Business Entity Options for Private Practice
Updated: Dec 6, 2021
Pros and Cons: How to Choose a Business Entity Your choice of business entity is important! It can have a big impact on your finances, legal security, and the way your business is perceived by others. Keep in mind that an entity can be changed as your business grows and matures.
To get you started, here are some pros and cons of popular business entities.
Sole-Proprietorship There is a reason sole-proprietorship is a popular business structure:there is essentially no setup. You do business under your own name and social security number, just hang your shingle! On top of that, it is an inexpensive option for a new business. You may want to file a DBA ("doing business as", also known as "fictitious business name" or "assumed name") with your state, otherwise there aren’t many costs associated with being a Sole Proprietor. You also can (and should!) get an EIN - Employer Identification Number - from the IRS. When it’s just you, yourself, and you, there are opportunities for tax savings if you use your personal car, cell phone, or home for your business. Another bonus? You can file all taxes for the business on your personal tax return, and your income from the business may be eligible for Qualified Business Income Deduction. The downside? While this is a great structure for new small businesses, you cannot have multiple members in the business outside of husband/wife. Also, you will be subject to self-employment taxes. But there’s a bigger problem. A sole-proprietor has no liability protection; which is another way of saying if your business was sued, your personal assets would not be protected. If you are growing, or are in a field with inherent risks and think this could be a possibility, it’s time to change your business to a different entity. Limited Liability Company (LLC) The good news is in the name: limited liability protection!
With an LLC, owners have some liability protection regarding their personal assets outside of the company. The structure of the business can still be quite fluid, and it’s easy to move funds in an out of the company without basis restrictions. The other benefits are similar to a sole-proprietorship. Taxes can be filed on a Schedule C form on a personal tax return, if the business is single-member, and deductible losses are not restricted by basis (only other income). Income also may be eligible for Qualified Business Income Deduction. The bad news: an LLC requires more from you. Just like a sole-proprietorship you will be subject to self-employment taxes on all of the business net income. On top of that there are more setup costs and additional annual reporting requirements compared to a sole proprietorship. Multi-member LLCs must file a partnership tax return annually.
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C-corporation A C-corp is an independent entity with liability protection for all shareholders. Nice! Your business can have unlimited shareholders, including foreign owners or shareholders. This structure also offers multiple classes of stocks, which can help you raise money in the long run. Another benefit is a wide range of tax-deductible benefits for officers and employees.
The not so good parts: A C-corporation can be costly to set-up, and has double-taxation. Also, owners of a C-corp are restricted in their access to company funds. When it comes time to do taxes, a separate Form 1120 will also need to be filed annually. S-corporation
An S-corporation structure makes it easy to have continuity through ownership changes. If you know your business will be changing ownership, this entity could support those changes. This structure also provides several tax benefits. The first being that your net income is not subject to self-employment taxes! Shareholders can take tax-free non-dividend distributions (though there are some restrictions), and pass-through income may be eligible for the Qualified Business Income Deduction. The other side of the coin:
Like the C-corp, this structure can be costly to set up and requires filling a separate Form 1120S annually. Unlike the C-corp, there cannot be different classes of stocks, and an S-corp cannot have more than 100 shareholders. Also, deductible losses and tax-free distributions are restricted by basis, ownership percentage, and the Accumulated Adjustments Account (AAA). Shareholders (that’s you!) MUST be paid reasonable compensation through payroll in order to take advantage of tax-free non-dividend distributions.
Two heads are better than one!
With a partnership, you reap the benefits of added knowledge, skill set, and contacts. All the risk is shared as well, which means it all feels a little more secure and a little less scary. This is also an inexpensive and easy way to start a new business since there are minimal startup expenses.
Where it gets tricky:
Speaking of risk, partnerships have no liability protection from business debt. This can get complicated, especially with two different people involved who may not agree perfectly on every decision. If the business goes into debt, both parties suffer. Also, a partnership would need to file a separate 1065 tax return to report pass-through income. Before you get started, you should have an attorney draft a partnership agreement so everyone is on the same page. Partners are bound by the partnership agreement, both legally and financially, so a lot of care needs to go into preparing this legal contract.
*This is not an all-inclusive list of entity types or their pros/cons. Each situation is different, so there is no one-size-fits-all “best” entity. Talk to a professional to find out what the best entity for your situation may be!
This article is designed to provide information only and should not be considered legal or tax advice. Because of the complexity of the law and the variables in your own personal tax situation, you can’t rely on our advice specifically related to your unique circumstances. In order to get the best tax savings and legal advice available to you, you should consult with your own accountant, attorney or advisor regarding your particular facts and circumstances.
GreenOak Accounting is an accounting firm that specializes in working with counselors and therapists in private practice. We provide monthly accounting & bookkeeping services, 1-time services and online courses. For more information on our specialized services for therapists please visit https://www.greenoakaccounting.com/our-specialized-services-for-therap