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23 May, 2024

Navigating Business Entities: A Guide for Dentists

Introduction

Are you a dentist looking to set up your practice or expand your existing one? One of the main decisions you’ll face is choosing the right business entity or corporate structure. Your choice can impact your liability exposure and level of taxation. In this article, we’ll explore the various business entities available to dentists, so you can decide which is the best fit for your practice.

General Principles

Incorporated Entities

Corporations and LLCs are formed at the state level. To set one up, you’ll need to file or register Articles of Incorporation or Articles of Organization. A federal tax ID number should be obtained from the IRS. States and their agencies (like payroll and sales tax departments) have unique requirements for ID numbers. Corporations and LLCs offer liability protections to owners, except in the case of withheld payroll taxes and acts of professionals.

Many states require dentists and other licensed professionals to form a Professional Corporation (PC) or Professional Limited Liability Company (PLLC). These business entities offer liability protection to you as an owner and dentist, while allowing you to operate within the framework of your licensing board’s regulations.

Taxable vs Pass-through Entities

Corporations are taxable business entities unless they elect S corporation tax status. Taxable corporations are termed “regular” or “C” corporations. Large publicly-traded corporations are usually C corporations. Taxed profits are distributed as taxable dividends. This means profits are taxed twice, which is a definite downside to C corporations.

Pass-through entities avoid double taxation. S corporations and partnerships are not taxable, but file an information tax return, which contains a Form K-1 for each owner. It shows the allocation of income to report on the shareholder or partner personal income tax return. Hence the term “pass-through” entity, since income, losses, deductions, etc. all pass through to the owners. As ordinary income, interest, dividends, and capital gains are all treated differently under tax law, these are all separately stated on your K-1, along with many other tax related items.

Types of Business Entities

C Corporations

A C Corporation is a business entity taxed on its profits. Owners can be W-2 employees and receive taxable dividends. Form 1120 is filed with the IRS annually to calculate and pay tax. Losses are carried forward to future years to offset future income.

S Corporations

C corporations and LLCs can elect with the IRS to be treated as an S corporation. However, there are various regulations that govern the procedure and timing of the election. For example, owners of an S corporation must be individuals, but certain trusts also qualify. Owners take income out of an S corporation as W-2 wages and distributions of already taxed income. Distributions are not subject to payroll taxes, which is a key tax advantage of S corporations. However, the IRS requires owners to maintain “reasonable W-2 compensation” to avoid abuse of this benefit.

Be aware that distributions in excess of capital contributions and profits can be taxable gains. This occurs most commonly when financed equipment is depreciated quickly, reducing profits while there is still cash available for distribution.

LLCs

Limited Liability Companies (LLCs) have become very popular for liability protection and flexibility. An LLC can elect to be taxed as a sole proprietor, a partnership, a regular C corporation, or an S corporation. As mentioned previously, some states also have Professional Limited Liability Companies (PLLCs) which offer additional protections for partners, which can be beneficial for dentists.

Single Member LLCs

A single-member LLC is considered a “disregarded entity” for IRS purposes (unless it elects to be taxed as an S or C corporation). “Disregarded” means that it does not file its own tax return, but combines annual revenue and expenses with the owner’s return. This could be an individual or a parent company.

Partnerships

General partnerships are formed when two or more owners agree to operate together to share profits. They are less commonly used now, as LLCs have become more popular. Multi-member LLCs are considered partnerships unless they have elected to be treated otherwise. Partners receive compensation for services as guaranteed payments or distributions of already taxed profits. Partners are not employees, so they do not receive a W-2.

Sole Proprietorships

As a sole proprietor or owner, you can operate under your own name, a DBA (doing business under an assumed name), or as a single-member LLC. Sole proprietorships are straightforward and easy to set up, requiring minimal paperwork, which makes them a great business entity for many small businesses.

With a sole proprietorship, you operate under your social security number. You can also operate under an IRS Employer Identification Number (EIN) if you have employees or use an LLC. Taxes are filed on Schedule C – Business or Profession as part of your personal income tax return.

Sole proprietorships are often used until it becomes more favorable to set up an S corporation (which is usually when you earn over $50,000 in annual net profit). They are also used in states that tax S corporations. However, one drawback of sole proprietorships is that you have unlimited personal liability, unless you’re operating in the LLC format.

The Best Business Entities For Dentists

Most dentists operating profitably as single owners will benefit from the S corporation structure, unless you’re in a state that taxes S corporations. When multiple dentists practice together, the common structure is for each dentist to own an S corporation, with each S corporation owning a partnership interest in the operating dental practice.  This helps mitigate payroll taxes and allows each dentist to choose tax strategies at the S corp level.

As you can see, there are many tax and legal complexities involved in choosing the right business entity for your dental practice. We recommend working with a dental CPA firm who knows the optimal business entities for dental practices. Choosing the wrong structure can leave you exposed to unlimited liability and unnecessary taxes which can erode your profits.

Conclusion

The choice of your business entity is not set in stone. As your dental practice evolves, you may need to reassess and potentially change your business structure to better suit your needs. By understanding the options available to you and seeking professional guidance, you can ensure your dental practice is set up for long-term success.

To find out more about business entities for dentists, book a free consultation with our team of expert dental CPAs todayHere at Drilldown Solution, we offer personalized accounting solutions tailored to the unique needs of your dental practice.

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Note: The material and contents provided in this article are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.

Ed Gabriel is President and Partner at DrillDown Solution. With over 20 years of experience, he holds a bachelor's degree in accounting from Brigham Young University and is a Certified Public Accountant (CPA).