Physiatry Practice Management Resources

Physicians who have their own practice -- solo or as a member of a group -- have many decisions to make, from hiring employees to picking out the right color of paint for the walls. First, though, a business structure must be selected. Although tax reduction isn't the only reason to select one form of business over the others, a knowledge of the tax implications will help in making the best choice.

Historically, the selection of a business entity started with a simple question: Should you incorporate your practice? If you decide this isn't necessary, you can practice either as a sole proprietorship or in a partnership. Either way, you have less paperwork while all of your practice income is passed through to your personal tax return; that is, you won't have to pay a corporate income tax.

If you don't incorporate your business, though, you expose your personal assets to creditors' claims. "Although a sole proprietorship is probably the easiest way to establish a business, a corporation could provide personal asset protection from creditors if a judgment against the practice exceeds the assets of the practice," says Mark A. Doran, a CPA and financial planner in Orange, Calif. "It should be noted, however, that generally no form of business protects a doctor from malpractice claims, so malpractice insurance is strongly suggested to protect against such cases."

Although incorporating your practice can't shield your personal assets from malpractice claims, it can provide protection, for example, if you're sued by someone who falls in your parking lot. Because doctors are viewed as "deep pockets" (plump targets) by many people in this litigation-minded age, some asset protection probably is desirable. However, if you set up your professional corporation as a regular "C" corporation, that corporation may have to pay income tax.

S Corporations Traditionally, the solution has been to elect "S" corporation status. S corporations are not subject to the corporate income tax: all corporate income flows through to corporate shareholders, pro rata. To qualify for S corporation status, though, certain criteria must be met. Only one class of stock is permitted, for example, and all shareholders must be citizens or residents of the U.S.

Recently, the choice of business entity has become even more complicated. You can operate your practice as a limited liability company (LLC), which offers the asset protection of a corporation along with the tax flexibility of a partnership. In some states, professionals are not allowed to practice as an LLC but can create a limited liability partnership (LLP), which is similar.

Among these various alternatives, which works best? "We usually see physicians doing business as regular C corporations," says Cynthia Conger, a CPA and financial planner in Little Rock, Ark. "C corporations can deduct certain expenses that are not deductible for other types of businesses. These include health insurance, disability insurance and medical reimbursement plans. For many medical practices, these deductions can save thousands of dollars a year in taxes."

Disability insurance presents a taxing dilemma. If the practice pays (and deducts) the premiums, then any disability benefits will be taxable income to the recipient. On the other hand, if you pay disability insurance premiums personally, with after-tax dollars, any benefits you eventually receive will be tax-free.

"My clients would rather take current deductions for disability insurance premiums, which can be expensive," says Ms. Conger. "They'll take the chance that they'll wind up with taxable benefits. We have many physicians as clients and, in 16 years, only one has filed a disability claim. Moreover, if you are disabled and need to receive benefits, you probably will be in a lower tax bracket because of lost income."

No Corporate Tax

Although C corporations are entitled to some deductions not available to other business entities, won't you be exposed to the corporate income tax with this structure? Not necessarily, according to Ms. Conger. "Any corporate profits can be paid to the physicians as a bonus," she says. "That will leave the corporation with no income to tax. In fact, the tax code encourages this tactic for professional service corporations, which don't get a 15 or 25 percent rate on small amounts of profits, as other C corporations do."

Dennis Kroner, president of Pitt, Ryan & Linnear, an accounting firm in Chicago, says that C corporations have two primary tax advantages: group health insurance and medical reimbursement plans are deductible for the company but not taxable to the recipients. "That's not true for partnerships, S corporations or LLC's," he says. "Individuals who own 2 percent or more of the company have to include the value of the benefit in their income."

On the other hand, says Mr. Kroner, C corporations have certain disadvantages. "If too much money is paid out to the physician, the IRS may say that some compensation is unreasonable to be taxed as a nondeductible dividend. However, if money is retained inside the company, the IRS can assess a tax on 'excess accumulated earnings.' As a practical matter, zeroing out a C corporation's taxable income can be difficult to monitor and a challenge to implement at year-end, when everyone is taking vacation time."