Wednesday, August 29, 2012

Is Electing an S-Corp Status the Best Option for this Dental Group?

I have a hypothetic tax question. Of course I am reviewing this with both the accountant and financial planner, but curious of your opinion.

Assume there is a group practice with multiple owners that make more than 250,000 net (let’s say 500,000 average for argument sake, but they truly are not equal, one might be 375,000, one might be 600,000, etc).

They currently operate under an LLC as the practice operating entity. 

…and I assume that LLC is currently being taxed as a partnership, correct?

They are thinking of electing S-Corp status through their LLC to avoid some of the pending tax increases.

As an S-Corp, how will this effect
1) their ability to unequally distribute compensation

It will add a couple of steps to the year-end planning process as well as the following years tax return prep, though it won't be a big deal. Basically you'll want the wages to be set at the lowest base salary for everyone. Then, when you calculate who is due what, you'll use the wages to "reconcile" the compensation differences. For example:

Let’s assume everyone takes a salary of $250k. At the end of the year, it's determined that one should make $375k. One should make $500k and the other $600k. That means that one gets $125k more, another gets $250k more and the last gets $300k more.

The last one gets a W-2 bonus of $175k ($300k-$125k), the second one gets a W-2 bonus of $125k ($250k-$125k) and the first one gets NO W-2 bonus. That leaves $375k of S-Corp profit split evenly at $125k each so everyone got what they were entitled.

The trick is this will have to be estimated in December then reconciled to actual for the year when all the numbers are final for tax return purposes. These reconciliation differences will also run through wages.

2) the ability for a partial sale of personal goodwill should a transition occur

Bingo. This is where the S-Corp complicates transitions and you might want to weigh this issue with existing income tax issues.

In my opinion the parent LLC taxed as a partnership provides the most flexibility when it comes to future transitions in and\or out.

There are a couple of potential options, each with pros\cons:

A. consider the S-Corps at the partner level instead of the parent LLC level
B. consider creating another entity, S-Corp, as a management or dental provider company with the 3 owners so that it won't own any of the tangible assets or personal GW, it just provides the dental services. The LLC pays that company for its dental clinical services to the extent of the LLC profits, the S-Corp then pays its doctor providers based on their clinical efforts accordingly.

I haven't thought this completely through; however, that MIGHT allow you to minimize your current taxes while maintaining the ease of future transitions.

This model is used quite frequently with certain corporate buyers. They own the "parent" company while the doctors have their own clinical corps. The parent company pays the doctors clinical corporation for services.

Good luck

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