According to the Small Business Administration, there are 32.5 million small businesses in the United States, which employ 46.8% of all private sector employees. Small businesses are generally defined as “an independent business having fewer than 500 employees.” Of these U.S. small businesses, 26.5 million (81%) have no employees and 6.1 million (19%) have paid employees. Veterinary practices are included in both of these groups.
How Small Businesses Are Legally Organized
86.6% of non-employer firms (they have no paid employees) are sole proprietorships, while 14% of small employer firms (have paid employees) are sole proprietorships (only have one owner).
About 7.4% of non-employer businesses and 11.9% of employer businesses are partnerships.
More than half of small employer firms are S-corporations. The differences between these business entity types affect taxation, liability and administrative responsibilities. Importantly, the structure can markedly affect taxation at the time of a practice sale. Because of this, seeking accounting and legal advice when forming a practice is very important.
The simplest form is sole proprietorship. It is not a legal entity; it is the default if you start a business and do not form a legal entity but simply obtain local licenses.
A sole proprietorship has a single owner who pays personal income tax on profits earned from the business. The business can operate under the name of its owner or under a fictitious or “corporate” name. However, the disadvantage is that there is no shielding of the owner’s assets from creditors or lawsuits in the case of a litigious client. A sole proprietor remains personally liable for all the business’s debts and damages awarded by a court of law.
Partnerships in veterinary practice are similar to sole proprietorships in that each partner receives a share of the practice’s profits. That share—along with their compensation for effort as a veterinarian—are taxed as personal income and are subject to payment of estimated self-employment taxes through the year.
Like in a sole proprietorship, if some of the income of the business is used to purchase assets with cash, or pay down debt, these amounts will be taxable to each partner as well. These are considered pass-through entities because the profit is not taxed at the business level, but passed through to the individual owners.
Another popular form of business is the Limited Liability Corporation, or LLC. This entity type is easy and inexpensive to form, has less administrative requirements, has maximum flexibility in how the firm is managed, and does not require a board of directors. In addition, because it separates the owner(s), also called the members, as an entity distinct from their personal assets, it protects them from business debts and damages, except those from malpractice claims.
An LLC can give business owners significantly greater federal income tax flexibility than a sole proprietorship, partnership or corporation. The Internal Revenue Service (IRS) allows business owners of an LLC to choose the way their business will be taxed. They can choose to be taxed as a sole proprietor, a partnership, an S corporation or a C corporation.
An S corporation is not actually an entity type, but a taxation method. S corporations are corporations that have elected to be taxed as a partnership. Because they pass profit through to the owners (called shareholders), taxes are due on monies that are not distributed to shareholders but are retained in the company or used to buy assets or pay debt.
However, S corporations allow veterinarians to be paid salaries as veterinarians (subject to income as well as payroll tax), then simply pay income tax on their profits (no Social Security and Medicare taxes). While this saves money in the short term, the accumulated Social Security earnings upon which future benefits will be calculated will be short-changed by this strategy, so robust retirement savings should be implemented.
C corporations are unpopular as a business entity because they are subject to double taxation. The business pays at the corporate level, and then shareholders pay on any income received as dividends. There are ongoing filings and fees to stay in compliance, less management flexibility, and a requirement for a board of directors with stringent rules for regular meetings and records of these meetings.
For very large practices where multiple shares will be sold to multiple shareholders, these transactions will have tax advantages to the sellers, which is not the case for the other entities.
When choosing the right business entity for your veterinary practice, it is highly recommended to seek professional advice. Tax consequences both present and future should guide your decision, along with your ability to meet administrative requirements. Because changing your entity later can be expensive, conduct due diligence before forming your business and make a wise choice that will last a lifetime.
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