Editor’s note: This is a guest post from a fellow business owner, Johanna Fox. Johanna is a CPA, CFP®, RLP® and senior partner at Fox and Company Wealth Management Services. Her woman-owned firm is fee-only and provides comprehensive portfolio and tax management services to physicians. Johanna is also a forum moderator and frequent contributor to The White Coat Investor. We have no financial relationship. Enjoy!
One of the most common questions we receive from solo business owners (physicians who either moonlight, have a side business, or are starting a business) is: which entity should I choose?
Let’s look at the three most popular choices:
- Sole proprietor – A sole proprietorship is the simplest form of entity. If your services are covered by an appropriate malpractice policy, it’s also probably the best choice for you. In essence, there are no special filings except maybe a local business license. You’ll file your business results (income and expenses) on a Schedule C with your Form 1040 and you’ll pay FICA taxes (Social Security + Medicare) on your profits. If this is just a side gig, chances are you’re paying only Medicare taxes of 2.9% (with an above-the-line deduction for half of that amount). Set up a home office and deduct mileage from your home to all business-related activities.
- Limited Liability Co (LLC) An LLC has an added layer of complexity. You’ll have to set up your LLC with the state where your business is located and in any other states in which you do business (think traveling locums). This will cost whatever the Secretary of State dictates. You’ll also have to file an annual or bi-annual license renewal in the same states and pay an annual fee or risk having your LLC administratively dissolved. As a physician, you will be licensed as a “SMPLLC” or “Single Member Professional LLC”.
The benefit of an LLC is your personal assets are protected from activities of the business. However, your activities as a doctor are not protected by an LLC, even if you do business as an LLC – you must have adequate malpractice insurance coverage. Beyond that, you report your activities the same as you do as a sole proprietor: Schedule C filed with your Form 1040 and pay FICA taxes on the profits. (A SMLLC is perfect for the piece of rental property you own, by the way. You also won’t owe FICA taxes because the income is “passive”, not “earned”.)
When would you want to file as an LLC?
- When you are doing work beyond the scope of your professional work as a doctor, such as when you write a blog and give advice.
- When you have employees whose actions could get you sued. For example, if you own a practice and your PA gives the wrong medication to a patient.
- The third time is when you own real estate. This is to protect you personally from accidents on your property. (You may be able to accomplish a similar level of protection with umbrella insurance.)
- See more in this article I wrote about LLC's.
California does not allow doctors to operate as LLCs so you’ll have to choose to be either a Sole Proprietor or an S-corporation.
- S-corporation An S-corporation provides the same level of liability protection as an LLC, but with the most complexity. You will register your corporation with the Secretary of State and pay a setup fee and an annual fee, same as with a SMPLLC – but the similarity stops there.
An s-corp requires you to file a separate income tax return, which will cost a minimum of $1,000 to $1,500 and up to $2,500 or more. In addition, because you are both the “owner” and “employee” of the corporation, you as the corporate owner will have to hire you, the employee.
The result is that you must pay yourself W2 wages, along with all requisite local, state, and federal tax forms and required payments. For example, you will have to pay into your state’s unemployment fund in case you ever fire or lay yourself off. Crazy, isn’t it? This, of course, is either going to cost you a lot of extra time or money for payroll administration.
If you have a home office, you’ll also have to set up an “accountable plan” to be able to deduct your home office expenses. More hassle…but not enough to bypass the home office deduction!
So why would anybody want to go the S-corp route? Because you may be able to save taxes. That’s a totally different article, which is in my rotation to post soon. However, my general rule of thumb (unless you live in CA) is that you shouldn’t even consider setting up as an S-corp until:
- Your gross receipts are at least $300k – $400k, and/or
- You have other employees besides yourself (meaning you’ll have payroll administration besides yourself).
Otherwise, stick with a sole proprietorship or a SMPLLC.
A final consideration beginning in 2018 is the Section 199A deduction. Before you make a final choice, you should definitely determine if Section 199A is available to you and, if so, which business entity (either sole prop/LLC or S-corp) will yield optimal results.
A common myth states that you must have a corporation in place in order to set up a retirement plan, such as a SEP or Solo-401(k). Not true. You have access to the same retirement plans regardless of entity. In addition to the contribution limits, businesses with multiple employees should consider cost and complexity when choosing a retirement plan.