Every day, new physician entrepreneurs choose a business structure with little to no training in healthcare administration. It’s simple, right? After all, you’re a doctor!
Whether you’re starting a side business in order to diversify your income or you’re leaving the hospital to start a private practice, it’s important to do your due diligence. That’s business speak for do your homework! And that’s something you know how to do, right? But where do you begin?
Choosing a business structure and filling out business forms may not be top of mind when you dream of your own healthcare startup, but it’s one of the first things you need to do with a business of any kind.
Think before you register your business structure.
After all, it’s a decision with huge implications. It’ll determine your legal liability for this business and how the IRS will tax your profits. The appropriate medical practice business structure can also vary from a non-healthcare business structure.
Business structures can quickly get complex, and the wrong choice can limit the growth and health of your company. They can also vary, depending on state and local laws in your area. For a detailed and thorough analysis on which choice is best for you, reach out to a business attorney.
For a basic overview, I’ve included a chart from CGPartnership.com that provides a great visual, and summarized the five types below:
Five types of business ownership
No single business structure will be right for every small business, but in many cases, a sole proprietorship can be ideal. Why? Mainly due to it’s simplicity. With a sole proprietorship, you own 100% of your business and report profits directly on your individual tax return. You can seek investments from a wide range of sources, and you will be the key decision maker for your business. The most significant drawback is the legal and financial responsibility of sole proprietorship. However, in most industries, you can find a good umbrella business insurance policy to cover these bases and mitigate your risk. As you can see from the figure below, compiled by 21st Century Taxation using Joint Committee on Taxation data, sole proprietorship is by far the most common business structure. However, you should do your due diligence to decide if it’s right type of business for you.
In a partnership, multiple people or businesses will divide ownership of the business, and profits will be divided among these entities on tax returns. Partnerships can be general partnerships, limited liability partnerships, and limited partnerships, but they are still absent of a corporate structure that takes ownership out of the hands of individuals or into the hands of stockholders.
Many business names include LLC (Limited Liability Corporation) in the title as this hybrid business structure rapidly grows in popularity. It allows for legal liabilities to be shifted away from business owners, while profits and losses are passed through owners without taxation of the business itself. So for example, if someone were to sue the business for any reason, it would not effect the personal finances of the owner(s). More than one owner can open an LLC, and most states refer to the owners as members rather than “partners” in their legal status. This verbiage is used to differentiate an LLC from a partnership where the profit distribution, liability exposure and tax distributions are not the same.
If you plan to substantially grow your business or you have a selective group of investors, it can be beneficial to opt for a corporation structure, also known as a C-corp. A corporation is a business entity separate from the individuals who founded it that can be taxed and held legally responsible for actions, and it can make a profit. The most significant drawback is the extensive record keeping required for corporations as well as the high cost of founding one, but this can be worth it in situations where high liabilities may be anticipated, since business owners will be shielded by the corporate structure. Some C-Corporations on the Fortune 500 list include Exxon Mobil, Intel, and Walmart.
One drawback that exists with corporations or a C-corporation is double taxation — a it’s taxed for its profits, and then individuals are taxed when earnings are distributed to shareholders. S-corporations avoid this by limiting the number of shareholders to 100 with a single class of stock. In this structure, profits are exclusively taxed on individual shareholders’ returns, but legal liability still falls onto the corporation. It’s important to note that many large companies, like the ones mentioned earlier choose a C-corporation filing because many states do not recognize S-corporations as a business entity type. An additional drawback of an S-corp. is that shareholders are required to pay taxes on the company’s profits rather than on personal income.
Because each business structure has so many potential benefits and drawbacks, it is helpful to consult with a business lawyer or tax specialist before deciding. In addition, you should anticipate the future growth of your business, because changing your business structure can be exceptionally challenging later on.