Don't Fail Before You Start: The Types of Business Entities that Doctors and Dentists Should Choose

Don't Fail Before You Start: The Types of Business Entities that Doctors and Dentists Should Choose

Hippocrates, as every student of medicine knows, is credited with moving the practice out of the realm of superstition into the study of natural causes. But how did the great man earn his living? From student and patient fees, according to Plato, which would have made his business a “sole proprietorship,” a form of business organization still available to modern practitioners. However, when it comes to setting up a business, doctors and dentists today have greater choices than ancient Greek physicians did.

In most US states, including California, a wide array of business entities or business forms are available including the sole proprietorship; general partnership (GP); limited partnership (LP); limited liability partnership (LLP); limited liability company (LLC); and the corporation. However, the limited liability partnership (LLP) and limited liability company (LLC) are not available to doctors and dentists. In this brief, we’ll examine the business forms that doctors and dentists can use. But before we do, let’s talk about some of the factors to consider when choosing a business structure.

The type of business entity you choose will determine aspects of the business that affect its performance and success. There are many factors you will wish to consider, and these five are, perhaps, the most important: (i) legal identity; (ii) your personal liability; (iii) control of business decisions; (iv) tax liability; and (v) ability to raise capital.

Will your business be considered a legal entity?
Some business forms – sole proprietorships and partnerships – make no legal distinction between the business and its owners. In law, the business and its owners are one and the same, even though, operationally, personal transactions and business transactions may be conducted separately. Such business structures are easy to set up, requiring the barest formalities. However, owners will be personally liable for business debts, which means that your personal assets, a car or your home, can be subject to the claims of your business’s creditors. Other business forms avoid that sort of liability by being separate legal entities or legal persons that can do many things a natural person can and a few, like living for a century or more, a natural person can’t. Such entities are purely a “legal fiction” that you create. Once created, this legal person has rights very similar to yours, including the power to hire people, like you, its owner.

Will you have personal liability for business-related financial claims?
As we’ve discovered, some business forms – sole proprietorships and the various partnerships forms – make no legal distinction between owner(s) and business, which means that the personal assets of owners can be levied upon to satisfy business debts.

What sort of control will you have over business decisions?
Operating as a sole proprietor will allow you the greatest degree of decision-making latitude. There are no restrictions on any legal activity. You are the boss. Naturally, if you have joined with others, as in a partnership, the power to make decisions will be shared with your partners. Additionally, if the business is incorporated, i.e. established as a corporation, it will require a written constitution that sets out how decisions are to be made and recorded. So there may be some “red tape” introduced in the decision-making process.

How does business structure affect tax liability?
Under most tax jurisdictions, sole proprietorships and partnerships are “pass-through” entities, which means that the owners of the business are taxed, not the business. For example, in a partnership, a partner would be taxed on his share of the profits. Conversely, corporations, being separate legal persons, are subject to tax. The practical effect of this is that the corporation’s owners (shareholders) are subject to “double taxation.” First, the corporation pays taxes on its profits and then, if it distributes any of that profit, shareholders must pay tax on the dividend income (share of profits) they receive.

How easy will it be to raise capital?
Business capital can take two basic forms: debt and equity. Generally, taking on debt, issuing notes or borrowing from a bank, depends more on the credit worthiness of the business than on its legal form. Equity, however, is another matter. Historically, providing equity capital meant having some say in the business. This approach, linking control to capital, still applies to sole proprietorships and partnerships. But in modern corporations, particularly large ones, control has been decoupled from capital. A large corporation, like the Coca-Cola Company, has thousands of shareholders, with just a few large ones being able to exert any influence on management. Consequently, when corporations raise capital through equity offerings, there is much less risk of loss of control.

Business Forms in California for Doctors and Dentists

Sole Proprietorship
Setting up a sole proprietorship is the easiest way to do business and requires no formalities. You simply get on with it. Naturally, if you’re a physician, a license to practice medicine issued by the Medical Board of California will be required. Dentists must have a license issued by the Dental Board of California. As we have seen, this simplicity in setup and operation comes at a price. Sole proprietors may have to use their personal assets to satisfy debts run up by the business.

To Incorporate or Not, that is the Question

In California, doctors and dentists have fewer options than some other states, if they wish to join together for business purposes. Indeed, the state does not allow many professionals, including certified public accountants, lawyers, optometrists, psychiatrists and psychologists, as well as doctors and dentists, to form either a general limited liability company (LLC) or a professional limited liability company (PLLC).

To join practices, doctors and dentists must choose between forming a partnership, an unincorporated legal entity, or form a corporation.
General Partnership
A partnership can arise in an informal manner similar to a sole proprietorship. An old statute defines a partnership as “the relationship which subsists between persons carrying on a business in common with a view of profit.” Two or more persons doing business together is all that is required and no formal legal filing requirement is involved beyond that. However, that rather amorphous relationship can be given some structure by a partnership agreement, which sets out the more important matters.

Limited Partnership
The looseness of the traditional partnership or general partnership form has prompted the development of a number of variants, such as the limited partnership and the limited liability partnership. In a general partnership, all the partners have unlimited liability, i.e. they are personally responsible for business debts. But some partners can have limited liability in a limited liability partnership, which means their liability is restricted to business debts. Nevertheless, at least one partner, known as the general partner, must have unlimited liability. But not all partnerships forms are available. In California, doctors and dentists cannot form limited liability partnerships (LLPs).

Professional Corporation (PC)
In California, doctors can work together in a single practice by forming a professional medical corporation. The same rules apply to dentists, who can form a professional dental corporation. Established under the Moscone-Knox Act, professional corporations are traditional corporations with additional requirements, most notably that they can only be formed by professionals licensed in a particular area of practice. Only doctors, for example, can create a medical corporation. Dentists must form a dental corporation. And, unless an exception applies, professional corporations must only provide services, including ancillary services, within a single profession.

A Medical Corporation Is the Appropriate Business Form for Doctors
But doctors rarely work alone and, consequently, other medical professionals are allowed to join physicians in a medical corporation. Registered nurses (RN), optometrists, physician assistants (PA), among other licensed professionals may be shareholders, officers, directors, or professional employees of a medical corporation so long as the shares they own do not exceed 49 percent of the total number of shares of the corporation. In a medical corporation, doctors must have majority share ownership.

A Dental Corporation Is a Professional Corporation Created to Provide Dental Services
However, unlike its medical counterpart, in California law, there is no provision that anyone other than a licensed dentist may be a shareholder, officer, or director of a dental corporation.

Tax Issues
For decades, the IRS was against doctors, dentists and other professionals incorporating their business practices because those professions were likened to law where the axiom “a corporation cannot practice law” prevailed. Nevertheless, many states thought differently. In 1968, California passed the Moscone-Knox Act, which permitted certain professions to incorporate, provided that control over the decisions made by the professional were not made or controlled by a layperson. A year after, the IRS threw in the towel and began recognizing such corporations as separate tax entities. Now, for tax purposes, in California , a professional corporation will be treated as a C-corporation, unless it elects to be treated as an S-corporation. The terms “C-corporation” and “S-corporation” refer then to tax entities, not separate legal corporate forms.

A C-corporation is the traditional corporate tax entity and its owners (shareholders) are subject to the “double taxation” bane. Not only are the corporation’s earnings taxed but shareholders themselves will be taxed on the distributions (dividends) they receive from the corporation. However, an S-corporation is a “pass through” entity, similar in tax terms, to a partnership. Thus, the entity is ignored and shareholders are taxed on their proportion of income, based on shares held.

For further information, please contact MBA Financial and Accounting Services.