside of your practice and if your practice is profitable. An S-Corp is required to pay its owners a reasonable salary, but earning more than the FICA maximum might mean paying extra social security taxes if your salary from all sources exceeds $110,100. You will get back the Social Security taxes withheld from your pay, but you do not get back the company’s 6.2 percent match.

 

Deducting Losses

It is not uncommon for healthcare professionals to lose money when opening, purchasing, or expanding a practice. The entity determines how much of these losses you can claim each year, assuming you borrow money to fund these transactions. An S-Corp might not be the best choice to maximize your upfront losses because you can only claim losses for 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 an 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. The S-Corp tends to be the better option for managing the tax burden while repaying loans if you borrow money to purchase, open, or expand a practice. The losses are not allowed up front for the S-Corp, so those suspended losses are released as you generate profits to pay off loans. You will claim the losses in the early years with an LLC or a sole proprietorship, which will not provide you with any tax shelter while you pay off your loans.

 

Other Considerations

Do you have children under 18? Going with a single-member LLC or sole proprietorship 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 these wages. Plus your child will not owe any federal income taxes on the first $5,800 of wages earned in 2011. 

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 your reported wages. Assuming the Roth rules do not change during your child's lifetime, your child will benefit from decades of compounded growth within these tax-free investment accounts. 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 and prepare a W-2 form for your child.

 

LLC’s Flexibility

You can start as a disregarded entity with an LLC, and your practice will be treated as a sole proprietorship for tax purposes. When the time is right, you can treat your LLC as an S-Corp by filing a Form 8832. The beauty is that you can continue to use the same employee identification number and national provider identifier, and do not need to re-credential with any insurance companies to which you submit claims.

 

Entity Selection Scorecard

Choosing the right 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 choice. 

 

 

Sole proprietorship

Single-member LLC

Multipartner  LLC

S-Corp

Save Medicare taxes on earnings

 

 

 

X

Possibly avoid paying quarterly estimates

 

 

 

X

Minimize accounting fees and state taxes

X

X

 

 

Maximize deductible losses funded by debt

X

X

X

 

Manage taxes better during loan repayment

 

 

 

X

Pay child under 18 tax-free

X

X

 

 

Deduct expenses not paid by practice

X

X

X

 

Avoid doubling up on FICA taxes

X

X

X

 

 

 

Mr. Schwartz is a certified public accountant at Schwartz & Schwartz, P.C., in Woburn, MA.

About the Author

Michelle Hogan, Editor
Editor, The Hearing Journal

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