Understanding the Different Types of Business Entities for Healthcare Professionals

If you’re preparing to start a business, you may have likely stumbled across a swarm of business types: LLC, sole proprietorship, C-Corp, S-Corp, etc. It can be overwhelming, which is why we sat down with Dr. Matt Geller, OD, Adam Cmejla, CFP, and Gary Topple, CPA to break down exactly what you may be getting into as a business owner.

A sole proprietorship is a business opened up in the name of that proprietor. For example, an office opened under “Matt Geller, OD.” As the owner, Matt would file a form with his tax return that will list his income as well as any business expenses. Similar to a sole proprietorship, an LLC incorporates the same tax filing process but is accompanied by some legal protections for the business itself. LLCs can also be opened and operated with a partner.

Now, if you’re owning your own business, are you writing your own paycheck? Not quite! There is no salary involved as a sole proprietor or owner of an LLC. You would receive either a guaranteed payment or a distribution of profits. Also keep in mind that your business is known as a pass-through entity which simply means that income passes through to you as the owner as self-employment earnings.

As an employee, you have 7.65% of your salary withheld from your paycheck for Social Security and Medicare, and your employer matches that. As your earnings through an LLC are classified as self-employment earnings, you have to pay 15.3% of your earnings toward SS and Medicare all on your own.

Owning an LLC with a partner operates under the same standards. Both partners, as owners, would receive a distribution of profits (bearing in mind that the ownership and percentages of pay do not have to be exactly 50-50), and there may also be a guaranteed payment. As an example of this, a partnership may be a 50-50 ownership but a 70-30 profit split. One of these partners may also be receiving a $500 payment to manage the practice (which is paid out prior to the distribution).

Due to the nature of a pass-through entity, this income will pass through to you whether you actively take it or not. If, for example, the business' profits pass through to a separate business account and not directly to a personal account, you are still responsible for any tax that applies to that money, regardless of whether you have directly withdrawn or used it. “The IRS doesn’t see your bank account,” says Adam. “It doesn’t matter which bank account it’s sitting in, at the end of the day, the numbers add up, and it’s going to find its way onto your personal return whether you like it or not.”

Corporations, by contrast, operate and act as a single entity (legally a person) and are legally recognized in this way. Two corporation structures that we’ll discuss here include C-corps and S-corps. In a corporation, the active owners of the corporation also draw a salary from it rather than money passing straight through.

C-corps include companies like General Motors and Ford. If you form a corporation, it is by default a C-corp. As an owner of a C-corp, if the organization has earnings and profits, you may take them out as a dividend, but the corporation first must pay a tax on it. Once that is through, you will also pay a separate tax on that dividend. With a little knowledge from your CPA, you can get the most out of your money; if your C-corp’s profits are less than $50k, the tax rate on that is 15%, but the tax rate on the dividend total is 20%. The highest operating income tax rate is currently 39%, so if you take the full value as salary, you may be taxed more!

S-corps are actually quite similar to an LLC, but the profits that flow through to you are not subject to the same self-employment tax. This is why the government requires the owner(s) to take a reasonable salary. “There’s no definition of reasonable,” says Topple. “But they require it.” The scope of reasonability also extends to any retirement money that you’re setting aside. As your own employer, you provide your own 401K match, but you are not allowed to match anything outside of the compensation in your salary.

One key difference between LLCs and S-corps is that LLCs allow for more flexibility. As we mentioned above, LLCs can have multiple owners who split ownership and can divide profits separately. “With an S-corporation, whatever your ownership is, that’s how you have to share profits,” Topple mentions. Beyond this, if there are any profits left over, you may draw them out as well. In the case of an S-corp there alos is no corporate tax as there is with a C-corp (unless you’re operating out of New York, so ask your CPA). Keep in mind, S-corps are often limited to individual ownership and are also only available to US citizens or residents.

Taxation aside, another key difference between C-corps and S-corps is the accessibility of different classes of shares in the company. C-corps allow different classes for investors, owners, etc. whereas S-corps are limited to a single class of shares. Within that, S-corps are also limited to one-hundred shareholders.

Profits and growth are fantastic to see and trying to figure out how to allocate profits and payments is a good problem to have, but what if your company experience losses? “If you have a loss in an LLC, you really lost money!” Topple says. “If you have a loss in an S-corporation, you may have caused the loss by taking too much compensation,” possibly trekking beyond the “reasonable” range. If it is a legitimate loss to profits for the S-corp though, you are able to use that loss to offset other income and you have basis in the S-corp. “Basically, if you’re at risk for the amount of money in the corporation then you have what is known as basis.”

If, for example, the company is a loss of $1000, and you lent the company that $1000, you have basis in that company. If this is the case, you may take the company’s loss on your personal tax return. Keep in mind, the $1000 in this example must be your own money. In the event you must take a loan to cover that payment, you may not take it as a loss on your personal tax return.

Deciding on the right business entity that meets your needs is complex. Even armed with this information, Adam Cmejla strongly urges: “don’t do it yourself.” CFPs and CPAs are available to provide support for folks just like you that are preparing to own and operate their own businesses. Take advice where you can get it!