One of the most critical financial decisions dental practice owners can make, is the choice of tax structure.
While choosing a legal entity, like a partnership or professional LLC is important, the question of how that selected entity will be taxed, is of equal importance.
Your annual tax obligations, along with profit distribution and methods of compensation are all determined by your tax classification. Fortunately, when you engage with professional dental practice accounting, the majority of legal entity structures can be strategically optimized with a range of legitimate tax treatments.
Ultimately, dental practice owners want to preserve as much of their income as they possibly can while being IRS-compliant, with an entity structure that’s tax efficient.
Let’s look in a little more detail at the options:
Launching a solo practice
It’s not uncommon for dental practice owners to launch as Single-Member LLCs, then transition to an S-Corporation once the practice is more stable financially and operationally. Long considered to be the standard route, this offers protection against liability as well as opportunities for tax optimization.
However, as the tax law has developed over the years, some practitioners have been advised to delay or avoid S Corp election thanks to the enhancement of provisions for the deduction known as Qualified Business Income.
Factoring in the QBI deduction
Accessible to both S Corporations and Single-Member LLCs, the QBI deduction allows owners of businesses to exclude from their taxes, up to 20% of qualified business income. The difference is in what income is qualifiable for this particular benefit:
- S Corporations – owners must receive a salary that’s reasonable and which is subject to standard payroll taxes. Then, only the profit that’s left qualifies for the QBI calculation.
- Single-Member LLCs – if operating as sole proprietorships, all profits are passed through to the owner directly, with the full amount of profit eligible for QBI deduction.
For those dental practitioners with taxable incomes of less than $500,000, the QBI deduction can equal significant tax savings.
Implications for retirement planning
Which tax structure dental practitioners choose may well be influenced by their retirement savings strategy. For those with aggressive contributions to their retirement plan, it could be advantageous to stay as a Single-Member LLC, whereas with an S Corporation, reasonable W-2 compensation is mandated by the IRS, with only this salary factoring into calculations for retirement plan contributions.
For single-member LLCs, all net income is qualifiable as earned income in terms of retirement contributions, while still being eligible for the QBI deduction.
Multi-owner practices
A more sophisticated approach is required for those dental practices with multiple owners, such as a structure that combines the advantages of S Corporation with the flexibility of an LLC. Opting for this configuration sets the practice up as a multi-member LLC operationally, but with a separate single-owner S Corporation holding each ownership stake.
Profits are distributed to each member S Corporation by the practice LLC, which manages its own benefits, compensation, and retirement contributions. Offering opportunities to optimize payroll tax, delivering liability protection, and persoanlized flexibility
The practice LLC distributes profits to each member S Corporation, which then manages its own compensation, benefits, and retirement contributions. This arrangement delivers liability protection, potential payroll tax optimization, and personalized flexibility for each owner while maintaining unified practice operations.
The primary drawback involves increased administrative complexity. Each S Corporation requires independent tax filings, payroll administration, and accounting oversight, demanding sophisticated professional guidance.
Making Your Decision
Tax structure selection requires careful analysis of your specific circumstances, including:
- Current and projected income levels
- Retirement savings priorities
- Administrative capacity and preferences
- State-specific regulatory requirements
- Long-term practice goals
Given the complexity and high stakes involved, consultation with both a dental practice attorney and a tax professional in accounting for dental practices is essential before finalizing any structural decisions.
Don’t leave money on the table with an outdated tax structure. Whether you’re a solo practitioner wondering if an S Corp is right for you, or a multi-owner practice exploring hybrid structures, professional guidance can make a significant difference in your bottom line.
