Not sure which business entity you should create for your medical practice? Learn the benefits of forming an S corporation and how to make the most of deductions.
If you are running a medical practice, it’s important to understand the kind of business entity you should form and the benefits of each. It’s also crucial to know laws and regulations in your particular state since they vary, and all of the tax implications.
Here’s what physicians need to know about choosing the right entity for their practice, the benefits of S corporations, and the top S corporation deductions to leverage.
Choosing the right business entity
When you run a business or are creating one, there are a few factors to consider before deciding which kind of business entity is right for you. You may already know you want to have greater liability protection—safeguarding your assets from unwanted creditors.
Here are the business entities you have to choose from:
Sole proprietorship: The most basic type of business with no legal protection. You report your income on your Schedule C, and all income is subject to self-employment taxes. If you live in a state with a high income-tax bracket, say 40%, you’ll also have to pay additional taxes that can push you up to 55% since self-employment taxes are 15.3%.
General partnership: An association of two or more individuals or businesses. A partnership can be formed by a written document or even a handshake. All income passes through and is also subject to self-employment tax.
Corporation: An entity created under state laws, and you may choose either an S corporation or C corporation. If you create one of each of these entities, you can take advantage of various tax benefits, and a corporation does provide liability protection.
Limited Liability Company (LLC) or Professional LLC (PLLC): Some states don’t allow medical professionals to practice in an LLC (California). But if your state allows it, an LLC is generally the preferred entity choice. It gives you flexibility, and you may still elect to be an S or C corporation while getting around certain corporation problems. With corporations, creditors can take your stock as a payment, but not with an LLC. Most independent physicians form an LLC or PLLC.
Limited Liability Partnership (LLP): These entities are formed by groups of professionals, and they are not offered in every state. A group medical practice could form an LLP, and then each partner could be an individual LLC. Thus, you can create an environment where partner-level financial decisions are being made in the LLP while giving more autonomy for individual shareholders with LLCs to do their own personal tax planning.
Limited Partnerships are not common for medical practices. But LLPs give an extra layer of legal protection around other assets, investments, and property. They can also be advantageous if you want to gift some of your limited partner interests, or non-voting interests, to children or family members.
Business trust: Another uncommon option. A problem can arise if a group has a buy-sell agreement with a restriction prohibiting individual shareholders from transferring or owning their interests in anything other than their name or a trust for their benefit. But a business trust allows physicians to own that interest. Then, they can name a PLLC as the beneficiary of the business trust that is owned by the physician.
S corporation advantages
Forming an S corporation offers several key benefits to physicians. These include:
- Pass-through entity
- Reduces the self-employment taxes subject to reasonable compensation
- Eligible for 20% qualified business income deduction
- Can shift income to lower-tax-bracket individuals
- Low risk of an audit
Avoiding self-employment tax is a significant benefit. For example, as a sole proprietor, you’d report everything on Schedule C and pay the 15.3% self-employment tax on income after deductions. But with an S corporation, you have more control over how your net income is paid out and ultimately taxed.
You can shift that income to a person in a lower tax bracket by making them a shareholder or part owner in your S corporation, and the rest of your income can be treated as a dividend you can give to yourself. There is no self-employment tax on dividend income, so you can significantly reduce the overall amount of payroll tax.
Top 10 S corporation deductions for physicians
- Vehicle deductions. You can divide your mileage into business, commuting, and personal categories, and track miles regularly to report the deductions.
- Business meals. You can deduct 50% for client meals, 100% for transportation to and from meals, and 100% for office parties. You can’t deduct meals with your spouse unless you’re traveling together for business. You can also deduct reasonable costs for small gatherings at your home if they’re business-related.
- Business travel. Travel deductions apply if you’re away overnight or long enough to need sleep. Per diem rates for lodging and meals can be more than actual expenses. If you’re visiting a high-cost locality, you have $297 for travel—low-cost is $200.
- Shift income to family members. Option 1: Put your children or parents on the payroll. They can earn up to the standard deduction ($12,400). The next $9,875 is taxed at just 10%. Wages paid to kids under 18 aren’t subject to FICA and Medicare taxes. Option 2: Shift income to adult family members. Gift property (equipment or real estate), then lease it back.
- Home office. Have your S corporation domiciled with your home address as the business address. You can deduct expenses like property tax, mortgage interest, utilities, rent, security, maintenance, and more.
- Retirement plan. Your type of retirement plan can have a significant impact on your total tax liability. Many sole proprietors have programs where they can contribute up to 25% of their compensation every year. But, when you add up the payroll tax you pay on the significant net profit number, the amount of income tax you’re saving barely exceeds the payroll tax you pay. Look at retirement plans that allow you to keep your W-2 amount as low as possible so that you can maximize your contributions.
- Fringe benefits. C corporations have a lot of fringe benefits. But when you have both a C and an S corporation, you can get fringe benefits from both of them. S corporations do include health insurance, qualified small employer health reimbursement arrangement, Health Savings Accounts (HSAs), disability insurance, and dependent care assistance.
- Rent your home to your business. Under tax law, if you have a rental property that you rent out for 14 days or less every year, that income is not taxable. And rent paid by your S corporation is deductible. Hold business meetings, events, or board of director meetings in your property, but make sure rent is reasonable.
- Create separate entities for business assets. If your business entity owns equipment or real estate, you should create separate entities, then lease it back to your practice. This isolates liability from each property and the practice and segregates business property into different entities to create deductions for qualified business income. You can also transfer interest in the entity to family members in a lower tax bracket and, if titled in a spouse’s name, you can establish employee benefit plans.
- Pay yourself the lowest reasonable salary. S corporations must pay shareholder-employees a reasonable wage that’s subject to FICA/Medicare taxes. To determine what is reasonable, look at their services, experience, duties, and business efforts, and what comparable businesses pay for these services, among other considerations.
When you’re unsure of the best way forward for your medical practice, work with Physicians Tax Solutions. We help you navigate which business entity to form, and ensure you’re taking advantage of all tax and other benefits available to you.
Physician Tax Solutions supports busy medical practitioners with proactive strategies and full-service tax preparation services that dramatically reduce tax bills. Contact us online or by calling 1-855-693-7829 to start saving today.