6: Business Entities

Chapter 6

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


Objectives
At the completion of the chapter the student will be able to:
1. Understand the various forms (business entities) of dental practices
    Proprietorship
    Partnership
    Corporation
       C corporation
       S corporation
       Limited liability company


Key Terms
board of directors
business entity
C corporation
corporation
dividends
employee status
joint and severable liability
limited liability company (LLC)
ownership interest
partnership
partnership agreement
pass-through entity
piercing the corporate veil
professional service corporation (PSC)
S corporation
shareholders
sole proprietorship
stock


Goal
Make students aware of the various business arrangements that are available to dentists. The student should be able to define his or her desires regarding participation in such an arrangement.

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 a dentist’s circumstance is unique, his or her resolution of these issues will be similarly unique. Understanding the differences between these arrangements will help match a dentist’s needs with the particular type of entity. A business arrangement should maximize factors that are important in a person’s particular situation. A ­dentist will work with an accountant, lawyer, and management consultant to decide which business entity is best for his or her circumstance.

The business entity that is chosen has almost no bearing on the day-to-day operations of the practice. A dentist still sees patients, hires staff, collects payments, and pays expenses regardless the form of business.

Entity Decision Points

Dentists should consider four main factors when deciding which business entity to use for a practice (Box 6.1).

1. The tax liability can be different between the various types of entities. Because each circumstance is unique, some practitioners can take advantage of taxes differences that others can not.
2. 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 level of risk tolerance, the choice of the business entity contributes to the office risk management plan. As with taxes, each circumstance is different, so no one business entity is best for all dentists.
3. Some types of entities limit the number of owners. Some require that owners be US citizens.
4. Finally, some entities (particularly corporations) require additional administrative burdens in tax forms, meeting minutes, and officer elections. If ­dentists are not willing to put in the extra time and effort to comply with the regulations, then 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 particular circumstance. Lawyers, accountants, and management consultants can give valuable advice, but it is up to the owners of the practice to decide the form of business the ­practice should take.

Box 6.1 Four Business Entity Decision Factors
Liability protection
Tax implications
Owner characteristics
Administrative burdens

Types of Entities

A general business (such as a hardware store or building contractor) can take any of the five types of entities listed in Box 6.2. Each state defines these types of ­businesses (or entities) in state laws and the tax codes. The federal government has tax rules regarding the entities as well. These basic forms of business each 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 entities given: sole proprietorship, general partnership, professional limited liability company, or a PSC. The actual business entity is the same as those for general businesses, but special liability and tax rules govern these professional associations. State laws generally require incorporated health care providers to use a special form of a corporation. Different states have different names for them (Professional Corporation [PC], PSC, Professional Service Association [PSA], or Professional Associations [PA]). Each state has a professional association act that governs these entities. Some states require that only practicing providers be shareholders; other states allow corporate or nonprovider ownership of PCs. Dentists should check with an attorney to be sure of the state’s rules on the entity types for professional businesses.

Sole Proprietorship

A sole proprietorship is the simplest form of business. It exists any time an individual earns money on his or her 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 6.3).


Box 6.2 Types of Entities
Types of General Business Entities
    Sole proprietorship
    General partnership
    Limited partnership
    Limited liability company (LLC)
    Corporation
Business Entities for Professionals
    Sole proprietorship
    General partnership
    Professional corporation (PC)
    Professional limited liability company (PLLC)

Advantages

Proprietorships are easy and inexpensive to establish. If a person operates a business and does not declare another type of entity, he or she is by default a proprietorship. There are no administrative requirements other than filing a doing business as (DBA) form if the practice has a name. There are no special accounting rules to follow except general IRS rules and rules of good accounting practice.

Disadvantages

Because a person is the business in a proprietorship, he or she cannot be isolated from legal or financial responsibility and liability of the business. A person must sign personally for loans, pledging personal collateral. He or she can use personal assets to satisfy any debts or judgments against the business. This liability is both personal and unlimited. Because the person is an owner, he or she is not considered an employee. This limits, to a degree, the tax-advantaged employee benefits that the owner can provide for himself or herself.

Ownership

As the name implies, sole proprietors are the only (sole) owner (proprietor) of the business. If there are two or more owners, then by definition the business is not a proprietorship, but it is instead a partnership (or other form of business).


Box 6.3 Advantages and Disadvantages to Sole Proprietorship
Advantages
    Easy and inexpensive to form
    Complete control of the business
    Income taxed once to owner
    No separate tax returns required
    Loses flow through to owner
    Easy to form or dissolve business
Disadvantages
    Unlimited liability for owner
    Fringe benefit deduction lost for owner

Compensation

A proprietorship builds up assets (including cash) in the business. Because a proprietor is the owner rather than an employee, he or she does not pay himself or herself a salary or a wage. Instead, he or she takes a draw (­withdraw) from the assets of the business or practice. In the short run, he or she can borrow money and then withdraw it from the practice to live on. Over time, he or she can only take compensation from the practice’s profits. If a person does not make a profit, then he or she cannot take a draw.

Taxation

A proprietorship is not a separate tax entity. The owner reports all profits or losses on his or her personal Schedule C. He or she must estimate their income tax liability and prepay it quarterly. He or she must also pay self-employment taxes (SETA)—the equivalent of Social Security (FICA) and Medicare taxes—for the self-­employed. From a tax perspective, it does not matter how much a person takes out of the business as a draw. The issue is how much money (profit) the business made. This defines the income tax due. If a person does not take a draw, then the asset (cash) remains in the practice but has already been taxed.

Dental Practice Implications

Proprietorships are the most common form of individual dental practices because they are so easy and ­inexpensive to set up. Dentists typically protect themselves from liability through adequate insurance. There used to be advantages, such as retirement plan funding, for other forms of business, but tax codes have ended most of those advantages.

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 similar to a multiowner proprietorship. If two people join to own and operate a business, they are a partnership, unless they explicitly state that they are establishing another form of business. This ­arrangement combines the abilities, energies, and ­financial risk of each participant. Partnerships have no limits as to the number of partners. (However, there must be at least two.) From a practical standpoint, large groups often take a corporate structure for reasons that are discussed in this section. There are advantages and disadvantages to a partnership (Box 6.4).


Box 6.4 Advantages and Disadvantages of a Partnership
Advantages
    Combined resources of partners (financial, managerial, or personal)
    Easy and inexpensive to form
    Income taxed once to owners
    Losses flow through to owners
Disadvantages
    Unlimited liability for owners (joint and severable)
    Profits must be shared with others
    Tax return (informational) must be filed
    Fewer fringe benefits for owners

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 allowance for including new partners or for partners who leave the partnership. There are few paperwork and technical requirements in setting up and operating the ­partnership. Start-up costs and technicalities are low because each member has a personal investment in the partnership, their combined credit worthiness may make securing loans easier.

Disadvantages

Several significant disadvantages to the partnership form of a group practice exist. First, partners share “joint and severable liability” for partnership debts. That means that a person is personally liable for debts of the partnership or the acts of 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 may occur when one partner want/>

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Jan 4, 2015 | Posted by in General Dentistry | Comments Off on 6: Business Entities
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