Opening up your own practice can be a really exciting time. However, we know it can also be quite stressful. After all, you went to study medicine and not law, so a lot of the ins and outs of setting up a business might be completely new to you.
Maybe you have been working for someone else as a W2 employee and now you’d like to start up as an independent contractor. You’re right to be looking into starting either a corporation or a limited liability company (LLC), as they are among the most popular options for physicians. Oftentimes, incorporation or starting an LLC can lead to a much lower tax bill for you individually, depending on your situation.
There are all sorts of acronyms and terms that keep coming up and maybe it’s all a bit overwhelming. We’re here to simplify all this legalese into plain English and guide you through the difference between setting up an S Corp. vs an LLC for a Physician’s practice.
As with all business and legal matters like this, you should always do your own research and explore your options, but you want to make sure to also consult with your own legal and financial professionals who will help advise what is best for your situation and corporate structure.
Before we get into the differences between S Corporations and LLCs for physicians, we need to do some defining first so we’re all on the same page.
What is an S Corp.?
An S Corp. is short for subchapter or small business corporation. It was created as part of the tax code back in the 1950s to help build up small and family owned businesses. What is unique about the S Corps. is that they are made to limit the burden of double taxation that can occur with conventional corporations, while also ensuring limited liability.
S Corps. don’t pay regular business income taxes, rather the shareholders split the income and losses. They then receive these as income and report it on their own individual tax returns. This gets around the double taxation we mentioned previously, but eliminates the corporate tax element.
Liability is really important and the main reason against going into business as just a sole proprietor. Should the business suffer financial hardship or legal problems, by and large, you as the individual are not responsible if you’ve incorporated. You and the company are separate entities. As a physician, liability is a huge consideration, so it is basically a given that you will form an LLC or corporation. Although neither a corporation nor an LLC will protect a physician against malpractice claims, a practice should generally not be run as a sole proprietorship or partnership.
It’s important to note that many states prohibit professionals from starting regular corporations and require that they start Professional Corporations (PC) instead. The main distinction here is that PCs require approval from the state professional licensing board, in this case the Medical Board of your state, and includes in the Article of Incorporation that the specific purpose of the corporation is to practice medicine. Further, all shareholders need to be licensed professionals in order to be owners of the PC. See, e.g., Cal. Corp. Code § 13406(a); NRS 89.070(c); Tex. Bus. Code § 301.006.
What is an LLC?
An LLC is a business entity that’s not quite a corporation, but isn’t a partnership or sole proprietorship either. It’s a bit of all of these which is what makes LLCs so attractive, especially for small business owners.
Similar to an S Corp, an LLC provides limited liability to you as an individual—it’s in the name, after all! The members of an LLC are protected from creditors coming after their personal assets should the company go into debt, although it’s important to remember that this asset protection won’t cover all cases of liability.
In terms of tax rates, an LLC has a lot more flexibility than a corporation. They are taxed like partnerships and sole proprietorships with what is called pass-through taxation by default. “By default” being the key phrase here. LLCs have the option to file as a C Corp. or S Corp. as well with the IRS.
Professional limited liability companies (PLLC) are a special class of LLCs reserved for, well, professionals! And of course, physicians qualify for this. It’s basically the same as a regular LLC, except the professional is protected in a PLLC. It's important to note that in some states, like California, professionals are prohibited from operating LLCs or PLLCs. So if you plan to start a practice in the Golden State, you’ll want to focus on the information regarding Professional Corporations instead.
What are the differences LLC or S. Corp?
As we’ve established by defining the two, S Corps and LLCs seem rather similar at first glance: both offer their members protection from liability and both avoid double taxation by allowing taxable income to pass-through and be filed directly as just income tax. However, at their core they are fundamentally different altogether: an LLC is a business structure, whereas an S Corp. just describes how a business is taxed.
The true comparison here is LLCs vs Corporations (with the S Corp. designation). The main things that set apart an LLC and a corporation is the reporting requirements. LLCs have less paperwork, which makes them easier and cheaper to set up and run. Corporations have to file corporate tax returns and owners are paid as W2 employees or through distributions. Therefore, the company gets taxed and then the individual gets taxed again on their dividend income. This doesn’t sit well with many small business owners and so they choose to file as an S Corp., rather than a C Corp.
The IRS, however, restricts who can start an S Corp. as opposed to an LLC. Only US citizens or permanent residents can own an S Corp. and shareholders max out at just 100. There are also more regulations associated with the S Corps., like issuing stock, drafting up bylaws, holding annual shareholder meetings, and keeping official meeting minutes.
LLCs have the most open ownership rules in most states, so pretty much anyone can be an owner of one: foreign citizens and businesses, individuals, and companies can all be owners. The most notable exceptions are for S Corps. and LLCs opting to be taxed as S Corps., for which the Internal Revenue Code lists certain types of financial institutions,, insurance companies, and current and former domestic international sales corporations as ineligible corporations. See 26 USC § 1361(b).
LLCs also have their own set of founding documents which can be analogous to those of a corporation. The Articles of Incorporation are used instead of the Articles of Organization. The Bylaws of a corporation translate to the Operating Agreement in an LLC and this is not required in most states (although highly advisable regardless). You only need to file the previously mentioned Articles with the state once and keep them updated with the statement of information, which basically just includes your company’s contact information.
Which one is better for physicians?
A lot of the information you are likely finding across the web is very general. As a physician looking to open your own office and practice medicine, you want to know what is best for your situation. Of course, your own lawyer and accountant will be in the best position to evaluate your business goals and vision for the future, but as an overview before you speak with them, here are some of the things for doctors specifically to consider when deciding.
The parts that are most attractive about setting up and LLC—less paperwork, fewer regulations, and overall flexibility—are also what can sometimes be their downfall. LLCs are not required in most cases to have an Operating Agreement, and even when they are, the laws don’t specify whether it needs to be in writing or what needs to be included. Rather, state laws usually outline what you cannot alter or include in your entity’s Operating Agreement. Thus, oftentimes the state rules apply by default if something isn’t in your Articles explicitly. Unless a unique situation is addressed specifically, a business partner may feel uneasy about working with a newly formed, not so well regulated company. For a doctor’s office, it may mean more difficulties in procuring the necessary medical equipment to set up the office.
As previously mentioned, In some states, one being California, professionals, including physicians, are prohibited from operating as LLCs. They have to form a professional corporation instead. So depending on where you live, you may not even have the LLC option available to you and will need to form a PC.
If one of your members leaves the practice, with a corporation it’s generally easier for them to transfer ownership. Further, professionals can take part in management and profits without being liable for malpractice arising from the actions of other physicians in the corporation.
Both LLCs (PLLCs) and corporations (PCs) provide a similar amount of protection in terms of personal liability protection for doctors. However, it is important to note that while there is some protection, there are major exceptions in cases of negligence or obvious things like assault. There is no clear cut answer as to which is better for doctors overall, since it really depends on your own situation. Company size is a major consideration as well. Generally, the smaller the organization the more likely it is to be an LLC or PLLC.
When it comes down to it, it’s fundamentally about the paperwork involved and ownership. If you will not have too many members and don’t plan to sell stock for raising capital, then LLCs are going to be easier to form. You can still file your taxes as an S Corp. and receive that tax benefit (with lots of tax savings), while lowering the amount of paperwork you have to file, thus keeping your legal and accounting bills more manageable.
However, if you plan to grow larger and want to be additionally protected from potential malpractice caused by the acts of others in your practice, you will want to consider incorporating. Further, if you live in a state where you are required as a medical professional to form a professional corporation, you may have no choice.