evolution when employees are being hired, income is increasing, perhaps a lengthy lease is contemplated, and substantial equipment purchases are being made, a corporation or limited liability company as the legal format may become increasingly attractive.
17. What Is There About a Corporation That Would Make Me Want To Incorporate My Practice?
At least theoretically, incorporation is a way to reduce certain legal exposures. A corporation offers the owners of the practice (its shareholders) the ability to separate themselves legally from its operation. These shareholders invest the required start-up capital to get the business running, and the board of directors they elect, who in turn appoint the officers, who in turn are responsible for the day-to-day operations as well as important strategic decisions for this new legal entity, the corporation. As a practical matter, the shareholders, directors, and the officers will be by and large the same persons, at least in all but very large associations. Nonetheless, flexibility is possible with this arrangement. The new dentist who starts as an associate may “buy in” and become a shareholder after some years as a valuable contributor to the practice, but might not be quite ready to assume the same management responsibilities as the founding dentist. So perhaps the associate might become an officer, but not a director.
Because a corporation is a separate legal entity distinct from its shareholder(s), an important advantage of a corporation over the other formats discussed above is that all shareholders have limited liability. In other words, the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts the business incurs, except in the case of fraud or malfeasance. This limited liability can be comforting to a group of dentists entering a fifteen-year lease, or purchasing $1 million of new equipment. (Note, however, that a bank from which the group may seek financing for that equipment purchase will likely ask for personal guarantees as to any significant loan, defeating the theoretical “limited liability” a corporation structure affords, at least for that transaction.)
At least theoretically, incorporation is a way to reduce certain legal exposures. A corporation offers the owners of the practice (its shareholders) the ability to separate themselves legally from its operation.
A “C” corporation may be less desirable from a tax perspective because there are two layers of tax — the corporation pays tax and after the corporate income tax is paid on the business income, any distributions made to stockholders are taxed again at the stockholders’ tax rates as dividends. Income paid to shareholders as wages are also taxed on the shareholder’s personal income tax return.
Alternatively, the corporation may be able to make an “S” corporation election. An S corporation is often more attractive to small business owners than a C corporation because an S corporation has some appealing tax benefits and still provides business owners with the liability protection of a corporation. With an S corporation, income and losses are passed through to shareholders and included on their individual tax returns, similar to a partnership, resulting in one level of federal tax to pay. S corporations also have limitations as to who can be a shareholder.
One real tax advantage of forming a corporation is the ability to establish fringe benefit programs in a tax-favored manner. These include medical plans, to a limited extent, retirement plans, and some withholding tax advantages when dealing with employees. The availability of these tax-favored fringe benefits is typically what drives the decision to incorporate. Tax-favored fringe benefits, combined with flexibility in structuring the business relationship among the participants; a greater ability to establish buy-out arrangements among the parties; and a certain legitimacy or successful air that is associated with being organized as a corporation — particularly a professional corporation — all point to why many dental groups ultimately choose to be organized as corporations. It should be noted that many states specifically require an incorporated health care professional to be formally structured as a “professional corporation,” or “PC” or “SC.” You will need to consult an attorney in your state to determine local requirements.
One real tax advantage of forming a corporation is the ability to establish fringe benefit programs in a tax-favored manner. These include medical plans, to a limited extent, retirement plans, and some withholding tax advantages when dealing with employees.
With these advantages come some negatives that must be considered. A corporation generally involves more maintenance tasks and expense of operation than the other entities mentioned above (although a limited partnership involves many of the same maintenance tasks and expenses as a corporation). A corporation must be registered with the state; annual reports are required; meetings must be held and records of same kept; and a bookkeeper is often necessary to maintain the necessary books and records. Not only must a separate tax return be filed, but corporate-level taxes may have to be paid. For those reasons, the new dentist will frequently defer forming a corporation for a period of time.
18. Will It Help Me to Be a Limited Liability Company?
It depends. A limited liability company is a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. The “owners” of an LLC are referred to as “members.” Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations or other LLCs. Unlike shareholders in a corporation, LLCs are not taxed as a separate business entity. Instead, all profits and losses are “passed through” the business to each member of the LLC. LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would. Like a partnership or limited partnership, LLCs have flexibility in determining how profits will be distributed. LLCs are somewhat easier to operate than corporations, as there are no requirements to keep formal minutes or conduct meetings of a board of directors, although some formalities are still required.
Members of an LLC are protected from personal liability for business decisions or actions of the LLC. This means that if the LLC incurs debt or is sued, members’ personal assets are usually exempt. This is similar to the liability protections afforded to shareholders of a corporation. Members are not necessarily shielded from wrongful acts, including those of their employees.
You should check with your tax advisor concerning the proper tax election for your particular circumstances (C corporation, S corporation, partnership taxation — the most common election — or sole proprietorship). You should also consult with your lawyer when implementing or becoming a member of an LLC, as there is no “one size fits all” approach when it comes to LLCs.
While all 50 states allow the formation of LLC entities, some states do not allow a health care practice to be conducted as an LLC. Other states require a health care provider choosing the LLC option to be organized as a Professional LLC (PLLC), an entity similar to a professional corporation. Thus, it is important to check the laws of your state and any other state in which you might wish to form your LLC.
19. Should I Create an Operating Agreement If I Choose the LLC or PLLC Format?
Operating Agreements are important, particularly if you plan to have multiple members in the LLC. Using an operating agreement can help to avoid management and ownership misunderstandings that may occur during the business relationship. A carefully drafted operating agreement will establish specific rules and procedures in connection with the operations of the LLC, such as the percentages of ownership, the share and distribution of profits and losses, the rights and responsibilities of each member, how the LLC will be managed, and ownership transitions (such as what happens when a member leaves, dies, retires, becomes disabled, or wishes to sell his or
