By Vanessa Orr
When setting up a business entity, many physicians make it a priority to ensure that whatever they choose—from sole proprietorships to C corporations to Single- or Multi-Member LLCs—provides them with the legal protections they need. But they may also want to consider how each entity affects their tax liability.
According to Marc Egort, CPA, P.A., the entity that a person chooses can affect everything from compliance to potential tax savings.
A single-member limited liability company, for example, is treated the same way as if a taxpayer was a sole proprietor; all income from providing services and the deduction expenses incurred in providing that income is put on a Schedule C as part of the payor’s personal tax return.
“Because it is all considered self-employment income, there are two types of taxes that they will have to address,” explained Egort. “One is income tax, of course, and the second is self-employment tax, which is based on the net self-employment income.”
Compliance is simple, as physicians don’t have to do a separate corporate income tax return, payroll, or even keep separate books. The most important thing is that physicians do not commingle their business and personal accounts.
A subchapter S corporation, on the other hand, is a separate entity from the taxpayer. The corporation does not pay income tax, as any net taxable income flows over to the taxpayer on their personal return.
“There are potential tax savings with this entity in the areas of payroll tax/self-employment tax,” said Egort. “Whatever net taxable income there is flows to shareholder, who only pays income tax on the net taxable income; they do not pay self-employment tax.”
To stay in compliance, however, the shareholders must agree to IRS rules that require them to pay themselves reasonable compensation and pay into payroll taxes based upon the services that they provide. Egort advises physicians to meet with a CPA to discuss where potential savings might lie in relation to compensation, which is subject to payroll tax, versus the distributions of profits, which are not.
“While there are potential tax savings, more compliance is involved including not just a subchapter S corporation tax return, but a real set of books to get to the tax return,” said Egort. “The taxpayer also has to engage in payroll, which they can do themselves and pay into payroll taxes or hire a payroll service to prepare regular checks and to pay into payroll taxes.”
A C corporation also works as a separate entity from any of its shareholders, but does pay income taxes on its taxable income. “Unless there is a compelling reason to be a C corporation, such as the shareholder not being a U.S. resident, most physicians do not choose to be C corps because of double taxation,” said Egort. “The corporation not only pays income tax on its income, but if shareholders take distribution of any dividends, they pay taxes on those dividends as well.”
Multi-member LLCs provide physicians with more options. They can choose to tax themselves like C corporations or tax themselves like partnerships, which have a few more moving parts.
“Similar to an S corporation, the LLC allocates its income on a pro-rata basis to all of the members, and that income is subject to self-employment tax in the same way that a single-member LLC is,” said Egort. “It is helpful to do some tax planning to discuss guaranteed payments to partners versus profits distributions; most likely, partners are subject to self-employment tax if they are providing services whether they are receiving profits distribution or not.”
Egort notes that it is important for physicians to understand that in S corporations or partnerships, they are not taxed on what they take as distributions, but on what the company earned.
“If a company earned $100,000 and a partner took no money out, he or she would still pay taxes on that $100,000,” he said.
He added that the ability to take deductions for all of those entities is primarily the same; if incurring an expense on behalf of generating income, for the most part, that expense is deductible in one form or another.
“It’s important to talk to your accountant, because taxable income is a moving target,” said Egort. “While the entity doesn’t change, people’s resources change in terms of revenue models, types of services they’re providing, or whether they’re incurring more overhead. Any change from the ordinary should be discussed with your accountant.”
For more information, contact Marc Egort at (754) 301-2183 or email marc@egortcpa.com.
