When starting a practice, it’s important for optometrists to decide on what type of business entity they want to be. Each entity has its own advantages and disadvantages, and each can result in paying different amounts of taxes each year. Doing some strategic tax planning can make a big difference at the end of the year.
This is the most common type of business entity because it is the easiest and cheapest to form and operate. However, a sole proprietorship has disadvantages when it comes to taxes and liabilities.
This type of entity is unincorporated, which means that all income and expenses relating to the business flow through to the personal income tax return of the owner. All income is subject to income taxes, so all business income can raise the tax bracket of the owner. Business owners are also subject to self-employment taxes with a rate that constantly changes.
The liability is much higher with this entity when compared to the others, as the owner is personally responsible for all the liabilities and debts of the business. If someone gets hurt, that individual can sue the practice, which the owner is ultimately responsible for.
The biggest advantage of having a sole proprietorship is how easy it is to open the business and start practicing. The owner doesn’t have to file any government forms. They just file the estimated taxes and report the business income and expenses on their personal income tax form at the end of the year. Most states do require certain documents to be filed, even with sole proprietorships, so be sure to check with the Secretary of State’s office.
Another popular and reasonably simple option is partnerships. This type of entity, which is made up of two or more owners, can limit the liability of the owners. Collaborating with other professionals can make a practice more credible and often makes for a stronger business.
There are two types of partnerships: general partnerships and limited liability partnerships.
With general partnerships, the owners have unlimited personal liability for the business, leaving all their personal assets at risk. Any one of the partner’s malpractice can result in all the partners being liable.
Limited liability partnerships give owners more protection. Optometrists are only personally liable for their own malpractice, and not for the malpractice of any of the other partners.
Having a partnership agreement is essential to cover all the details of operation and avoid any misunderstanding. There should be an outline of ownership percentages, titles, responsibilities, sale of interest, and more.
Partnerships are separate legal entities and file a Form 1065 tax return for the business. The Form K-1 is given to each partner of the practice detailing their share of the business income. These K-1’s are then reported on each partner’s personal income tax return. Partners in a partnership still must pay self-employment taxes.
Corporations are the most complicated entities to form, but they offer the most tax advantages and liability coverage. Corporations come in three different types: C Corporations, Limited Liability Companies, and S Corporations.
•C Corporation – For optometrists, this type usually does not have many tax advantages. Shareholders have limited liability, but are “double-taxed.” The corporation pays tax on the business income, and the shareholders also pay tax on any dividends that are paid out by the business.
•Limited Liability Company – This type is not actually a corporation, but it offers limited liability. It operates similar to that of a partnership. The income of each member is subject to self-employment taxes, but LLCs can choose to be taxed as S Corporations to avoid this.
•S Corporation – Optometrists favor this form above all, and it is usually the best type of entity to operate as. It offers limited liability, and the income is not subject to self-employment tax. Owners must take a reasonable salary that employment taxes are derived from.
All three are considered by law to be separate legal entities, giving more legal protection. Only the C Corporations pay taxes on the business income, while LLCs and S Corporation members receive a Form K-1.
Forming a corporation is more complicated than the other types of entities, requiring a document to be filed, such as an Articles of Incorporation, in the state of operation. C Corporations and LLC’s can elect to have an S Corporation status for tax reasons simply by filing an Election by a Small Business Corporation.
Deciding what form of entity is vital for optometrists as it affects their bottom line and the level of liability they have to shoulder. S Corporations have the most advantages and liability protection for optometrists. When deciding which entity to form, be sure to consult with a tax advisor and legal counsel as there are many aspects to consider. Let Caro & Associates help you today with strategically planning for the future of your optometrist practice.
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