Choose your Business Entity - Keep your Option Open

Picking an entity formation for your practice or real estate operation isn’t a one-size-fits-all situation. A company’s entity formation depends on the needs of the business. Generally speaking, however, there are three entity formation types that you can choose to organize your business.

• Sole Proprietorship

• Limited Liability Company (LLC)

• Corporation

Some businesses may decide they would like to form a limited liability company, or LLC, because of the entity’s flexibility and legal liability protection. Others may choose to incorporate as a corporation, especially if they plan to create a product or service that they will be selling (like that new dental devices you have thought about). And others may stick with the default entity formation of a sole proprietorship. 

Reasons to choose an entity?

Entity selection is the process of creating a business structure. That structure allows the business to act as a separate, legal entity from its owner. Liability protection creates a separation between the assets belonging to the owner and those belonging to the business. 

Why do you need limited liability when running a business? Let’s say your practice experiences an unforeseen circumstance, like a elderly patient slipping on ice as they leave your office. If you had not created a LLC or corporation, your personal assets may be at risk of seizure.

Sole Proprietorship

A sole proprietorship is often known as a default entity formation. Essentially, that means many businesses begin as a sole proprietor for a few reasons. It’s an affordable entity formation with the least amount of paperwork involved in the filing process.

Sounds pretty good, right? There is one catch. Sole proprietors are responsible for good things impacting the business—and bad things, too. The sole proprietorship would NOT protect your personal assets from an liability created at the practice.

Therefore, we recommend that you work with an attorney to form an LLC for any business venture you get involved with. This gives them access to limited liability. It allows the business owner to keep running the company with extra peace of mind that their business has extra protection. 

LLC

An LLC is a popular entity formation for several reasons. Forming an LLC means businesses have the ability to access limited liability protection for personal and professional assets. 

The owner of the LLC, also known as a member, may also choose a flexible management structure for the LLC. Three options are available, including single member LLC, member managed LLC, and manager managed LLC. In a single member LLC, for example, the sole owner manages the LLC. Whereas a member managed LLC would be managed by multiple members of the LLC and a manager managed LLC would allow the LLC to appoint a board of managers to run the company.

Another major appeal in forming an LLC is choosing how you would like the entity taxed. By default, LLCs are taxed as partnerships. This means profits “pass-through” to members and are reported on individual tax returns instead of at the business level. Members of the LLC may also deduct losses on their personal tax returns to further offset income and ease tax filing. The tax rules around partnerships are also much more flexible than electing S-corp status (see below). The IRS allows partnership to create flexible distributions rules and add debt to basis so it is usually the preferred option during the first few years of practice.

LLCs can elect to be taxed as an S Corporation. This type of corporation is still a pass-through entity that flows the profits through to your personal return. The primary reason to elect S-corp. status is the ability to avoid self-employment taxes. The S-corp. does need to follow corporate law which include minutes, Board meetings, restricted distribution with multiple members and no basis for debt. For these reasons, the S-corp. election works best after a couple of years when you have paid down your debt and want to start taking additional funds from the practice.

Corporation

Of the three entity formations, a corporation is the most structured entity. It shares certain similarities with LLCs, including limited liability and the ability to elect as an S Corp for tax purposes. 

However, a corporation is not nearly as flexible as an LLC. Corporations require formal structures to run their business. This includes electing a board of directors and corporate officers. Corporate minutes must be taken during meetings and bylaws must be established as the corporation’s rules and regulations. A corporation may issue shares of stock and sell percentages of the business to its owners, which are also known as shareholders. Ideally, this is the kind of entity that may be the best fit for a business with plans to offer an IPO or sell your amazing dental device to the world.

Which entity formation should I incorporate as?

As stated above, each situation is different but in general, we recommend forming as an LLC due to its flexibility and reduced paperwork. If you have any questions about which entity will work in your situation, we recommend consulting your attorney for the legal ramification and give us a call for the best option from a tax perspective.