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Choosing the Right Business Entity for Your Professional Micro-Corporation

Aug 09, 2024

When establishing your single-member professional micro-corporation, selecting the appropriate legal business entity is a critical decision that can impact your tax obligations, liability exposure, and overall business operations. Here's a comparison of the key options available to you:

Sole Proprietorship/Single Member LLC/PLLC:

100% of Profit Subject to SE Tax:

In these structures, all profits are subject to self-employment (SE) tax, which includes Medicare and Social Security taxes.
Deductible Business Expenses:

You can deduct legitimate business expenses to reduce taxable income and lower your overall tax liability.
Simple Tax Filing:

Sole proprietors and single-member LLCs file taxes as part of their personal tax return, simplifying the tax filing process. Both can be classified as disregarded entities for tax purposes, meaning the business income is passed through to the owner's personal tax return.
Liability & Asset Protection Considerations:

Sole Proprietorship: This structure does not offer liability protection. Personal assets can be at risk in the event of business debts or legal actions.

Single Member LLC/PLLC: While these structures offer some degree of liability protection, they may not provide comprehensive protection against personal liability, especially in cases of professional malpractice.
Audit Risk:

Although physicians often choose this structure due to its simplicity, it is also among the most highly audited tax entities due to the use of Schedule C and the high-income levels typically associated with medical professionals. According to recent IRS data, approximately 1.4% of sole proprietors and single-member LLCs classified as disregarded entities are audited each year. For physicians, the audit rate can be higher, with estimates suggesting that around 2-3% of doctors are audited annually due to their high income and potential for deductions.

Professional Corporation/Professional Association (PC/PA):

Exclusivity to Licensed Professionals:

These entities are designed specifically for licensed professionals, including physicians. It depends on which state you live in whether it’s called a PC or a PA and you can learn more at my blog post: Micro-Corporation Names: Your Professional DNA
Tax Classification Options:

PC/PA entities can choose to be taxed as an S-Corp or C-Corp, offering flexibility in tax planning and optimization.
- Common Classification as S-Corp or C-Corp: Many physicians opt for an S-Corp or C-Corp classification due to favorable tax treatment and liability protection benefits. Read more at my blog post: Which Corporate Structure Is Best For Self-Employed Doctors?
- 21% Flat Tax Rate for Net Profits (C-Corp): C-Corps are subject to a flat tax rate of 21% on net profits, potentially resulting in tax savings compared to individual tax rates.
- Tax Classification as S-Corp or C-Corp: S-Corps offer pass-through taxation, meaning profits are passed through to shareholders and taxed at individual tax rates, while C-Corps are subject to corporate tax rates.
- Dividend Taxation (C-Corp): Dividends distributed to shareholders in a C-Corp are taxed at their personal tax rates, potentially resulting in double taxation.
Liability and Asset Protection: PC/PA entities provide limited liability protection for personal assets, shielding them from certain business-related liabilities (excluding malpractice).
Distributions Not Subject to SE Tax:

Distributions received by PC/PA members are not subject to SE tax, offering potential tax savings.
W-2 Compensation (S-Corp): As an owner-employee of the corporation, you receive compensation in the form of W-2 wages, which are subject to SE tax. Read more at my blog post: The Self-Employed Physician’s Guide To Determining Their Salary
Tax-Efficient Fringe Benefits: PC/PA entities can maximize tax-efficient fringe benefits, such as medical expense reimbursement plans (MERP), to benefit the household and reduce taxable income. Read more at my blog: The Self-Employment Advantage: Personalized Benefits.
Reduced Audit Risk:

Physicians who structure their practices as Professional Corporations (PCs) are generally less likely to be audited compared to those operating as sole proprietors or LLC’s that use schedule C. Here are the key reasons:
- Corporate Tax Return: A PC files a separate corporate tax return (Form 1120 or Form 1120S for an S-Corp) rather than a Schedule C on the individual tax return. The IRS tends to scrutinize Schedule C filings more closely due to the higher potential for underreporting income and overstating deductions.
- Clearer Separation of Personal and Business Finances: PCs provide a clear separation between personal and business finances. This distinction can lead to fewer red flags for the IRS, as it reduces the likelihood of commingling personal and business expenses, a common issue with sole proprietorships.
- Structured Payroll: In a PC, physicians typically pay themselves a salary, which is subject to payroll taxes. This structured payroll system can make the business appear more compliant and less risky to the IRS compared to sole proprietorships, where income and expenses are more intertwined and subject to personal discretion.
- Reduced Likelihood of High-Risk Deductions: PCs often have more formalized accounting practices, leading to more accurate and justifiable business deductions. This reduces the chance of claiming high-risk deductions that could trigger an audit in a sole proprietorship.
- Professional Management and Compliance: PCs are often managed with more rigorous adherence to regulatory and tax compliance. The presence of professional accountants and legal advisors can ensure that the corporation meets all tax obligations accurately and on time, further lowering audit risk.

Professional LLC (PLLC):

Exclusive to Licensed Professionals:

PLLCs are tailored for licensed professionals and offer similar benefits to PC/PA entities. You can read more about this at my blog post: Professional Micro-Corporations: Should I Start A PC or a PLLC?
Tax Classification Options:

PLLCs can choose to be taxed as a pass-through entity (single or partner) or corporation, providing flexibility in tax planning. This is one reason that many CPA’s prefer this business structure because you can choose one of 3 tax classifications: disregarded entity, S-Corp, C-Corp. In contrast a PC only has two tax classification options: S-Corp or C-Corp.
Liability and Asset Protection:

PLLCs offer limited liability protection, shielding personal assets from certain business liabilities.
Simplified Setup and Compliance:

PLLCs are relatively easy to establish, cost-effective, and have fewer compliance requirements compared to corporations.
W-2 Portion Subject to SE Tax:

Wages paid to PLLC members are subject to SE tax, similar to PC/PA entities.
Distributions Not Subject to SE Tax:

Distributions received by PLLC members are not subject to SE tax, offering potential tax savings.
Reasonable Salary Requirement:

PLLC members must receive a reasonable salary, similar to S-Corp owners, to comply with IRS regulations. Read more at my blog post: The Self-Employed Physician’s Guide To Determining Their Salary
Tax-Deductible Business Expenses:

PLLCs can deduct legitimate business expenses, although some expenses may be added back as income for tax purposes. Make sure to work closely with an accounting professional to make sure you manage this properly
Audit Risks:
- You are at increased risk for an audit if you choose a disregarded entity tax classification. This is among the most highly audited tax entities due to the use of Schedule C and the high-income levels typically associated with medical professionals.
- You can reduce your risk for an audit, if you choose an S-Corp or C-Corp tax classification—for all same reasons noted above or a PC.

When choosing the best legal business entity for your single-member professional micro-corporation, consider factors such as tax implications, liability protection, compliance requirements, long-term business objectives and audit risks. Consult with a qualified attorney, accountant or tax advisor to assess your specific circumstances and make an informed decision that aligns with your financial and professional goals. At SimpliMD I can make this much easier for you by allowing me to be your professional business guide and will personally coach and connect you with our network of professionals who help doctors set up and operate their professional micro-corporations all over the country. This will save you time and money as I help you efficiently work with professionals who have been vetted by SimpliMD. We’ll make sure things are done correctly for you using a playbook that is tax efficient and enhances your wealth accumulation.

S-Corporation (S-Corp) for Physicians: Optimizing Tax Efficiency and Liability Protection

If you are seeking enhanced tax efficiency and liability protection, the S-Corporation (S-Corp) structure offers a compelling solution. By electing S-Corp status for your single-member professional micro-corporation, you can leverage a range of benefits tailored to your unique needs and preferences. Here's a closer look at the advantages and considerations of choosing an S-Corp:

W-2 Portion Subject to SE Tax:

As an S-Corp owner-employee, the portion of your income received as wages (reported on a W-2) is subject to self-employment (SE) tax. This includes Medicare and Social Security taxes, similar to other employment income.
Distributions Not Subject to SE Tax:

Unlike wages, distributions received from the S-Corp are not subject to SE tax. This presents an opportunity for tax savings, as distributions are taxed at the individual's ordinary income tax rate rather than the higher SE tax rate.
Reasonable Salary Requirement:

To comply with IRS regulations, S-Corp owners must receive a reasonable salary for their services rendered to the corporation. This ensures that compensation reflects fair market value and prevents owners from circumventing SE tax obligations by characterizing all income as distributions. Read more at my blog post: The Self-Employed Physician’s Guide To Determining Their Salary
Deduct Business Expenses but Some Expenses Added Back as Income:

S-Corp owners can deduct legitimate business expenses, reducing taxable income and lowering overall tax liability. However, certain expenses, such as personal expenses or excessive shareholder benefits, may be subject to IRS scrutiny and added back as income.
Health Insurance:

S-Corp owners may be eligible to deduct health insurance premiums paid by the corporation as a business expense, providing valuable tax benefits and enhancing access to affordable healthcare coverage for themselves and their families.
Tax Classification and Flat Tax Rate:

S-Corps are pass-through entities, meaning profits and losses are passed through to shareholders and taxed at individual tax rates. The most common PC/PA classification for doctors is an S-Corp, offering flexibility in tax planning and optimization. S-Corps are subject to a flat tax rate of 21% on net profits, potentially resulting in tax savings compared to individual tax rates.
Paid as W-2 by Corporation:

As an owner-employee of the S-Corp, you receive compensation in the form of W-2 wages, which are subject to SE tax. This structured compensation ensures compliance with IRS regulations and establishes a clear distinction between salary and distributions.
Maximizing Shareholder Expenses and Business Deductions:

S-Corp owners can maximize tax efficiency by leveraging shareholder expenses and business deductions to reduce taxable income. This includes optimizing fringe benefit plans, such as medical expense reimbursement plans (MERP), to benefit the household and enhance overall tax efficiency.

In summary, most of you will choose a PC or PLLC taxed as an S-Corporation because it offers you a powerful structure for optimizing tax efficiency, managing liability exposure, and maximizing after-tax profits. By understanding the unique advantages and considerations of your business entity options and tax classifications, you can work with a legal or accounting professional to make informed decisions that align with your financial goals and long-term business objectives.

I invite you to let me help you with this complex process through my highly efficient business guide services where I will provide a personalized business consultation and then based on your needs will connect you with a vetted professional in our network who can help you create your micro-corporation and support it’s operation. This will be $500 well spent!