Get a Jump on Taxes by Considering Your Business Entity Options

November 23, 2016
Sarah Handzel, BSN, RN

How will you report yearly earnings to the Internal Revenue Service this year? There are advantages and disadvantages to each business entity type.

With tax season right around the corner, it’s never too early to start thinking about the way in which your practice will report yearly earnings to the Internal Revenue Service (IRS). Dentists can choose from several business entity types, each of which has different consequences to consider when filing taxes. It’s possible to file as a corporation or as an unincorporated entity, like a limited liability company (LLC), sole proprietorship, or general partnership. Before deciding how best to file, you should consider consulting with a certified public accountant who can further advise you on each option for your practice and the ramifications of your entity choice on taxes in your home state.

The following is intended to provide a brief summary of each type of business entity. In part 1, we’ll discuss some of the smaller, simpler entity options. In part 2, we’ll move on to larger entities, including corporations.

1. Sole proprietorship — this is the simplest structure used to form an unincorporated business that is owned and run by one individual. The business and you, the owner, are not indistinguishable from each other. As the owner, you’re entitled to all profits from the business, but you’re also responsible for every business debt, loss, and liability incurred. Tax preparation and filing is relatively easy. The business isn’t taxed separately from your personal income, and the tax rates are the lowest of all types of business structures.

Advantages

· You have complete control over your business decisions.

· This type of business is easy to form, and it doesn’t cost a lot to do so.

Disadvantages

· There is a lot of personal liability. After all, you and your business are regarded as one entity, so you can be held personally responsible for all the debts and obligations of the business.

· It can be hard to raise capital for this type of business.

· Since you’re solely responsible for all business decisions, this type of structure can place a heavy administrative burden on you.

2. Partnership — according to the United States Small Business Administration, there are three types of partnerships possible: a general partnership, a limited partnership, and a joint venture. Distribution of profits, liability, and the ability to make management decisions vary depending on the type of partnership formed. Each partner in the business is responsible for several additional taxes on top of the annual return of income, employment, and excise taxes. All partners must also pay income taxes, self-employment taxes, and estimated taxes as appropriate.

Advantages

· Partnerships are easy and inexpensive to form.

· Since partners are all invested in the success of the business, there is a shared financial commitment.

· Each partner brings different strengths and skills into the partnership.

Disadvantages

· Partnerships retain full, shared liability among all the partners. That means each partner is liable for their own actions in addition to the business debts and liabilities incurred through the decisions of other partners.

· Whenever you have multiple people partnering together, you’re bound to disagree over something. Partnerships mean that you have to be willing to make compromises and resolve disputes as graciously as possible.

·Since partnerships are jointly owned, the profits aren’t yours exclusively. You have to share the business profits with each partner—this can lead to conflict if one partner is putting in the lion’s share of the work in terms of time spent at the office, effort, or allocation of personal resources.

3. Limited liability company (LLC) — this type of business structure receives the benefit of the limited liability features usually reserved for corporations and the tax benefits and operational flexibilities of a partnership. These businesses can have only one owner or be owned by multiple people who are referred to as “members”. LLCs are not taxed as separate business entities – each member receives profits and losses that have been “passed through” the business and are then reported on the member’s personal tax returns.

Advantages

· LLCs protect every member from personal liability regarding business decisions or actions. If the LLC is sued or takes on a debt, the member’s personal assets are usually protected from legal action.

· You don’t have to keep as many records. LLCs have less registration paperwork compared to other types of entities. Start-up costs are also typically less.

· LLCs have fewer profit sharing restrictions, and members can distribute profits as they see fit. It’s up to the members to decide who gets what percentage of the profits.

Disadvantages

· In quite a few states, if a member leaves the LLC, the business is dissolved legally unless there were already provisions in the business operating agreement prolonging the life of the company in such situations. The members must still fulfill any and all business and legal obligations in order to officially close the business.

· All members of a LLC are considered to be self-employed. They must pay self-employment taxes toward Social Security and Medicare, and the entire net income of the business is subject to this tax.