CHAPTER 13
Business Entities
Any business arrangement that is not profitable to the other person will in the end prove unprofitable for you. The bargain that yields mutual satisfaction is the only one that is apt to be repeated.
B.C. Forbes
Business entities in dentistry can take any of several forms. There is no “right” business arrangement for dentists. Many physical, financial, managerial, and legal considerations will influence their decision. Because each dentist’s circumstances are unique, their resolution of these issues will be similarly unique. Understanding the differences between these arrangements will help match a dentist’s needs with the type of entity selected. Any business arrangement should maximize factors that are important in someone’s situation. A practitioner will work with an accountant, lawyer, and management consultant to decide which business entity is best for their situation.
The business entity that a practice owner chooses has almost no bearing on the practice’s day‐to‐day operations. A dentist still sees patients, hires staff, collects payments, and pays expenses regardless of the type of business.
ENTITY DECISION POINTS
Dentists should consider four main factors when deciding which business entity to use for a practice.
- The tax liability can differ among the various entities. Because each circumstance is unique, some practitioners can take advantage of taxes differences that others cannot.
- Business entities also differ in liability protection. Some entities provide general liability protection (though not professional protection) that others do not. Along with adequate insurance protection and a personal risk tolerance level, the business entity’s choice contributes to the office risk management plan. As with taxes, each circumstance is different, so no one business entity is best for all dentists.
- Some entities limit the number of owners, and some require owners to be US citizens.
- Finally, some entities (mainly corporations) require additional administrative burdens in tax forms, meeting minutes, and officer elections. Dentists who are unwilling to put in the extra time and effort to comply with the regulations must choose a different, less burdensome entity.
The owner(s) of the practice must understand and evaluate the advantages and disadvantages of each form of business, given their circumstances. Lawyers, accountants, and management consultants can give valuable advice, but it is up to the practice’s owners to decide the form of business the practice should take.
TYPES OF BUSINESS ENTITIES
A general business (such as a hardware store or building contractor) can take any of the five types of general business entities listed in Box 13.1. Each state defines these types of businesses (or entities) in state laws and tax codes, and the federal government also has tax rules regarding the entities. These primary business forms have a unique combination of advantages, disadvantages, ownership, and compensation issues.
There are special rules for health professionals and others who perform professional services for the community (e.g. architects, accountants, and lawyers). These businesses (including dental practices) must take one of the four types of business entities for professionals listed in Box 13.1: sole proprietorship, general partnership, PC, or PLLC. State laws generally require incorporated healthcare providers to use a particular form of corporation. Different states have different names for them (professional corporations, professional service corporations, professional service associations, or professional associations). Each state has a professional association act that governs these entities. Some states require that only practicing providers be shareholders; others allow corporate or non‐provider ownership of PCs. Dentists must check with an attorney to be sure of the state’s rules on the entity types for a professional business.
SOLE PROPRIETORSHIP
A sole proprietorship is the simplest form of business. It exists any time an individual earns money on their own. In this form of business, the owner is the business. Profits and losses are therefore personal. The person who has day‐to‐day responsibility for running the business usually owns the business. There are advantages and disadvantages to a sole proprietorship (Box 13.2).
Advantages
Proprietorships are easy and inexpensive to establish. If someone operates a business and does not declare another type of entity, they are, by default, a sole proprietorship. There are no special accounting rules except general Internal Revenue Service (IRS) rules and rules of good accounting practice.
Disadvantages
Because the person is the business in a proprietorship, they are not isolated from the business’s legal or financial responsibility and liability. They must sign personally for loans, pledging personal assets as collateral, and they may have to use personal assets to satisfy any debts or judgments against the business.
Ownership
As the name implies, sole proprietors are the business’s only (sole) owner (proprietor). If there are two or more owners, the business is not a proprietorship but a partnership (or another form of business).
Compensation
Because a sole proprietor is an owner rather than an employee, they do not pay themselves a salary or a wage. Instead, they take a draw from the assets of the business or practice.
Taxation
A sole proprietorship is not a separate tax entity. The owner reports all profits or losses on their tax return on a federal Schedule C. They must estimate their income tax liability and prepay it quarterly. A sole proprietor must also pay self‐employment taxes – the equivalent of Social Security (FICA) and Medicare taxes. From a tax perspective, it does not matter how much someone takes out of the business as a draw, and taxes are paid on how much money (profit) the business makes.
Dental Practice Implications
Proprietorships are the most common form of individual dental practice because they are so easy and inexpensive to set up, and dentists typically protect themselves from liability through adequate insurance.
GENERAL PARTNERSHIP
A partnership is a business entity in which two or more people have a common interest and share ownership, profits, and losses from a business. Although the partnership is a separate legal entity from its owners, it is conceptually like a multiowner proprietorship. If two people join in owning and operating a business, they are a partnership unless they explicitly state (and file papers stating) that they are establishing another business. This arrangement combines each participant’s abilities, energies, and financial risks. Partnerships have no limit as to the number of partners (although there must be at least two). From a practical standpoint, large groups often take a corporate structure for reasons discussed in that section. There are advantages and disadvantages to a partnership (Box 13.3).
Advantages
A partnership is perhaps the most versatile method of group dental practice organization. It allows varying degrees of ownership, income distribution, and cost allocation. Compensation, for example, may be based on fixed dollar amounts or percentages of production or collections. Partnerships can make allowances for including new partners or for partners who leave the partnership. A partnership agreement must be prepared for the entity. Start‐up costs and technicalities are low. The combined creditworthiness of the partners may make securing loans easier.
Disadvantages
Several significant disadvantages exist to the partnership form of a group practice. First, partners share “joint and severable liability” for partnership debts. That means that each person is personally liable for the debts of the partnership or the acts of the other partners. For example, if one of the partners acting for the partnership buys a piece of property, other partners are responsible for the debt as if they had purchased it themselves. If a partner is guilty of malpractice, the court may require other partners to help pay any judgments not covered by insurance. Another disadvantage is that if an adequately constructed partnership agreement is lacking, ownership in the partnership may be more difficult to transfer if one partner decides to leave. Finally, management of the partnership may be more complicated because each partner has a voice in the decision‐making. A well‐written partnership agreement that lists the responsibilities, provisions, and requirements of the group members helps to overcome these problems.
Ownership
Partnerships involve more than one owner, but these do not need to be equal owners. One person can provide more of the start‐up capital and have more say in the operation of the business. Because partnerships can take so many forms and can even exist on a handshake, dentists should always have a written partnership agreement when entering a partnership. A written partnership agreement clarifies each partner’s role and identifies the rights and responsibilities of each partner. The written agreement compels the partners to define their relationship in advance. This exchange of ideas gives partnerships a greater chance of success. Most states have enacted some form of the Uniform Partnership Act that defines the rules of a partnership for that authority. For these reasons, consult an attorney familiar with the law in this area before completing an arrangement.
Compensation
Partners are compensated like proprietors and they draw on the partnership’s assets. Partners do not necessarily need to divide income from the business evenly, but whatever the income distribution method decided on, the partnership agreement should state it clearly. For example, dentist partners may decide to divide income according to production levels for the month or may allocate specific payments to specific dentists.
Taxation
The partnership is like a proprietorship from a tax perspective. The IRS does not tax the partnership itself, but the partnership must still determine its profit or loss and file an information tax return. Like a proprietorship, a partner must estimate individual income taxes, prepay them quarterly, and pay self‐employment taxes. Once the partnership determines the profit or loss, this is passed through to the individual partners based on their partnership agreement for taxation purposes. For example, if someone has a 50/50 partnership with an income of $10 000, each partner would receive and pay tax on $5000 in compensation. If losses occur, these also apply to the individual partners’ tax returns. The partnership files a tax return (Form 1065) with the IRS that states how much income each partner has for the year (Form K‐1). The IRS then runs a computer match to ensure each partner has reported their income correctly.
Dental Practice Implications
Partnerships are not common in dentistry. Most practitioners prefer the independence of an individual practice or the protection of a corporation or LLC.
CORPORATIONS
A corporation is the third common business form a dental practice may take. Incorporated dental practices operate similarly to other business corporations. Owners establish corporations under applicable state law. They issue stock or shares in the ownership of the corporation. They may issue one or millions of shares. The number of shares that someone owns is proportional to their ownership interest. People who buy stock buy a share in the assets of the company. If the company’s value increases or decreases, each share of stock also changes. If the corporation makes a profit, the board of directors may elect to pay out some (or all) of the profits to the stock owners as dividends. Changing the ownership of a corporation is easy: a person sells shares of stock. There are places where someone can buy or sell shares of publicly traded stock called stock exchanges (e.g. New York Stock Exchange (NYSE), Nasdaq). No one publicly trades shares of individual dental practices, so the sale occurs between two or more private citizens. (In the real world, dental practice transfers get more complex.) Some of the more extensive networks of dental practices may trade on the public stock exchanges.
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