Protect your personal assets from your business liabilities
The business structure you choose influences everything from day-to-day operations, taxation, asset allocation to how much of your personal assets are at risk against creditors or litigation. You should choose a business structure that gives you the right balance of legal protections and tax benefits. But with multiple options and so many legal details to sort through, how can one really know which entity structure is best for a dental practice or small business?
CWA Planner and CPA Tom Gates knows this can be a point of stress for clients—and it should be—because being structured under the wrong entity can carry heavy consequences.
“Depending on the entity you choose, it could greatly impact the level of personal liability outside of the corporate entity,” Tom says. “It’s really important to select the correct type of business formation so that you can protect your personal assets from your business liabilities.”
Liability protection may be the biggest concern, but Tom reminds that there are other reasons, like how your profit and loss are shared and how it’s taxed, that your setup can impact. Whether you are starting a new business, buying new property or assessing your current setup, knowing the positives and negatives to the different types of structures can give insight to ensure you are not only protected, but are set up in the most advantageous structure for you.
“Depending on the entity you choose, it could greatly impact the level of personal liability outside of the corporate entity. It’s really important to select the correct type of business formation so that you can protect your personal assets from your business liabilities.”
Tom Gates, CPA, Financial Planner
Most Common Business Formations
- Sole Proprietorship: Treated as self-employment. Easy to form and gives you complete control of your business. You’re automatically considered to be a sole proprietorship if you do business activities but don’t register as any other kind of business.
- Positives: Administratively easy, and do not have to file a separate tax return.
- Negatives: Full personal liability against all business debts and litigation.
- Limited Liability Company (LLC): Lets you combine the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. Each state has specific rules regarding the operation of an LLC so working with an experienced attorney familiar with state law in the formation of the entity is critical.
- Positives: Protects your personal assets from business liabilities. Offers flexibility on the taxation of earnings, and if a partnership, the distribution of money.
- Negatives: Members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security unless an election to be treated as an S corporation or C Corporation is made.
- Partnership: Partnerships are the simplest structure for two or more people to own a business together. There are two three common kinds of partnerships: general partnership (GP), limited partnerships (LP) and limited liability partnerships (LLP).
- Positives: Allows flow through taxation and special allocation of income and expenses.
- Negatives: Unlimited personal liability for general partner unless structured as an LLP. State law varies regarding the operation of partnerships, a lawyer is essential to ensure set up correctly in applicable state(s).
- C-Corporation: This is a legal entity that’s typically used for larger company set-ups. Corporations can make a profit, be taxed, and can be held legally liable. Corporations offer the strongest protection to its owners from personal liability, but the cost to form a corporation is higher than other structures. In some cases, corporate profits are taxed twice — first, when the company makes a profit, and again when dividends or wages are paid to shareholders on their personal tax returns.
- Positives: Strongest protection from personal liability and unlimited shareholders/capital.
- Negatives: Extensive record keeping, operational processes and reporting, and potential for double taxation.
- S Corporation: This type of corporation is designed to avoid the double taxation drawback of regular C-corps. S-corps allow profits and losses, to be passed through directly to owners’ personal income without ever being subject to corporate tax rates.
- Positives: Income is taxed at the shareholder level rather than the corporate level.
- Negatives: Limited to the number of shareholders you can have and restrictions on the distribution of profits amongst partners.
Structures with Options & Flexibility
Although there is not a one-size-fits-all structure, Tom finds that in many cases he recommends his solo dental practice owners set up a Limited Liability Corporation, and then make an S-Corporation election for the practice.
“As a solo practitioner, setting up a limited liability company allows the owner to limit their personal liability, and offers flexibility on how earnings are taxed. Additionally, there is no requirement for equal distribution—should you take on a partner or shareholder,” Tom says.
Once you’ve established an LLC, there are options within it. The Internal Revenue Code allows you to make an election on how that LLC will be taxed. For example, if you are the solo-practitioner, you can be taxed as a disregarded entity (like a sole-proprietor), or as an S-corp or C-corp. That allows more tax and financial planning flexibility, especially when it comes to reporting the income and employment taxes.
Making an S-corp election may be a great choice for your practice’s LLC, but Tom denotes that buildings and other real estate should be treated differently. Owning a building (even if your practice is within it), should always be separate from your practice entity, for liability and litigation protection. It could be set up as a separate single member LLC—allowing it to remain a disregarded entity. In this case, you would not have to file another tax return, while still getting the limited liability protection by being within a LLC.
Partnerships are another unique case. You will want to create a new and separate partnership entity, that will in turn contain the different owners’ unique structures. Tom is seeing many of these cases set up as LLCs within the designated state.
This is another situation where, since the LLCs are state-by-state, having an attorney that specializes in that state’s laws is very beneficial. They can help determine if the LLC is an acceptable structure within that state. If it’s not—you will likely need to set up an LLP. The biggest benefit to an LLC or LLP for a dental practice with multiple owners is the ability to choose how the income and loss are distributed among the partners, allowing for production-based allocation.
It’s not too late
Need to make a change? Tax-free reorganizations are common and can be done within the parameters laid out by the internal revenue code. For example, if your building is within the business structure, or you are ready to take that next step to limit your personal liability, an experienced CPA and attorney can help you make the switch while limiting mistakes and avoiding extra taxes.
Tom says, “Structuring a business is complicated, which is why reviewing the current setup is usually one of the first things I tackle when meeting with a new client. By deep diving into the structure, I can determine if there is a more tax-efficient way to structure it that will not only protect them from liabilities but save them money.”
The most important thing to do is to find an experienced CPA to guide you on how to structure the business, and then a knowledgeable attorney within your state to set it up.
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