Sole Proprietor vs. Incorporating: What’s Best for a Dentist?
Updated: Jan 11, 2021
For those evaluating purchasing a dental practice, a common question is whether or not to form a corporation. The answer really depends on your unique situation, and you should evaluate several angles before incorporating and committing to all that entails.
What’s The Point?
The primary and most important purpose of incorporating is business owner liability protection. Liability protection from what, you ask? From life. Stuff happens; people sue. You’re going to have insurance, regardless, but is it enough, and what happens if it isn’t enough?
Damages from a Lawsuit
Let’s say you have $1 million of liability insurance coverage, for which you pay $5,000/year. Something goes wrong, you’re sued, and you now owe $8 million in damages to your former patient. Your insurance will pay $5 million, but you’re on the hook for the remaining $3 million above your coverage limit. Whether or not you’re incorporated, the $3 million can come from the business. Assuming you don’t have that much cash in the bank, your business’ assets will be liquidated to generate the cash needed.
Segregation of Assets
Having formed a corporation won’t stop a lawsuit from gutting all of your business’ assets. The benefit of a corporation, however, is that it stops the bleeding at the business level and doesn’t allow it to extend to the other parts of your life. In the situation mentioned above, assuming the dentist wasn’t incorporated, the person who sued can reach into your personal life to get the money they were awarded by the court. Let’s assume that only $1 million of cash was generated from your business bank accounts and liquidated assets. The person who sued has the right to seek the remaining $2 million from your personal bank accounts, and might even force you to sell your home, rental property, etc. to generate the needed cash.
The main benefit, therefore, is that the corporate structure isolates your business activity from the rest of your life. In the example discussed above, the person who sued would get their $1 million from the liquidated practice and that would be it. The minimum annual fee for a CA corporation is $800, and that’s fairly inexpensive “insurance” to protect your home and other assets. If you own the business property used by your dental practice, you’ll likely want to ensure it’s further segregated in it’s own LLC. Additionally, it’s typically a good practice to also place any other rental properties in their own LLC.
Additional Protection Strategies
It’s critical to ensure that your insurance coverage is adequate. The corporation structure is designed to protect the rest of your life from a highly unusual, catastrophic event which completely liquidates your dental practice. As such, it’s much preferred to have sufficient insurance coverage to avoid the destruction of your practice. Insurance coverage should be reviewed at least annually which a trusted professional.
In the S-Corporation structure, when there’s a single owner, the cash sitting in the corporate bank account is usually capable of being taken as either owner wages or as a capital distribution (“dividend”). Some corporate owners keep far too much cash in the corporate checking account. Think about it: why would you keep excess funds in the bank account where it can be easily accessed by potential creditors? Once you pay yourself and the funds are in your personal bank account, in most situations the funds are beyond the reach of any potential creditors at the corporate level. The whole point of the corporate protection is to isolate assets, so leaving excess cash at the corporate level defies logic.
Instead, the corporate owner should identify a healthy cash balance threshold and routinely pay wages or dividends to keep the corporate account below that threshold. For example, if the business typically spend $50,000/month, the owner might keep an extra $30,000 buffer in the account just in case. Therefore, the healthy account threshold would be $80,000 and the corporate account balance shouldn’t far exceed that amount.
The motivation for forming a corporation used to be tax reduction, which is no longer quite as applicable due to the need for reasonable officer compensation (see article here). While there is some room for improving your tax structure with a corporation, the main benefit is really the liability protection we just discussed.
Incorporating can be quite expensive, and that initial cost may actually make it not make sense for dentists later in their career. In addition to the annual fee paid to the state, one has to factor in additional expenses including preparation of the corporate tax return and the requirement to run payroll for the owner. Corporations are required to conduct an annual meeting in which formal minutes are kept. Additionally, there’s an annual filing with the Secretary of State identifying the Officers and Director(s) of the corporation. Failing to complete these steps and treat the corporation as a true separate entity can result in what’s called “piercing the corporate veil”, in which case one can lose any liability protection.
The primary purpose of incorporating is liability protection, and it can be considered a fairly inexpensive type of catastrophic “insurance” to isolate your business liability from the rest of your life. However, incorporating adds significant ongoing responsibilities and governmental filings and each practitioner should evaluate their unique circumstances to determine if it’s the right move for their practice.
Dave Sholer, CPA, MBA works exclusively with dentists in California, offering full-service accounting & tax solutions for dental practices of all sizes.
Want more info? Dave offers a no-cost, zero obligation consultation to answer whatever questions you have and/or to review your books, tax returns, and payroll situation. He can review your unique situation to determine if incorporation makes sense, and can even get your corporation set-up if it is the right move. Additionally, Dave’s full-service model includes all annual corporate filings such that there’s no burden on your life.