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Tax and Legal Implication of Dental Practices

posted Nov 7, 2015, 10:36 AM by Zaher Fallahi   [ updated Nov 7, 2015, 12:07 PM ]


Generally, dentists may choose one of the four types of entity for their practice; (a)sole proprietorship, (b) corporation, (c) S corporation and (d) partnership. Dentists are not permitted to use limited liability company (LLC) in California. Legal counsel and tax advisors should explain the pros and cons of each entity type from both legal and tax viewpoint and assist dentists in selecting the most advantageous form of entity for them. It is advisable to include provisions such as "right of first refusal" and "spousal consent" in the bylaws, of the corporation or partnership agreement, or prepare a separate contract to protect the remaining dentist from being forced to practice with a stranger in case of separation.

 

Following are the most commonly used business entities:

(a)Sole Proprietorship

A sole proprietorship is the simplest version of doing business.  This is an individual doing business without being a legal entity such as a corporation.  If the individual wants to use a name other than her or his name, she or he may select a fictitious name also known as Doing Business As (DBA), which is registered with the County where the business is located.  Dentists using a DBA must obtain permit from the California Dental Board before registering with the County.

For liability purposes, a sole proprietor has unlimited personal liability to business creditors. Therefore, this type of entity may not be the most ideal choice of business entity type for that matter.  For income tax purposes, a sole proprietor is considered an individual taxpayer who files the IRS form C along with his or her income tax return form 1040, and is subject to quarterly estimated tax payments and is held liable for his or her taxes and the employees’ payroll taxes (trust fund recovery penalty).  

Tax Tip:  It is known fact to tax practitioners that Schedule C s with sales in excess of $100,000 are more susceptible to an IRS audit and it is advisable to be incorporated.

(b)Corporation

A corporation is a legal entity established under the state statute for conducting business.  Provided that a corporation is incorporated properly and maintained according to law, the owners of the stock of a corporation may not be held personally liable to the business creditors.  The corporate officers may be held personally liable under the “duty of care” or other legal theories to the stockholders. They may also may be held personally liable for the employment tax purposes also known as “trust fund recovery penalty”.  

For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A C corporation realizes revenue, deductions and net income or losses, pays taxes and distributes profits to shareholders as dividends. The shareholders pay income tax on the dividends. Because the dividends are not tax deductible at the corporate level, the stockholders will pay income tax twice on the same income; once at the corporation level and once in their individual level. This is called “double taxation”. In addition, C corporation shareholders cannot deduct any losses of the corporation in their individual tax returns.

Tax Tip: To avoid double taxation, it may be advisable to consider an S corporation.

(c)S Corporation

Stockholders of S corporations enjoy the same legal protection as C corporations. For federal tax purposes, S corporations elect to pass each individual stockholder’s share of the corporate profits, losses or credits through K-1 to the shareholders. Shareholders of S corporations flow-through their share of the corporate income, losses or credits on their individual income tax returns and pay tax at their individual income tax rates. Therefore, S corporations avoid double taxation on the corporate income. In addition, Stockholders of S corporation can deduct their losses up to the amount of their capital in the corporation known as “basis of stock”. California S corporation pay the greater of $800 or 5% of their net income.

 

In order to qualify for S corporation status, the corporation must meet the following IRS requirements:

a) Be a domestic corporation

b) Have only allowable shareholders:

    i) including individuals, certain trusts, and estates and

    ii) may not include partnerships, corporations or non-resident alien shareholders

c) Have no more than 100 shareholders

d) Have only one class of stock

e) Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

 

(d)Partnership

A partnership is created when two or more persons join together to carry on a trade or business for profit.  Owners of a partnership are called “partners”. Each partner contributes cash, property, labor or talent, and shares in the profits and losses of the business.  Partner’s share of profits or losses may not be proportional to their contributed capital. Generally, all partners of a “general partnership” are held jointly and severally liable to business creditors regardless of the percentage of their capital. A 5 % general partner may lose his or her personal wealth because of another partner’s misconduct. There are also “limited partnerships” where the limited partner’s liability is limited to his or her respective capital in the partnership only.  

For federal tax purposes, a partnership must file an annual IRS Form 1065; “information tax return” to report the income, deductions, gains, losses, etc., from its business operations. However, it does not pay income tax and passes through any profits or losses to its partners through K-1, and partners include them in their personal income tax returns Form 1040. Partners who actively participate in running the business pay both applicable Social Security and Medicare taxes in addition to income tax on their K-1 income. Partners are subject to quarterly estimated tax payments. Although, general partnerships do not pay income taxes, they involve some of the most complicated tax laws.

Zaher Fallahi, CPA, dental CPA and physician’s CPA since 1992 http://www.zfcpa.com/ .  Telephones: (310) 719-1040 (Los Angeles), (714) 546-4272 (Orange County), e-mail  taxattorney@zfcpa.com

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