Incorporation and S corporation election for solo medical practices

So we’ve described how to fund the practice. The next step is to find a office and do tenant improvements but I’m going to be skipping ahead for my next posts while Ho Sun discusses his office search.

The first step in the decision tree is to choose your corporate structure: LLC (limited liability corporation) vs PLLLC (or professional LLC) vs corporation election. The second decision is how to choose to be taxed, whether to choose S Corp election.

When should you incorporate? You definitely need to do this before credentialing as you will need your business TIN (tax ID number), but you need a business address to incorporate. You could put your home address down as your business address, and change it later with your state’s corporation commission once you obtain office space, but I thought this would be too much of a pain so I waited until I turned in my office lease agreement. This is why getting a office address is such a critical step in the startup process, as it is a bottleneck for credentialing (but don’t rush and get the wrong location or overpay rent).

One could choose not to incorporate and do business as a sole proprietor. But in an incident where your employee caused liability which you are responsible for, or if there is a slip and fall on your premises, a corporation often shields you for vicarious liability. Thus, incorporating can protect your personal assets. It is also more credible to the public to be a corporation. As a sole properietor, you can’t elect to be taxed as a S Corp (see below for why S Corp election can be advantageous in many situations). If you sell the practice or pass away, it is probably easier to have a corporation separate from personal affairs.

You should definitely search your state’s corporation commission site to see if the name you have proposed for your practice is already taken or in use. Some states such as Arizona allow you to reserve a name for 30 to 90 days before you formally incorporate.

Most solo doctors would choose to incorporate a LLC rather than a corporation. That’s because the paperwork and hassle is less. But some states don’t allow solo docs to incorporate as a LLC, a corporation is the only option. A LLC can elect to be taxed as a S corporation so you’d get the exact same tax benefits as if you were a corporation electing S corporation taxation.

https://www.rocketlawyer.com/article/llc-vs-s-corp.rl (this article is technically incorrect as you can’t start a S Corp; you can start a LLC or corporation and elect a S Corp election for either one).

Here’s a link to the list by state of whether you can be a LLC rather than a corporation. Some states require that if you incorporate as a LLC it must be a professional LLC, or PLLC. Other states such as California not only require that you be a corporation rather than a LLC but also slap a 1.5% tax! Some states have naming requirements. Where I am in Arizona, physicians can choose to elect LLC without any extra requirements.

http://www.northwestregisteredagent.com/professional-entity-requirements-by-state.html

If you are a single member LLC by default you are taxed as a sole proprietor on Schedule C. This is considered pass through, which means you’re taxed at the same brackets and same rates as if you earned wages. The difference is that you pay self employment tax. You are responsible for both the employer and employee part of the FICA, or social security tax (6.2% times two for 12.4% on first $128,700 for 2018) and Medicare tax (1.45% times two for 2.9% for all self employment income, additional Obamacare tax of 0.9% for income over $200k singles, $250k couples). Therefore the total self employment tax is 15.3%.

If you were paid wages, half of this (6.2% plus 1.45% for first $128,700, then 1.45% for amounts over $128,700) would be paid by your employer. The other half is deducted from your wages, along with federal and state withholdings.

You could elect to be taxed as a S Corp. The advantage of being taxed as a S corp is that you can take part of your compensation in distributions rather than salary. The distribution portion is not subject to self employment tax. But the tax brackets are otherwise still the same as if you earned wages. Since most ophthalmologist salaries are over $128,700, this saves you $2900-3800 for every $100,000 taken as distribution rather than salary.

You can’t abuse the system and take zero salary and everything as a distribution. For S corps you need to take a “reasonable salary”. So if you took a $200k salary and $100k distribution you’d save $3800. Once you have a high profit, if you took a $300k salary and a $300k distribution that would save you $11,400 in taxes compared to taking everything in salary!

The exception for avoiding FICA taxes via distributions is year one and possibly year two when your profits are low. If you have a profit of $100,000, a reasonable salary might be $65,000 with a $35,000 distribution. Taking $35,000 as a distribution rather than salary saves approximately $5200 in self employment taxes.

Update: the new tax law of 2017 allows for a 20% deduction on qualified business income for pass through taxation (sole proprietor and S corp election, but not C corp). The deduction has a income limit (includes income from wages, spouse and investments) and is phased out over the income limit. For more details read this blog post. I also discuss in this post why it almost always doesn’t make sense for a solo or small practice to be taxed as a C corp. C corps are for raising large amounts of capital which small practices don’t need, and in addition to not qualifying for the pass through deduction, you can’t avoid the Medicare tax like you can with S corps by taking distributions.

One other advantage of S corps is that if you have a IRA the money you put in a IRA isn’t subject to the Medicare tax if you are taxed as a S corp, but it is if you are taxed as sole proprietor. If you max out your SEP IRA this could save about $2000 in taxes. Most of the time you can’t avoid paying FICA social security taxes by taking distributions rather than salary, since your salary will be at least the FICA limit of $127,600.

http://www.nolo.com/legal-encyclopedia/why-you-might-choose-s-corp-taxation-your-llc.html

https://www.kitces.com/blog/s-corporation-to-reduce-self-employment-taxes-and-social-security-fica/

If you incorporate as a corporation (rather than a LLC) by default you are C corp taxed. Just with a LLC you can elect S Corp taxation. My understanding is that if you plan to go public and have over 100 shareholders it is necessary to form a corporation and maintain C corp tax status. For C corps you would pay taxes on any wages you took just like for S corps. After wages are paid to yourself, for profits you are taxed twice, at the corporate level and then individually.

Most solo and small medical practices choose to be taxed as a a S corporation. You would use form 2553 to elect S Corp taxation. You are allowed to elect at the beginning of any year, so you could choose to be taxed as a sole proprietor and make the S corp election when you feel that the tax savings outweigh the costs and paperwork. Once you make the election you can’t change it back for five years.

http://www.thetaxadviser.com/issues/2013/dec/casestudy-dec2013.html

Many solo docs who form LLCs don’t need to hire a service. They can do it themselves. In Arizona you can incorporate online for $50 (add $35 for a rush fee)

http://ecorp.azcc.gov/Entity (under “Create”)

Ho Sun used a company called Biz filings to incorporate. There are plenty of companies on the internet that will do it for you. If you need the rush service and you live far from the state capitol it might make sense if documents need to be done in person, but many in our google group have done it ourselves.

And you can easily obtain your IRS EIN yourself for free online:

https://sa.www4.irs.gov/modiein/individual/index.jsp

If you elect S Corp taxation for your LLC or corporation, form 2553 must be filed within 75 days of incorporation, or the first 75 days of any calendar year you want to elect. Once you elect you can’t change back for five years.

https://www.irs.gov/pub/irs-pdf/f2553.pdf

Note that if you live in a community property state your spouse has to sign the form also:

http://biztaxtalk.com/node/1312

There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Alaska is an opt-in community property state that gives both parties the option to make their property community property.

Finally, when you incorporate, you need to name a registered agent. A registered agent is someone designated to receive any service of lawsuits. Many of us list ourselves at our business address as the statutory agent. If you have a lawyer, or a friend that is a lawyer, you could list them as your statutory agent if they are willing to do it for you. It’s easy to change your agent by filing the right forms with your state’s corporation commission.

Every state is different but most experts feel that LLCs may have more asset protection than corporations. That’s because LLCs have members with a membership interest. A charging order against a LLC would allow a creditor to seize distributions but not the assets of the LLC itself. In contrast, a corporation’s owners hold shares which could be forced to be sold:

http://www.pfshield.com/asset-protection/basic-asset-protection/llcs-vs-corporations/

However in some states single member LLCs may have more limited creditor protection if the member, not the LLC, is at fault.

7 thoughts on “Incorporation and S corporation election for solo medical practices

  1. Someone asked this question in another post: I need some advice. I am planning to go solo, no clinic, just inpatient consults, therefore I will not have general business liabilities, of course I will have malpractice insurance. Should I form an LLC or continue as a solo proprietorship before starting the credentialing process with private health insurance companies and Medicare? Is there any strong reason to form an LLC in my particular situation?

    Answer: if you have no employees (vicarious liability for scheduling patient at wrong time; lawsuit could be settled through your corporation rather than personally avoiding reporting to National Practicioners databank) or no office (slip and fall, could go after your personal assets), then it’s fine to go for it as sole proprietor.

    Even as a sole proprietor you will want to get a TIN from the IRS.

    In states like AZ it is easy to be a LLC ; in some states doctors have to be a corporation. If it was advantageous you could elect S corp taxation to avoid self employment taxes on the distribution part, but there’s a time and hassle factor of running payroll for yourself and the return is more complicated (1120 and K1 many pages, schedule C is one page and any idiot can fill it out themselves). I’ve even heard of accountants recommending S corp taxation to line their pockets with more work at the expense of their client!!

    If you elect to incorporate in some states like CA you must be a corp not LLC and would usually elect S corp taxation and pay a business tax and some states you pay unemployment taxes on your salary. This would negate any advantages of taking S corp profits as distributions rather than wages to avoid fica/Medicare taxes. So it depends on your state and your income.

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    • One other important thing I forgot to mention, is that if you form a LLC it doesn’t always make sense to elect S corp election, especially in the case that you have $128,000 or so of W2 income from other sources. Why? Because if you elect S corp, you will pay about 6% of the employer’s part of FICA taxes. If you don’t elect S corp (regardless of whether you form a LLC or are a sole proprietor) then you wouldn’t be responsible for SE taxes- see form SE section B line 8A (skip line 10 to calculate FICA taxes if your W2 income is over the FICA limit).

      If you have no other W2 income the opposite is true, taking a S corp distribution over wages saves in FICA taxes, but as I said above this needs to be weighed against potential unemployment taxes, hassle of bookkeeping, more involved tax return.

      I will also await clarification regarding the pass through deduction under the new tax law (TCJA of 2018) before I make further comment about how S corp election affects the deduction.

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  2. Thank you for the responses! I am not planning to have employees in the near future as I will cover inpatient consults only (I am an infectious disease specialist). I will start the credentialing process as a sole proprietor for now and I am planning to use my home address as a business address. I also estimated that the benefits from an S corp outweigh the hassle and costs when one makes $500,000 or more. That will not be my case in the near future. By the way, you guys are truly an inspiration. Your blog has so much useful information that you could even write a book.

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  3. Great article. Thanks for posting it. I have a question. I am soon retiring from a HMO at age 55. I am considering working just occasional locum tenum positions. Should I even bother with forming any LLC or PC and just practice as sole proprietor? I do not anticipate that I will be earning more than $100k per year. Thanks

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    • Thanks for the kind words about the article.

      See my August 29 answer above. If this was your only source of working income I suppose you could do LLC with S Corp election. And do wages of 70k/ distribution of 30k thus saving about $4500 in self employment taxes.

      If your total income over FICA limit of $128k probably not worth it unless you earned over $400k. Depends on state.

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