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Where to start with choosing an entity

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Okay, let’s start at the very beginning - what actually is an entity? A business entity is an organization that has been created by one or more people to carry on a trade or business. We’re going to look at some of the most common types in this blog. 

Just like choosing the best plan of care for a patient, deciding on the right business entity can impact both your short and long-term financial results. 

The structure that your practice assumes is important in determining how much money you can put in your pocket, as well as your business’s limitations and tax liabilities. 

This list below gives an extensive overview of each entity to help get you thinking about which is best suited to your business.

The entity options

Sole Proprietor

First, the sole proprietorship. This is the simplest form of business to get up and running. With this type of business entity, you will incur the least amount of legal “formalities” for starting and running your practice. As a sole proprietor, you will assume all responsibility in terms of the operations, liabilities, and the company’s finances.

A sole proprietor isn’t required to register with the state. In fact, anyone can typically establish this type of business anytime, anywhere.

However, it is important to keep in mind that in a sole proprietorship, your personal property is directly tied in with the business, so this type of entity structure can put you at risk of your business assets, as well as your personal assets.

Pros: 

- Easy and low-cost to set up

- No corporate business taxes

- No annual reporting / filings required

- Not restricted by formal business structure

- Easy record keeping

Cons:

- Unlimited liability (which can impact both business and personal assets)

- No ongoing business life (i.e., the business can “die” with the owner)

- Can be difficult to raise capital (i.e., banks may be reluctant to give loans to sole proprietors)

- Inability to take on solely business debt

- May be viewed as unprofessional

Who should choose this entity?

If you are a physician who earns a few thousand dollars a year from consulting, speaking engagements, or filling out surveys, this may be the option for you. 

You shouldn’t take on the additional responsibilities of a more complicated entity unless your home state attorney says otherwise, or for liability purposes. 

This is a good entity for those looking for ease of business operation, along with very little paperwork - provided you’re willing to accept being personally liable for the company’s obligations and debts.

Limited Liability Company or Professional Limited Liability Company (PLLC/PLLC)

A popular form of business entity structure is the Limited Liability Company, or LLC. A Limited Liability Company offers protection from personal liability for business debts, just like a corporation. 

Many physicians automatically think that operating a business means you need to create an LLC. However, it’s important to not jump into an LLC just because everyone else is in one. Just like a medication, you need to know the reason behind prescribing this type of entity, so you don’t accidentally harm your financial goals.

While setting up an LLC is more difficult than setting up a sole proprietorship, operating one is significantly easier than operating a corporation. If you are a licensed professional, such as a physician, you will be required to file as a Professional Limited Liability Company or PLLC. 

Let’s look into the pros and cons:

Pros of an LLC:

- Low filing costs and less paperwork than other business entity structures

- Flexibility to be taxed as a sole proprietor, partnership, or corporation

- The business can be small (just one member) or large (an unlimited number of members)

- Flow-through of income taxation 

Cons of an LLC:

- Income is paid out as distributions (as versus as “wages”)

- High renewal fees, depending on the state

- May be more difficult to raise capital (as versus for partnerships and corporations)

Who should choose this entity?

The LLC business entity structure could be a good option if your goal is limited liability. It’s similar to a corporation, but without the formal structure and time-consuming reporting requirements. 

Having “LLC” in your practice’s name can make it appear more official, implying that the business is registered with the state, and that it has gone through the various requirements for becoming a legal entity in the eyes of the state.  

If you operate as a sole practitioner in the medical profession, and you intend to expand your practice and bring in new owners over time, a PLLC could be an option for you - at least in the beginning. Bear in mind, with this type of entity, any additional owners will typically require the negotiation of an operating agreement, which can be costly.

Partnership

If your practice is (or will be) owned by more than one person, a partnership could be a viable type of business entity structure. Partnerships are defined as a legal form of business operation that exists between two or more individuals who share the management and the profits/losses. 

There are two common types of partnerships. These are general partnerships and limited partnerships – and while the two have a number of similarities, there are also several key differences.

Pros: 

- Simplified taxes

- Less paperwork / easy to create and maintain

- Pass through taxation

Cons:

- Unlimited legal liability for the partners

- Management issues (i.e., with all partners having equal power and responsibility, it can cause potential problems, unless guidelines have been set forth)

- Limited life span of the partnership

Who should choose this entity?

Typically, a general partnership entity structure will be a good alternative for those who want a business that is fairly easy to form and operate, and who are also willing to accept personal liability for the business’s obligations and debts. A lot depends on the type of business you are running.  

A general partnership is rarely an appropriate form of entity for a medical practice. Most physicians will want a Limited Liability Partnership (more about those coming up) if there is more than one partner so you are not liable for the negligent actions of your partner.

Limited Partnership

Another form that a partnership can take on is as a limited partnership entity. In a limited partnership, there is a general partner (or more than one general partners) who organize and manage the business and its operations, as well as limited partners who contribute capital, but who do not actively run the day-to-day business affairs. 

The limited partners are usually considered “silent partners,” while the general partner(s) take part in decision making and are also solely liable for the liabilities and obligations of the entity.

Pros:

- Contributed capital can be generous

- Limited partners have limited liability for losses

- Workload may be split according to the skills of each partner

Cons:

- Disagreements among partners may cause friction

- General partners are personally liable for the partnership’s debts

- Limited partners do not have much say in the company’s decision making

Who should choose this entity?

As a pass-through LLC entity owner, you may be able to deduct 20% of your business income with the 20% pass-through deduction (aka, QBI deduction or Sec. 199a deduction) that was established under the Tax Cuts and Jobs Act.

The limited partnership may be a viable option for those who are looking for the “pass through” tax status, while at the same time limiting personal liability (at least for the limited partners) and separating yourself from the actions of your partners.

C-Corporation/ Professional Corporation

Corporations are considered to be a separate entity from their owners. Because of that, a corporation can provide limited personal liability for its owners, and as a separate legal entity, only the assets of the business can be subject to corporate debts or legal issues. 

In the corporate structure, the directors of the corporation will elect officers who will manage the company’s day-to-day operations. The company’s profits, which are referred to as dividends, are then distributed to the shareholders, based upon the number of shares each individual owns.  

It’s important to point out that, much like the LLC, as a licensed professional, physicians have to register their business a Professional Corporation (PC) if they choose to form a corporation. 

A business may be set up either as a C-Corporation or an S-corporation.

A C-Corporation

One of the attributes of a corporation is their “legal immortality”. In other words, unlike a sole proprietorship, a corporation can go on long after its founder passes away or leaves the company.

In addition, unless there is a specific agreement that states otherwise, the shareholders of a corporation are allowed to freely transfer their shares to other potential purchasers provided that they act within securities laws.

Pros: 

- Limited liability for owners / shareholders

- Unlimited life span for the business

- Stock options that can help to attract top-notch employees 

- Lower audit risk

- Raise capital more easily

Cons:

- Double taxation

- Time-consuming paperwork and annual meeting requirements 

- Registration can be expensive

Who should choose this entity?

Typically, the C-Corporation entity option may best serve those who are looking for limited liability, along with a more formal business structure, the ability to reduce overall income taxation and accumulate business assets. Using the C-Corporation structure may also allow for more opportunities to raise needed business capital. 

An S-Corporation

S-corporations are a very popular type of entity because of the control over payroll tax to the owners. An S-corporation acts like a partnership, but has the added liability benefits of a C-Corporation. 

It is named, based on the legal provisions that are found under Subchapter S of Chapter 1 of the Internal Revenue Code (IRC).  

An S-corporation is a corporation (in a physician's case, a PC or PLLC) that has made an election to have its income and expenses passed through to its shareholders. Also, generally, S-corporations are audited less frequently than sole proprietorships.

Pros:

- Asset / liability protection

- Pass through taxation

- No SE tax on profit above wages (distributions)

- Easy transfer of ownership

Cons:

- Formation process can be tricky without assistance from a tax professional

- Restrictions on the company’s stock shares

- Potential tax penalties if mistakes are made on reporting

Who should choose this entity?

The S-corporation entity structure is often preferred for small businesses due to the potential tax-related savings. Structuring a business as an S-corporation can also be enticing for those who want the limited liability and the more formal structure of a corporation, yet the benefit of the pass through taxation of the business’s profits. 

If you’re thinking about setting up an S-corp, check out our 5 success rules.

Get advice from a professional

The decision of which entity to use should not be made lightly. Nor should it be made without advice from legal and tax professionals, as there can be a long list of pros and cons with each of the available structures, depending on your business objectives. 

Also, depending on the type of legal entity that you choose, there will typically be some specific filing requirements and required paperwork – such as which income tax form you must file each year.

If you want to find out how taxation works in each of the entity options, I’d encourage you to have a read of my upcoming book for physicians.  Sign up on my Resources page to be among the first notified when it's ready for purchase.