Welcome to the final episode on legal forms of organization for a medical practice. In the previous post (in case you missed it), I covered business structure options including sole proprietorship, partnerships (general and limited), LLCs, and LLPs.
In this post, I’ll cover the remaining legal entities: private practices operating as corporations.The two corporate forms are C corporations and S corporations.
Note: Several books authored by Mike Piper are excellent references for this as well as other tax and accounting topics.
Let’s dig in:
Why choose to incorporate?
Under a corporate model, the partners operate as shareholders, or owners, of a corporation. Shareholders will often maintain an agreement restricting the sales of their individual shares to maintain control over who owns the practice.
Among other benefits, a corporate model provides protections under the law from personal liability. The corporation is structured as an independent financial entity and only the assets of the corporation are vulnerable to creditors or lawsuits. Thus, incorporating can protect your personal assets. It also allows for easier transfer of ownership (through the sale of shares) as a corporation is separate from personal affairs.
While C corporations and S corporations are similar in many respects, there are a few key differences that can have implications for how much you’ll pay in taxes, your ability to raise money, and the degree of ease with which you can expand your business.
On a basic level, the differences between the two can be boiled down to: formation, taxes, and ownership. Also, if you want to sound cool and save time, you can call them C corps and S corps.
A C corporation is the regular, default type of corporation. Whether you structure your business as a C corp or an S corp, you follow some of the same basic steps for corporate formation (additional steps are necessary to organize as an S corp).
C corporations have no restrictions on ownership, so you can have an unlimited number of shareholders, as well as different classes of shareholders, such as foreign investors. The structure provides a little more flexibility if you plan to expand or sell your practice and also makes it easier to raise capital.
The taxable income of a regular C corporation is subject to double taxation, first at the corporate level, then at the individual income tax level (see example below if you’re so inclined). The corporation itself pays taxes on all profits left in the business.
However, owners of C corporations don’t pay tax on the corporation’s earnings unless they actually receive the money as compensation for services (salaries and bonuses) or as dividends. Dividends are also subject to self-employment taxes.
It should be noted that the corporate tax rate was recently changed to a single flat tax of 21%. This is significantly lower than individual rates at certain income levels.
An S corporation is a variation of a corporation, sometimes also referred to as a subchapter S corporation, after the tax code section that regulates these types of businesses.
The S corporation structure is generally well-suited for smaller businesses and is limited to 100 shareholders or fewer. There’s no hierarchy or difference between shareholders and shareholders must be US citizens or resident aliens.
S-corps are considered “pass-through” entities. Essentially, corporate income, losses, deductions, and credits can be passed through to shareholders for tax purposes. Pass-through taxation allows for business profits and losses to be reported on each owner’s personal income, thereby avoiding the corporate level taxes (although it can vary by location).
This structure offers the benefit of both limited liability (as with C corps) and relief from “double taxation” (unlike with C corps).
Using an S corporation structure can also lower the self-employment tax. The taxable business income can be split into two components — salary and distribution. Only the salary component is subject to self-employment tax (i.e., Medicare and Social Security taxes). The second component of the S corporation income comes to the shareholder (owner) as a non-dividend distribution, for which the shareholder only has to pay ordinary income tax.
A comparative view
S corps, C corps, and limited liability entities are more expensive to operate than sole proprietorships and general partnerships.
The self-employment tax is applicable on the entire net business income for a sole proprietorship, partnership (any type), or LLC (although the Medicare portion is taxed on a capped level of income).
The Tax Cuts and Jobs Act (TCJA) of 2017 (https://www.irs.gov/tax-reform) introduced a new individual income tax deduction of up to 20% that applies to partners in partnerships, shareholders in S corporations, members of limited liability companies (LLCs) and sole proprietors. However, there are limitations for certain service professions, and high-income radiologists may not be able to claim the deduction.
Personal assets of shareholders are protected by the structure of an S or C corporation. No shareholder is personally responsible for the liabilities and debts of the business. Creditors have no claim on the personal assets of shareholders in order to settle business debt. With sole proprietorships or partnerships, personal assets are vulnerable. Limited liability entities, as the name suggests, limit liability to varying degrees.
Under a sole proprietorship, partnership, or LLC the life of the business is linked to the owner/owners’ life or exit from the business. S corps and C corps have independent life spans. Their longevity is not dependent on shareholders, whether they leave or stay, thus making it relatively easy to do business and look at long term goals and growth.
|Because different states have different regulations, a radiologist should be careful about trusting the advice of even an experienced colleague on such matters who doesn’t practice in the same area.|
Liability and tax ramifications can vary widely among different organizational models. Because different states have different regulations, a radiologist should be careful about trusting advice on such matters from a colleague who doesn’t practice in the same area.
A contract lawyer, familiar with the parameters of each organizational type and state regulations, can review a practice’s structure and provide insight into any financial or legal vulnerabilities there may be to the group or to the individual radiologists.
In other words, ensure your bum is appropriately covered. Consider your most advantageous tax options and check your local laws if you’re considering starting your own or joining an existing practice.
And, finally, if you’ve gone cross-eyed reading over all those tax details, please consult an optometrist—and a tax/financial pro.
Example of C corp double taxation:
if a regular C corporation with four equal shareholders reports taxable income of $440,000, and the corporate tax rate is 34%, the corporation will pay $149,600 in corporate tax. The corporation subsequently distributes the remaining amount ($290,400) among the four shareholders with each shareholder getting $72,600, which is again taxed. The $72,600 is reported on each shareholder’s personal income tax return and taxed at their applicable individual income tax rates.