Practice Management

ENTITY SELECTION FOR YOUR PRACTICE – Part 2

To read Part 1 of this aticle, click here

So what are the comparative advantages of a Sole Proprietor vs an LLC vs an S Corporation?

Let’s start with a sole proprietor. A sole proprietor is not a separate legal entity and is not a separate taxable entity. Basically, it’s you, and you report the income and expenses from your practice to the IRS on a Schedule C attached to your federal tax return.

An S-Corporation, on the other hand, is a separate legal entity and files its own tax return, an 1120S. The S-corporation doesn’t pay its own taxes, however. Any income or allowable loss from the S-Corporation will flow through to your personal tax return and will be reported to you on a Schedule K-1.

An LLC is sort of a hybrid of a sole proprietor and an S-Corp. An LLC is a separate legal entity. If the LLC has only one owner, however, the LLC defaults to be treated as a “disregarded entity” for tax purposes, and you’ll report the income or expenses on a Schedule C attached to your tax return, just like you would as a sole proprietor.

Type of Entity

Separate
Legal
Entity

Files Own Tax
Return

Sole Proprietor

No

No

Single Member LLC

Yes

No

S-Corporation

Yes

Yes

An LLC with multiple owners would be treated as a partnership for tax purposes, and would therefore need to file a partnership tax return (Form 1065) each year.

Which type entity makes the most sense? It is usually easier for sole proprietors and LLCs to deduct losses – especially in the early years of the practice. Sole proprietors and LLCs also have an easier time deducting personal-type expenses like automobile expenses and the home office deduction.

S-Corps, on the other hand, can help their shareholders save taxes once the practice becomes successful by letting them avoid paying Social Security and Medicare taxes on money paid out as “S-Corp Distributions”. Plus, by paying yourself a salary through the practice’s payroll along with the other employees, you can avoid the headaches associated with remitting your personal income taxes through quarterly estimates.

Flexibility of an LLC:

One strategy we are seeing more often is for a person to open a practice as a Single Member LLC, and maintain their practice as an LLC until it makes sense to be treated as an S-Corp. At that time, the LLC will file a Form 8832 with the IRS to elect to have the LLC treated as a corporation, and then will elect S-Status by filing a Form 2553.

One huge benefit of this strategy is that you do not need to get a new Employer Identification Number for your practice if you decide to switch from being taxed as a Sole Proprietor to an S-Corporation. This will also allow you to continue to use the same NPI and avoid being required to re-credential with all the insurance companies.

To Incorporate or Not To Incorporate?

There are certain instances when incorporating your practice will most likely not make sense, and a Single LLC would be the preferable entity to select. We wrote about this in our July 2005 Newsletter in an article titled: To Incorporate or Not to Incorporate. Basically, if you earn a good salary each year, and then earn some extra money on the side by moonlighting or consulting, incorporating that practice might cost you a lot in extra taxes, state fees, and professional fees.

Which is Best for You?

Most of the practice clients we work with these days set up either an S-Corp or an LLC. There are pros and cons of each type entity, so you want to review your specific situation with your CPA and your lawyer to make sure you set up the correct entity based on the current set of facts and circumstances.

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