Physiatry Practice Management Resources

Question Our practice is a hospital-based physician group planning to leave the hospital system to start a private practice. We are struggling with the choice of legal structure for our practice. Could you give us advice on which type of business entity we should form?

Answer Your practice has several choices available to you. The legal entity you choose would depend on the flexibility and limitations of those legal structures, and the income tax characteristics of each. Below is a summary of the different types of legal entities available and some of the advantages and disadvantages of each.

The choices available to most practices are the corporation, the partnership and the limited liability company (or partnership). Some states also allow a single-member limited liability company.

All of these legal structures provide protection from legal suits outside of those connected with medical malpractice. Which entity you choose will determine how your practice reports the practice's income tax information to the government. (For our purposes we will discuss only the federal government reporting.)

If you choose the corporate structure, the IRS allows two types of tax reporting, as a C-corporation or as an S-corporation.

A C-corporation reports its annual activity to the government, and if there is a tax liability, the corporation pays the tax. The IRS categorizes a C-corporation medical practice as a personal service corporation. The IRS taxes any profit of a PSC at 35%.

In your case, if profits were left in the corporation at year-end, the corporation would pay a 35% tax on that profit. In the next year, when the physicians paid that profit to themselves in the form of a salary, it would be taxed again to the physicians, resulting in a double taxation of that money. To avoid this double taxation, your accountant will advise you to "strip" all profits out of the corporation by year end by paying a bonus to the doctors.

While most doctors enjoy getting this year-end bonus check, stripping all the profit from your corporation means taking most or all of the money out of the corporation. However, the practice needs cash for operating overhead. In most cases the doctors must either lend back a portion of their bonus to the corporation to cover expenses, or they must guarantee a line of credit to draw on to cover practice expenses until cash flow is restored to the practice.

In addition, it is difficult to know how much bonus will be necessary to wipe out all the profit, because it is impossible to predict how much money will be received from payers. Too little bonus will result in profit left in the corporation. Too much will cause the doctors to report more personal income than necessary and will cause a loss to the corporation that will not provide a benefit until the following year.

The S-corporation is different from a C-corporation in that any profit left at year-end is taxed only to the shareholders of the corporation, avoiding the double taxation. This profit will be divided among physician shareholders in proportion to their ownership interest.

This income is reported regardless of whether or not the cash representing this income is taken out of the corporation. However, when the money is subsequently taken out, it can be taken as a nontaxable distribution.

Because most practices pay physicians according to a compensation arrangement based on productivity, dividing the remaining profits of the corporation according to ownership percentages could cause a conflict with the compensation formula. This can be avoided by paying bonuses to the doctors in differing amounts to account for the differences in productivity. Any discrepancies remaining after the final accounting is made can be corrected early the next year through salary adjustments.

Income is measured nearly the same, whether your practice is a C-corporation or an S-corporation, except for health insurance premiums for the owners. In a C-corporation, the medical insurance premiums are a nontaxable fringe benefit paid by the corporation. In an S-corporation, medical insurance premiums are a taxable fringe benefit, the value of which is added to the physician's W-2.

A deduction for a portion of the insurance premiums is allowed on the physician's personal income tax return, to offset the amount included on the W-2. This deduction will increase over time until the IRS finally allows a 100% deduction of the premiums in several years.

A partnership and limited liability company or partnership act virtually the same for financial and income tax reporting. In most cases, all will report to the IRS as a partnership. Like an S-corporation any remaining profit at year-end is taxed to the partners. However, the profits can be divided in any manner the partners wish, and the allocation can change from year to year. This allows much more flexibility and little or no planning for compensation.

The major difference from a corporate structure is in how a partner is paid. As an employee of the corporation, all the physicians will be paid via W-2 wages, with income taxes deducted and paid to the government with each payroll period. The partners take draws of profit from the partnership. These draws are very much like the doctors' base salary. However, no taxes of any kind are deducted from these draws.

The partners must pay their income taxes and payroll taxes (self-employment taxes) on these draws and their share of the partnership's remaining profit through personal quarterly estimated income tax payments. This process can be a little intimidating. However, personal accountants can guide you through this process and it will become routine.

A single-member limited liability company is allowed in some states and is a very good choice for a single practitioner or single owner. For income tax purposes it is the same as a proprietorship. There is no separate income tax form to file, which is not the case with a corporation or a partnership. But it provides legal protection that is not available to a proprietorship.

By Rita M. Schwager