Which business structure is right for your practice? (Proceedings)
Choosing the correct structure for your veterinary practice is an important decision with consequences reaching far into the future. Selecting your practice structure is definitely not a "do it yourself" project. Substantial tax, legal and accounting expertise is required. Veterinarians nevertheless need to stay active in the process to ensure the experts' narrow technical proposals get folded into a coherent plan that reflects your needs and goals.
The accompanying table compares the more common business structures from a liability, management and formality perspective (in simplified form). Following is a brief and much simplified overview of the tax characteristics of each entity.1. Sole Proprietorships. Since sole proprietorships are not legally separate from the single owner, there is no separate tax return. The practice's profits are included in owner's total income and are taxed at his ordinary income tax rate. In addition to federal and (if applicable) state income tax, the owner must also pay self-employment tax equivalent to the payroll taxes due as if the owner were an employee of the practice.
Upon the sale of the sole proprietorship practice's assets, the IRS will recapture all depreciation/amortization deductions taken by the owner/seller thereof and tax such amount at the seller's ordinary income tax rates. In the unlikely event that any gain remains on the assets (after adding back any depreciation/amortization to their respective "bases" ) they will be taxed at the lower 20% long term capital gains rate (assuming the relevant holding period is met).
The buyer receives a "step-up" (increase) in his basis in the assets proportional to the amount of (purchase price allocated thereto) allowing him to re-depreciate/amortize them. Thus, asset sales usually are a better deal tax-wise for the buyer than for the seller, and all other things being equal, buyers will prefer to purchase assets rather than stock (in a C corp).
2. Partnerships. Partnerships are "pass-through" or "flow-through" entities for tax purposes, meaning that each partner includes in his own taxable income the profits (or losses) of the partnership, which are taxed as ordinary income at the partner's individual rate (much like the owner of a sole proprietorship). Note that each partner's share of partnership income is taxable each year, whether such share was distributed to the partner or retained in the partnership. If the latter, then the partner may not have the cash to pay the tax.
A consequence of the pass-through principle is that the sale of partnership interests are treated for tax purposes similarly to the sale of the underlying assets of the partnership (i.e., the assets are subject to depreciation recapture as in sole proprietorships).
3. Corporations. All corporations must file separate tax returns.
If the holding period requirement has been met, the sale of C corporation stock is taxed at the favorable 20% long term capital gains rate. The buyer does not receive a step-up in the basis of the underlying assets since he is buying the corporation stock. (The buyer can under certain circumstances elect to treat the transaction as an asset sale for tax purposes (a.k.a. a Section 338 election).)
4. Limited Liability Companies. Limited Liability Companies are very quite tax-wise. Single member LLCs can elect to be taxed either as a C corp or a sole proprietorship. Multi-member LLCs can elect to be taxed either as a C Corp or a partnership. Unfortunately, not every state allows veterinarians for form LLC (ie, California).
5. A Word Regarding Real Estate. If the practice owns its own real estate it's better placed in a separate entity held by the owner(s) or held individually by the practices owner(s). This allows the owners to receive rent (which will be deductible from the practice's income). Moreover, placing the real estate and the practice in the same legal entity frequently leads to problems because the buyer can't afford to buy the real estate in addition to the practice.
***Choosing the correct business structure for your practice is important. Don't treat it lightly.