Close-Up: Business Entities

Physician's Money Digest, September30 2004, Volume 11, Issue 18

Presented by McNeil, Makers of Tylenol

n.

Business Entities:The legal form and structure within which a business operates, including corporations,partnerships, limited liability companies, and proprietorships.

If you own a business, as many private-practicephysicians do, it should not be overlooked in yourestate planning. According to the NationalAssociation of Financial and Estate Planning(NAFEP; www.nafep.org), the type of entity that youchoose for your business is an important consideration,as each structure has its own benefits and weaknesses.These structures include corporations (eg, C, PSC, andS), partnerships (eg, limited and general), limited liabilitycompanies (LLCs), and proprietorships. Other than apartnership, all of the other types of business entitiesrequire some level of formalization.

What are the benefits of forming a business entity?The NAFEP indicates four main factors. First, it limitsyour personal liability from any legal problems the businessmight incur. Next, it provides a simple method ofdividing ownership interests among multiple partners.In the case of multiple owners, it also affords a centralizedmanagement system. Lastly, you are able to takeadvantage of business tax breaks furnished only to legalentities, such as health insurance, pension plans, andprofit distributions.

Types of Entities

It should first be noted that the C, S, and PSC distinctionshave nothing to do with the legal structure ofthe corporation. These letters, according to the NAFEP,refer to how the corporation is treated under federal taxlaws. Otherwise, the three classifications are identical.

The major advantages of C corporations are limitedliability, the efficient manner in which it handlesa large number of shareholders, and the ease andlegality of buying and selling its stock, which can beowned by other business entities as well as individuals.A significant disadvantage, however, is that allprofits are taxed at the corporate level, and then dividendsor profits are taxed to the shareholders. Thisresults in a double taxation of profits.

With S corporation status, the double taxationproblem of the C corporation is eliminated, as tax liabilitiesare passed directly to shareholders. However,there is a limit to the number of shareholders, andshares cannot be held by other corporations. S corporationscan also have deductible employee stock ownershipplans and employee pension plans for bothowners and nonowner employees. However, annualshareholder meetings are required.

PSC stands for personal service corporations, andthey are nearly identical to C corporations. The maindifference is that the business activity revolves aroundthe sale of personal services—such as health, law, oraccounting—rather than the sale of products or nonpersonalservices. The NAFEP points out that this type ofclassification is often used by professionals to achievecorporate tax-deductible employee benefits for one ormore professionals offering personal services.

LLCs combine the limited liability feature of corporationswith many of the advantages of partnerships.However, unlike S corporations, any person orlegal entity can own its own shares, all members canvote, and there can be any number of shareholders.LLCs are required to file annual reports with the statein which they were created, but no annual shareholderor directors meetings are required.

What's Best for You?

The difference between general and limited partnershipsis that general partnerships have no limitedliability for any partner. In contrast, limited partnershipsoffer limited liability for the limited partners,but not for the general partners. A major disadvantageof partnerships is that limited partners have novote or say in how the business is run.

Determining which business entity is right for youdepends on your situation. For example, if you plan totake your business public, you must use a C corporation.However, the NAFEP notes that if you place a highemphasis on reducing self-employment or Federal InsuranceContributions Act (FICA) taxes, then an S corporationshould be discussed with your tax advisor.

On the other hand, if your primary concern is toachieve limited liability, especially if there is more thanone owner in the business, NAFEP suggests you seriouslyconsider the LLC taxed as a partnership. In additionto the limited liability benefit, various noncorporateemployee benefit programs are available.

Whichever way you decide to go, be sure to workclosely with a tax advisor who is knowledgeable of differentbusiness entity structures.

Who Needs a Business Entity?

If you're a physician who is a sole proprietor and/orself-employed, you may be wondering why youshould consider a formal business entity. After all,you don't have multiple owner issues associatedwith many small businesses. However, your status asa proprietor, self-employed or general partner providesno limited liability protection.

According to the NAFEP, if you deal with any oneof the following six entities or groups, the potentialexists for your business to be sued. They include customers,employees, creditors, contractors or subcontractors,competitors, and regulatory governmentalagencies. As a result, you could find yourself at personalrisk from business-related lawsuits.

Talk with your tax or business advisor to see if abusiness entity is the best way for you to distanceyourself from these potential problems.

Pop Quiz

1) The benefits of forming a business entity include:

  1. Limiting personal liability
  2. Centralized management
  3. Business tax breaks
  4. All of the above

2) The C, S, and PSC distinctions have nothing to dowith the legal structure of the corporation. True orFalse?

  1. True
  2. False

3) Which business entity does not face the disadvantageof double taxation?

  1. C corporation
  2. PSC corporation
  3. S corporation
  4. All of the above

4) Which business entity is not required to hold annualshareholder or directors meetings?

  1. C corporation
  2. PSC corporation
  3. S corporation
  4. LLC

5) If you plan to take your business public, you mustuse this form of business entity:

  1. LLC
  2. S corporation
  3. C corporation
  4. Partnership

Answers: 1) d; 2) a; 3) c; 4) d; 5) c.