Mike McAninch is a Practice Integration Advisor with Buckingham Strategic Wealth, where he specializes in helping dentists connect their money and their values to realize their most important financial goals.
We’ve devoted several articles in recent weeks to evaluating the advantages and disadvantages of selecting certain types of business entities. The two other business entities we’ve addressed, namely the Sole Proprietor and S Corporation, are pass-through entities, where the practice’s business earnings are reported and taxed at the owner’s personal income tax rate. Today, we’ll discuss C Corporations, whose earnings are subject to their own income tax. As you might have guessed, this new level of income taxation creates an additional layer of complexity. Let’s take a look!
What are the advantages of operating as a C Corporation?
The first benefit of a C Corporation involves liability protection. In most cases, the owner of corporation stock has limited liability for the actions of the corporation. The most notable of these protections comes into play if the corporation declares bankruptcy. Should that occur, the owner’s assets are shielded from creditors.
Second, certain owner expenses not tax deductible by other business entity types are tax deductible by a C Corporation. For example, in a C Corporation, certain fringe benefits like health-care insurance premiums, long-term disability insurance premiums and education assistance programs are deductible by the corporation and are not reportable as income to the employee. This might be advantageous to the dental practice owner.
Third, pension contributions by a C Corporation are tax deductible when compared to a Sole Proprietor, whose pension contributions are not deductible within the business. As a result, a C Corporation avoids FICA and Medicare taxes assessed on a Sole Proprietor’s earnings.
What, then, are the disadvantages of operating as a C Corporation?
First, C Corporations are subject to federal income taxes at a rate of 21% (and in some cases state income taxes as well). To avoid this corporate income tax, most C Corporation dental practice owners pay themselves a “bonus” salary to eliminate any corporate profit.
Second, should cash accumulate in a C Corporation, paying out that cash to the practice owner may result in two layers of income taxes: corporate income taxes on corporate earnings and personal income taxes on dividend income the owner receives.
Third, even if no tax ultimately is owed, C Corporation practice owners must still file two sets of tax returns: corporate and personal. This requirement adds a layer of tax preparation expenses on top of the cost of filing personal tax returns.
Selecting a business entity type is a decision that you, your accountant and your attorney should carefully analyze. Once you choose a business entity, changing it likely will incur additional income taxes and possible penalties. Our Practice Integration Advisors have experience in selecting entity types, and we would be glad to discuss that decision with you!