We have had the honor of speaking at many conferences this year and have fielded too many questions to count. Having said that, one particular question seems to come up with great frequency among those who own group practices:
“What’s the difference if I’m an S, C or LLC as it relates to the tax impact of selling my business?”
Well, we’ve also closed several deals recently (and have several others in the works) where the corporate election will have a major tax impact on the outcome of the deal. There are structural considerations of the transaction that can offset some – not all – of the tax impact, but make no mistake – corporate entity election swings major dollars at the closing table.
In an effort to shed some light in this area, we posed the question above as well as a few others to one of the dental industry’s noted authorities, Steve Mizrach of Dorfman, Mizrach & Thaler, LLP. Steve is the Partner in charge of Healthcare Services at DM&T and has a broad background in taxation and accounting. He has extensive experience with healthcare providers as well as MSO’s and DSO’s in matters that include structuring transactions, financing and financial analysis, and general practice strategies. Needless to say, Steve is an industry expert and we’re thankful for his contribution to this blog post.
What are the fundamental legal and accounting and tax differences between an S, C and LLC?
From a legal point of view S’s and C’s are both corporations while an LLC is a Limited Liability Company. Each of them provide protection from personal liability thus limiting one’s loss to the amount of funds invested in addition to any debts that are personally guaranteed. Given that corporations have existed far longer than LLC’s some attorneys prefer corporations to LLC’s due to this longer history as it relates to case law.
From a tax perspective, a C corporation is taxed as a separate entity and as a result incurs its own taxes. To the extent that a C corporation distributes profits to its owners, a dividend arises whereby the recipient is taxed on the amount received which creates a second level of tax. This is where the term “double taxation” arises.
S corporations, on the other hand, tax their owners irrespective of whether they receive any money. There is no entity level tax nor are dividends taxed to the owners. Thus, there is only one level of tax. Not all corporations qualify as S corporations and there are certain rules that must be adhered to in order to maintain S status.
LLC’s can be taxed as either Schedule C’s, partnerships, C or S corporations, depending upon whether certain elections are filed as well as the number of owners in the business. If no elections are filed, then an LLC is deemed to be taxed as either a Schedule C or a partnership, depending on its owners.
The owners of a partnership are taxed on the profits of the entity much like an S corporation. However, partnerships offer greater levels of flexibility than S corporations in allocating income and losses as well as distributions.
Which entity do single doctor practices use most often?
In our experience, most single doctor practices either file as a Schedule C or S corporation.
Is there any difference for multiple doctors in one or two locations?
In situations where multiple doctors share profits differently as a result of having different locations, we have found that the best choice of entity is either forming a partnership whereby income can be specially allocated or perhaps forming separate entities for each location.
One of the benefits of having separate entities for each location is to limit the amount of the liability to the entity that exists within that location. This is especially useful when there are different doctors who are responsible for operating individual offices.
At what point does a “group practice” become a formal DSO structure?
We have found that practices start to think about formalizing a DSO structure when they have determined that they would like to have 5 or more offices and can envision having more partners who will be sharing profits differently.
Another reason is to create a vehicle for financing so that the DSO structure can facilitate the process of raising funds for growth.
What corporate entity do you see most often for these DSO’s and why?
On the DSO side, we usually see LLC’s taxed as partnerships especially when the DSO is owned by the founders as opposed to private equity. The primary reason for this is to allow for a single level of taxation especially upon exit, i.e. sale, as well as to allow for special allocations of income and loss.
When private equity is involved, we often see C corporations used in order for the investors to be insulated from taxation of the operational activities of the DSO. Within the DSO environment, depending on whether the owner doctors share in the profits of the practice as opposed to just being compensated for the performance of dentistry, we often like to use LLC’s taxed as partnerships when the doctors share in the profits and C corporations when they are only compensated for the dentistry performed.
Our primary reason for this approach is avoid double taxation on the payment of dividends while insulating the doctors from the taxation of the profits of the practice when their compensation is limited to their performance of dentistry.
What are the considerations if someone wants to change their corporate entity?
From the legal and regulatory perspective, if one wants to change their structure to implement a DSO arrangement, consideration should be given to having the proper legal documents drafted that will allow the DSO to maintain a legal business relationship with the practices.
In addition, if the entities elect to change their business entities, care must be exercised by making sure that the new entities receive the proper approvals from landlords, leasing companies, etc. so that they will be recognized.
From a tax perspective, it is critical to obtain advice from a professional well-versed in taxation to provide an analysis of the tax ramifications and provide the procedural guidance of changing the tax structure of an entity.
We are often asked by a client or prospective client about the tax ramifications of converting an S or C corporation to an LLC. If a corporation were to convert to an LLC, this would be the equivalent of the corporation selling its assets at fair market value and then distributing them to the shareholders, who would then contribute them to the LLC. This could provide potentially disastrous tax consequences to the owners whereby they would most likely incur a substantial tax liability in order to change their structure.
Stay tuned as we’ll be covering topics around the potential sale of your business in much more depth in the coming weeks. And if you think you might be nearing the point of wanting to actually take your business to market, then please consider joining us in Houston March 21st – 23rd for our seminar: “Selling Your Group Dental Practice or DSO: what you need to know and what you should expect.”
- As always, if you’d like to discuss these topics or any others related to trends in our industry, please feel free to contact me at perrin@TUSK-Partners.com or Steve at firstname.lastname@example.org. TUSK provides industry-leading resources for the emerging market DSO. We help our clients START, GROW and SELL their DSO or Group Dental Practice. To learn how we can help you, please contact us directly at info@TUSK-Partners.com or visit our website HERE.