Which business structure is right for your practice? (Proceedings)


Choosing the correct structure for your veterinary practice is an important decision with consequences reaching far into the future. Selecting your practice structure is definitely not a "do it yourself" project. Substantial tax, legal and accounting expertise is required. Veterinarians nevertheless need to stay active in the process to ensure the experts' narrow technical proposals get folded into a coherent plan that reflects your needs and goals.

Choosing the correct structure for your veterinary practice is an important decision with consequences reaching far into the future. Selecting your practice structure is definitely not a "do it yourself" project. Substantial tax, legal and accounting expertise is required. Veterinarians nevertheless need to stay active in the process to ensure the experts' narrow technical proposals get folded into a coherent plan that reflects your needs and goals.

     • It's Mostly About Tax. Tax considerations are the primary drivers in choosing a legal structure for a veterinary practice. The two key aspects are taxation of income/profits and taxation upon the sale or transformation of the practice. Don't paint yourself into a corner by choosing a business structure without establishing a succession or exit strategy. Exit strategies should focus not only on your richly deserved retirement, but also on contingencies such as death or disability). Since the transformation of an existing business structures in anticipation of a sale or the buy-in of a new partner usually triggers adverse tax consequences, it is usually better to choose an initial structure with the necessary flexibility to handle new arrivals, departures and divestitures at minimum fiscal cost.

     • Liability Shield. In some structures such as partnerships, the owners are personally liable on their individual assets for the debts of the business. In others their personal assets generally are not at risk. Business structures, however, do not insulate veterinarians from liability arising from malpractice claims. But the shield works for almost all other claims, which in our litigious society are increasingly frequent. Unless you are an equine or food animal veterinarian, you generally have greater exposure to claims from your client's "slipping and falling" in your hallway, than malpractice.

     • Flexibility and Formalities. Some structures allow more management flexibility and/or are less burdensome to administer than others. Veterinarians generally tend to ignore formalities which is a serious mistake. Courts regularly have looked past the liability shield and held owners personally liable when the owners have failed to observe the formalities separating their personal affairs from those of the practice entity.

An Overview

The accompanying table compares the more common business structures from a liability, management and formality perspective (in simplified form). Following is a brief and much simplified overview of the tax characteristics of each entity.

      1. Sole Proprietorships. Since sole proprietorships are not legally separate from the single owner, there is no separate tax return. The practice's profits are included in owner's total income and are taxed at his ordinary income tax rate. In addition to federal and (if applicable) state income tax, the owner must also pay self-employment tax equivalent to the payroll taxes due as if the owner were an employee of the practice.

Upon the sale of the sole proprietorship practice's assets, the IRS will recapture all depreciation/amortization deductions taken by the owner/seller thereof and tax such amount at the seller's ordinary income tax rates. In the unlikely event that any gain remains on the assets (after adding back any depreciation/amortization to their respective "bases" ) they will be taxed at the lower 20% long term capital gains rate (assuming the relevant holding period is met).

The buyer receives a "step-up" (increase) in his basis in the assets proportional to the amount of (purchase price allocated thereto) allowing him to re-depreciate/amortize them. Thus, asset sales usually are a better deal tax-wise for the buyer than for the seller, and all other things being equal, buyers will prefer to purchase assets rather than stock (in a C corp).

      2. Partnerships. Partnerships are "pass-through" or "flow-through" entities for tax purposes, meaning that each partner includes in his own taxable income the profits (or losses) of the partnership, which are taxed as ordinary income at the partner's individual rate (much like the owner of a sole proprietorship). Note that each partner's share of partnership income is taxable each year, whether such share was distributed to the partner or retained in the partnership. If the latter, then the partner may not have the cash to pay the tax.

A consequence of the pass-through principle is that the sale of partnership interests are treated for tax purposes similarly to the sale of the underlying assets of the partnership (i.e., the assets are subject to depreciation recapture as in sole proprietorships).

      3. Corporations. All corporations must file separate tax returns.

          • "S" Corporations. "S" corporations are corporations that elect to be taxed as a partnership. As "pass-through" entities, profits will be taxed in the hands of the shareholders whether distributed or not. An advantage of S corporations is that shareholders may take a portion of their profits as "S corporation profit," free of payroll or self-employment tax (i.e., subject only to income tax). Profit corresponding to what the veterinarian shareholder would have earned as an employee is subject to payroll taxes in addition to income tax. (Sole proprietorships on the other hand must pay self-employment tax on all profits.) S corps are popular with veterinarians for this reason.

          • "C" Corporations. "Plain vanilla" corporations (called "C" corporations to distinguish them from "S" corps) are not "pass-through" entities and are subject to corporate income tax, usually at the 35% rate for veterinary practices. Distributed profits (dividends) are taxed as ordinary income in the hands of the shareholders. This "double taxation" discourages the distribution of C corporation profits. On the plus side, C corp profits are not taxed until distributed, pension plan contributions are not subject to the S corp limits, and employee-shareholders' health benefits are not taxed. Veterinarians wishing to maximize their benefits will choose a C corp over an S corp.

If the holding period requirement has been met, the sale of C corporation stock is taxed at the favorable 20% long term capital gains rate. The buyer does not receive a step-up in the basis of the underlying assets since he is buying the corporation stock. (The buyer can under certain circumstances elect to treat the transaction as an asset sale for tax purposes (a.k.a. a Section 338 election).)

      4. Limited Liability Companies. Limited Liability Companies are very quite tax-wise. Single member LLCs can elect to be taxed either as a C corp or a sole proprietorship. Multi-member LLCs can elect to be taxed either as a C Corp or a partnership. Unfortunately, not every state allows veterinarians for form LLC (ie, California).

      5. A Word Regarding Real Estate. If the practice owns its own real estate it's better placed in a separate entity held by the owner(s) or held individually by the practices owner(s). This allows the owners to receive rent (which will be deductible from the practice's income). Moreover, placing the real estate and the practice in the same legal entity frequently leads to problems because the buyer can't afford to buy the real estate in addition to the practice.

***Choosing the correct business structure for your practice is important. Don't treat it lightly.

Simplified Partial Comparison of Different Business Structures

(Ex tax issues)

Making the Decision of Selecting The Right Business Entity for You

(from the internet)

The following attempts to take you through the decision making process of deciding which type of legal business is most appropriate for different enterprises. In doing this I will introduce the different structures in America.

     • When starting a company, one needs to take various factors into account in order to decide which organizational from will best suit the goals of the business.

     • The main questions which need to be answered are: 1) the ease with which the company can be formed and properly registered with the government, including cost; 2) ways to raise capital; 3) the liability or risk to the owners, operators and managers; 4) the issue of who has control indecision making; and 5) methods of growth and expansion.

     • A business owner must also consider external factors that will affect the business and the best form to cope with such factors as: 1) degree of government control, 2) taxes, 3) geographical area/competition, 4) ability to change the operations of the business (flexibility), and 5) the ease of transferring ownership.

     • Three main types: Proprietorships, Partnerships, and Corporations.

     • In America, there are approximately 20 million companies. Of these, approximately 70% are sole proprietorships, 20% are corporations and 10% are partnerships. However, corporations account for a majority of business activity and 90% of business receipts (footnote 5). There are relatively few large companies in America. Large companies are almost always organized as a corporation. A majority of America's have income of under $100,000.

     • Sole Proprietorship – A business owned (and usually operated) by one person who is personally responsible for the firm's debts. The benefits are: 1) the easiest to form with one owner. The owner has the ability to make quick decisions on his own, be his own boss as well as reap all profits from his work. 2) Tax benefits, only the proprietor is taxed on his income which he takes out of the company. The company itself is not required to pay taxes on its income or profit. 3) The number of employees is not limited. Negative aspects are: 1) Unlimited liability means the owner is responsible for the company's debts. 2) Limited life and existence of a sole proprietorship is tied to the owner. 3) Assets may be passed on but technically in order to continue operations, a new business must be started and filed.

Due to the reliance of one individual's talents and resources, this form of business is not well suited for large enterprises.

Proprietorships sere a wonderful function for society. Virtually every possible human desire is attempted to be satisfied, many new products and ideas stat out and are crated in sole proprietorships. Small proprietorships are great for businesses where customers feel special attention is important (i.e. tailors, hairstylists, interior designers, etc.)

     • General Partnership – An enterprise owned by two or more people who are responsible for the firms debts. A partnership enjoys the advantages of a proprietorship with regard to ease of formation and additionally enjoys the advantage of being able to pool resources with one or more partners. For businesses planning and growth individuals with different talents are necessary. Also the ability to get financing increases as more people are obligated to the company's debt. A partnership enjoys the same tax benefits as a sole proprietorship where as only the individual partners pay taxes on money they take from the profits of the company. Disadvantages are: 1) Like a proprietorship, all general partners are liable for the company's debt. It's also important to realize that each partner is financially liable for the business actions of his or her partners. 2) Disputes between partners are often a problem. A partner's initial investment is usually stuck in the company because if a partner wants to take back his investment, the entire ownership structure of the company must be changed requiring a whole new partnership agreement to be drawn up and filed. 3) Determining what the partner is entitled to with regard to compensation for his share of the firm is extremely complex.

It is absolutely essential to draw up a detailed partnership contract, clearly identifying each partners role in the company and how various possible disputes between partners are to be solved. The size of a partnership an vary significantly.

     • Corporations (joint stock company) – A business considered by law to be a legal entity separate from its owners with legal rights, privileges, and obligations of a person; a form of business organization where the liability of the owners is limited to their investment. A corporation must file what are called articles of incorporation with a state and each state has it own laws which govern and regulate the activities of corporations. Corporations are the most complicated and expensive type of business to form. The two major positive factors of organizing as a corporation is the limited liability of all owners and managers with the exception of illegal activity, and the ability to raise capital. Another benefit is a corporation's status as a separate entity with an ongoing life. The company acts as its own legal entity and can sue and be sued. The disadvantages are taxes. There is a 34-40% tax on corporate profits of $155,000. Plus all individuals working for the copmany pay income tax and the owners pay income taxes on any capital gains that they receive from their investment. This situation where tax is paid on corporate profits and then again when these profits are distributed to stockholders in the form of dividends is referred to as 'double taxation'. The other negative is the cost and complexity to incorporate, particularly legal costs. The company must produce financial statements for government agencies and they must be made public and accessible to anyone.

Agency conflict managers and owners are separate and sometimes management will ct in their own best interest as opposed to the best interest of the stockholders. The goal of every corporation is to increase shareholder wealth (value of each share of stock).

Companies that incorporate need to decide what sort of structure they want to adopt Two major types of corporations: Privately held (closed) and publicly held (open)

Privately held – There are many small corporations in which all the owners of the company's stock is predetermined. These are referred to as 'privately held' corporations whereas the sale of their stock is not open to the public. For corporations which register with major stock exchanges as a way to raise money from the public are called publicly held corporations. Almost all major U.S. companies are organized as publicly held corporations.

     • What is stock? A share of ownership in a corporation. Qualities include certain special rights as predetermined by contract. Each share is of equal value. There are two types of stock.

Corporations can raise capital through the issuance of stocks and bonds. The two types of stock sold to shareholders have different rights all of which are predetermined in the corporate charter and agreed upon by stockholders. 1) Preferred stock of which usually less (fewer shares) is offered often recipe better dividends and are always paid their dividends first. The ability to sell large amounts is often restricted and preferred stockholders have no say or vote in management decisions. However, 2) common stockholders may receives less dividends, but there are no restrictions as to when or how much can be sold and they have voting rights. Holders of common stock an hold stockholder meetings and with over 50% of a corporations stock being represented, can vote to have managers hired or fired as well as any merger and acquisition or other major strategic decisions.

Stockholders typically influence a corporation through its board of directors (BOD) which are elected by the stockholders to serve as a representative body on behalf of all stockholders. Most stockholders usually submit a proxy entrusting their vote to the decisions of the board of directors as opposed to looking into the complexities of the company themselves. The BOD, in practice, is typically made up of affluent members of the community with expertise in that industry, and the corporation's largest shareholders. The BOD is responsible for the appointment and removal of the corporation's officers, what to pay for dividends and often major decisions with regard to the firm's operations. The size of the board depends on the size of the corporation. For large corporations, there are millions of stockholders and often management and directors of a corporation own less than 5% of the company.

Other Forms

     • Limited Partnerships allow investors to invest in a small business (partnership) and their obligation or liability is limited to their investment. However, a limited partner is not allowed to take an active management role in the operations of the company. Everything else is the same as a general partnership and each limited partnership has a general partner who is responsible for the operation of the business as well as remains obligated by any of the company's debts.

     • S Corporation where everything is structured as a corporation and the firm enjoys all the benefits of a corporation but simply is taxed as a partnership. This form was created in 1958 to assist small businesses. Thus the firm enjoys the benefit of easy transfer of ownership, limited liability and pays taxes like a partnership avoiding double taxation. However, there are some specific requirements such as the company must be 100% domestically owned no more than 35 stockholders, and there are restrictions on the type of activity in which the firm may engage. (For example, they cannot derive more than 10% of their income form investment in stocks, bonds, and other securities.)

     • Franchising is the right and privilege granted by one company (franchisor) to another (franchisee) to use their name, trademark, products, technologies, etc., in return for a licensing fee and royalties. Franchises combine small business with many of the benefits of large business. Franchisees usually are sole proprietorships and have all the positive and negative aspects related to that. Moreover, the main corporation (franchisor) usually maintains ownership and control of its most profitable stores,, as well as the first stores in any new market (i.e. in Kyiv, McDonald's Corporation owns the restaurants).

In a franchise like McDonald's Corporations, mot stores are owned by an individual who pays McDonald's a licensing fee to start the franchise which allows it to use the McDonald's name, suppliers and means of distribution. A McDonald's franchise is one of the most expensive at around $1 million. Also McDonald's is paid a percentage of income from each store (royalty). The business owner gets the benefit of the McDonald's name and reputation and is given the means to maintain all the company's quality standards. Because McDonald's is so big, they buy in enormous bulk quantities and distribute to the franchises at very low prices. Also the main corporation pays for Michael Jordan to do commercials and all other marketing from which the individual owners all benefit. The high cost of marketing is the reason franchisors often maintain ownership of the first few stores in each market. Also to make sure everything is done correctly in order to establish the best reputation as possible, right away.

The disadvantages for franchisees are that they bear nearly all the risk in the enterprise and franchisors have very strict requirements for quality standards, operating procedures, etc. also, as a result, franchisees can be hurt if there is a negative image associated with the parent company (Example – Jack in the Box). One major issue with franchises has been something called 'cannibalism' Cannibalism refers to a franchisor selling many licenses in one market, therefore the franchisees resultantly eat at each others profits. A negative aspect of franchising in general is that the have driven many small business owners out of business.

     • Non-profit companies or often called Non-Governmental Organizations (NGO) – These are organizations established with the goal to address a social issue or problem. They are not taxed and all profits must be reinvested in the company. Examples are often hospitals, universities, charity organizations, etc. There is no stock and ownership is held in a trust.

     • Joint venture is an enterprise in which two or more persons or companies temporarily join forces to undertake a certain project. It can be registered as any of the other forms.

     • Employee Stock Ownership Plan (ESOP) – In this case, the founders, managers, or owners of a corporation buy all of its own stock, usually with loaned funds and this stock is placed in a trust. The firm then owning its stock, awards it to its employees based on various criteria such as performance, seniority, etc. However, whether the stock has been issued to employees yet or not, the employees control the voting rights of the shares purchased for the trust. Two main reasons for ESOPs: 1) to motivate employees as they directly benefit from the success of the company and, 2) to protect the company from any possible hostile takeover bids. If a company fears that a large corporation or competitor may want to buy out the company and change it, a company may beat them by implementing an ESOP.

     • Of the 4 million corporations in the U.S., there are only approximately 2,000 large corporations. However, it is these 2,000 corporations which account for a majority of the country's business activity. Large corporations also play a vital role in the U.S. economy other than just crating jobs and making a profit. Much of the scientific and technological research is done by or paid for by U.S.' large corporations. Whereas small companies and entrepreneurs account for many new ideas and products, large corporations do the long-term expensive research which requires significant capital in order to maintain the best quality products and latest technologies. Corporations conduct this research and constant product improvement to remain competitive in a very quick changing global economy. The enormous size of these organizations gives them the resources for such activities.

     • The latest trends of the American population has been towards small business. In the early 1990s, America's major corporations were forced to downsize, reducing the number of people it employs. As a result, many of the people who were laid off were men in their fifties which had very high salaries. Many of these individuals rather than go to work for another large company and have the same thing happen, would rather use their expertise and start a new business. Economists credit 55% of technical innovation in America to small and mid-size businesses. However, if a product is not successful and a company fails, it is so common in America that it is simply considered a learning process for the owner. Failure is considered part of the economic process where only the most efficient producers are the ones who succeed.

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