The "S" Corporation, the LLC or LLP.

Bruce Bryen, CPA

Which is the Better Entity Format?

Where do I go for advice?
There are substantial differences between the "S" corporation and the LLC and the LLP. Because questions arise concerning critical business consequences such as income tax issues, potential payroll tax problems, liability protection, the capacity to borrow, and in what format that borrowing should take place, one of the best places to seek advice is from a CPA experienced with dentists and their financial matters.

What are some differences in these structures?
The "S" corporation has certain characteristics that can trap a dentist into a bad income tax situation. "Basis" is critical for the ability to take advantage of losses that flow through to the dentist's personal tax return from the "S" corporation. What is "basis?" Profits that remain in the corporation and funds advanced to the practice by the shareholder(s) establish "basis" in the dental practice's corporation. Loans from lending institutions and anyone other than the owner (shareholder) of the corporation don't count as "basis" even if those loans are guaranteed by the dentist personally, outside of the corporation. In an LLC or LLP, loans that are personally guaranteed by the dentist DO count as "basis" and allow the dentist to report losses that flow through to the personal tax return.

Why does it matter?
Suppose you are a shareholder in an "S" corporation and have treated its income as most professionals do? That means that you probably have withdrawn all of your practice income.  Chances are that your "basis" in the "S" corporation is minimal. Now suppose the practice is ready to acquire equipment with a cost of $125,000 and the dental supply house has arranged financing for the "S" corporation. You are ready for a write off that will flow through to your personal tax return so that you can receive a refund or not pay taxes in the current year. You can't write off the loss without the "basis." The loan from the lender to your corporation does not count towards your "basis" even if you have personally guaranteed it. You won't receive the refund until you establish your "basis" in the "S" corporation. With an LLP or an LLC, and using the same set of circumstances, you will get your refund or not pay tax if you have personally guaranteed the loan in the fiscal year of the dental practice.

What are some of the differences?
Your compensation is another variance between the "S" corporation and the LLP and LLC. With an "S" corporation, you receive a salary and the corporation pays payroll taxes upon its disbursement and profit is probably treated as a dividend. You most likely never have heard of the term "unreasonable compensation" which is an area that the IRS likes to challenge because you have tried to report a salary at a level that will save you payroll taxes. Many dentists report a high dividend which is not subject to payroll taxes. Be careful how low your salary is and how high your dividend is. The IRS may want to reclassify these items so that you have to pay more payroll taxes and adjust your salary and dividend. You will also owe penalties and interest if there is an IRS audit and a change to the classification of salary and dividend do occur. The LLC and the LLP do not pay salaries to their owners. They pay "guaranteed payments," which are not subject to payroll taxes when received from the LLC or the LLP and the practice has no payroll tax liability for those payments.

Tell me more
The "S" corporation and the LLP and the LLC both offer liability protection to its owners as long as they do not treat the dental practice as their alter ego by disregarding the business aspects of the entity. Minutes of meetings should be documented, business expenses should be paid from the practice and support for those expenses established, and the overall approach should be that it is different from the owner. The phrase "piercing the corporate veil," should be looked at carefully.

Bruce Bryen, CPA has successfully assisted dentists with their personal and financial matters for more than thirty years. As a partner in The Snyder Group, he delivers creative and prudent financial strategies to help dentists build and protect wealth at every stage of their careers. His extensive expertise includes financing, debt restructuring, retirement planning and tax advising to help dentists keep more of what they earn. Bruce is also experienced in providing litigation support services and has testified on numerous occasions as an expert witness.