What Organizational Format is the Most Efficient?
Bruce Bryen, CPA
As a recent graduate, you will be working in a dental practice that has its legal business structure as one of the following:
- LLC
- LLP
- C Corporation
- S Corporation
- Proprietorship
- Hybrid of one of the above
- Other
Your employment contract will be with one of the above business entities, and you may not have the knowledge to discern why your employer chose a particular type of legal entity for their practice. As you will learn, each legal business structure involves different financial and tax components; with some businesses, the chosen business structure of the owner can greatly hinder the bottom line.
The choice of an entity should be carefully considered, as there are many financial and tax aspects as well as legal protections that each type of entity affords. If your goal is to learn the clinical as well as business end of the practice, and to eventually buy or start up your own dental practice, then it is critical to understand how to manage your practice as efficiently as possible. You want to earn as much as you can for the effort that you will be putting into your practice from a clinical perspective, and retain as much of those earnings from an income tax point-of-view as well. The legal protection of those assets from creditors and others is also an important factor that varies depending on the type of business entity that you choose.
What are Some Advantages and Disadvantages of Each?
Each business structure has its own distinct advantages and disadvantages. It's important to understand the variations between them before you launch your own practice.
The LLC is a separate format in which the dentist is afforded the legal protection of a corporation and yet does not have the formal requirements of reporting income as an employee in the form of a w2. The income or loss from this type of dental practice flows through to the personal tax return of the dentist directly from the LLC. There are no potential double taxes to pay, which is the case typically in one type of corporation commonly referred to as a C Corporation. Tax and financial considerations are available in the form of the management of tax filing requirements, rather than a tax requirement due when your paycheck is issued as an employee of a corporation. The cash and financial management availability is better served because of the frequency requirement of the tax payments for yourself, as the owner. All other financial and cash management issues are similar to any other type of business venture. Equipment and other tax write offs are more easily attained with this type of entity than with corporations because of tax rules involving equity in the venture and credit for loans to be counted as equity. You can learn more of the specifics of these rules as you hire or retain individual advisors such as CPA's or dental practice consultants.
The LLP is similar to the LLC in almost all aspects. Depending upon the state in which you decide to practice, a requirement for either the LLC or the LLP will be the legal response to the actual entity to be formed and registered with that particular state, but from a federal government point of view, they are similar. The advisor that forms the entity for you will have the knowledge from the particular state in which you decide to practice as to whether the LLC or the LLP is the correct form.
What about the Other Types of Entities?
The next two types of business entities listed are the C Corporation and the S Corporation. Each of these legal formats provides protection from creditors. They each require the owner who works at the dental practice to be paid in the form of salary, like any other employee. Payroll taxes are due, most often, when the payroll check is issued. Cash and financial management are less important regarding issues of compensation to the owner because there is little that can be done concerning how payroll tax issues are managed. Other financial management issues are, of course, very important, just as with the LLC or the LLP.
The C Corporation is an entity that files a tax return and pays its own tax when income is left in it. Sometimes advisors refer to this concept as double taxation and shy away from giving advice about the use of this type of entity. Dental CPAs, who are commonly the most sought after because of experience and knowledge in working with dentists, will use the C Corporation and make sure that no double tax occurs by providing excellent and timely advice to the dentist regarding how to disburse its income. Upon the sale of a dental practice, the stock of the C Corporation provides an excellent source for the lowest tax treatment for the seller. This is one of the reasons that advice to use a C Corporation as your legal entity, may be picked.
The S Corporation provides the same legal protection as the C Corporation but has the property of requiring only one federal tax. It is a flow through entity, similar to the LLC and the LLP. Its income or loss is reported by the owner(s) on their personal tax returns and no federal tax is due from the entity.
The Proprietorship and Other Legal Entities
The proprietorship is probably the easiest form to use for the start up dental practice. This format does not require a separate business entity to be formed. There is no legal protection afforded to the dentist. All of one's assets are exposed to creditors or other plaintiff. There are no payroll tax requirements such as those in the corporations. Reporting requirements for the owner are less than with any other type of entity. The profit or loss of the practice is reported on a separate schedule of the personal tax return. When a dentist has little in the way of assets or has a large amount of debt and little to lose, this type of entity may be popular because there are few costs associated with its formation compared to all other types of legal entities. The need for an attorney for formation purposes is minimal for protective and tax purposes because there is less to protect and fewer tax considerations available to the proprietor. As more income is earned and more assets are acquired, the need for more sophisticated approaches to entity formation should be addressed.
There are other types of entities as well, all of which are complex. It is very important to retain an advisor with experience in working with dentists. Unfortunately, your first employer may not have the knowledge to assist you. He or she may think they know the intricacies of the business world, but their expertise probably comes from their own experience. Contact a CPA as the first step to learning how to proceed with your business experience and get their resume for your review before retaining that CPA.
Bruce Bryen is a CPA with over forty years of experience. He is the Managing Partner of his accounting firm, Bryen & Bryen LLP, based in southern New Jersey.
Mr. Bryen specializes in deferred compensation, such as retirement planning design; income and estate tax planning; asset protection and structuring loan packages for presentation to financial institutions. ■
Mr. Bryen is experienced in providing litigation support services to dentists with expert witness testimony in matrimonial disputes cases. You may contact Bruce Bryen at
856-985-8550, extension 112.