Practice Management

Chose the Best Entity Type for your Pratice – Part 3

By Andrew Schwartz, CPA

In the first two parts of this series, we covered the basic types of entity choices you have when setting up a practice and the benefits and pitfalls of S-Corporations.  Let’s wrap up by looking at deducting losses, other considerations you should have, and a final scorecard.

Deducting Losses

It’s not uncommon for healthcare professionals to lose money in years that they open a practice from scratch, purchase an existing practice, or expand their current practice.  Assuming you borrow money to fund these transactions, the type of entity determines how much of these losses the you can claim each year.

To maximize the upfront losses you can claim, an S-Corp might not be the best choice.  If you set up your practice as an S-Corp, you can only claim losses to the extent of the money you invested into the practice.  Guaranteeing loans or other liabilities is not sufficient to allow you to claim these losses.

Running your practice as a LLC or a Sole Proprietorship allows you to claim larger losses up front.  The only catch is that you need to be personally liable for paying off these loans.

If you borrow money to purchase, open, or expand a practice, the S-Corp tends to be the better option with respect to managing the tax burden while repaying the loans.  Since the losses are not allowable up front for the S-Corp, those suspended losses are released as you generate profits to pay down the loans.  With a LLC or a Sole Proprietor, you’ll claim the losses in the early years which will not provide you with any tax shelter as you pay down your loans.

Other Considerations

Do you have children under the age of 18?  If so, going with the Single Member LLC or Sole Proprietor will let you take advantage of a quirky tax break.  While you get to deduct “reasonable” wages paid to your child for services provided, neither you nor your child owes Social Security or Medicare taxes on wages paid. Plus, he or she does not owe any federal income taxes on the first $5,800 of wages earned (in 2011).   (We wrote about this opportunity in our May 2007 Newsletter.)

This is true arbitrage.  You move money from your practice’s bank account to your child’s bank account, and the government gives you a tax break on that money.  You can also contribute money into a Roth IRA for your child based on the wages you report.  Assuming the Roth rules don’t change during your child’s lifetime, your child will benefit from decades of compounded growth within these tax-free investment accounts.

Caveat employer.  Keep in mind that you are only supposed to pay your child a fair wage for services actually performed.  You will also need to complete and file quarterly and annual payroll tax forms, as well as prepare a W-2 form for your child.

Flexibility of a LLC

LLCs are very flexible entities.  With a LLC, you can start as a disregarded Entity, and your practice will be treated as a Sole Proprietorship for tax purposes.  When the time is right, you can then elect treat your LLC as an S-Corp by filing a Form 8832.  The beauty of this strategy is that you can continue to use same EIN and NPI, and don’t need to re-credential with any insurance companies you submit claims to.

Entity Selection Scorecard

Choosing the correct entity for your practice is a tough decision.  You should definitely reach out to a lawyer and an accountant who are familiar with your state’s rules and regulations prior to making your final decision.

Even so, here is an Entity Selection Scorecard to help you with your decision:

S.P.

S LLC

M LLC

S-Corp

Save Medicare Taxes on Earnings

X

Possibly avoid paying quarterly estimates

X

Minimize accounting fees and state   corporate taxes

X

X

Maximize deductible losses funded by debt

X

X

X

Manage taxes better  during loan repayment

X

Pay child under the age of 18   tax-free

X

X

Ability to deduct 100% of expenses  not paid by practice

X

X

X

Avoid doubling up on FICA Taxes

X

X

X

S.P. = Sole Proprietor, S LLC = Single Member LLC, M LLC – Multiple Member LLC

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