4 Important Differences Between LLCs and S Corporations

One of the worst problems that can occur financially is that a year’s worth of careful planning can be lost when a financial advisor or dentist does not understand the difference between a limited liability corporation (LLC) and an S Corporation. One of the most common misunderstandings dentists and advisors may have when it comes to these two types of businesses regards the issue of basis, which will be explained in more detail below.

It is important to get questions about LLCs and S Corporations answered while there is still the opportunity to resolve problems—before a solution is out of reach. When considering which type of business is right for your practice, consider the following list of material issues and their impact on the unsuspecting dentist.

1.    What occurs when the dental practice borrows money for equipment or any other item from a conventional lender?

With an LLC, the debt counts towards the basis of the dentist. With an S Corporation, it does not.

What is the effect on the dental practice and the taxable income it reports (and the tax that may be owed by the dentist) in each of these “flow through” business entities? As an example that can be easily understood, if there is a taxable loss because of a quick depreciation write-off in the LLC, a loan from a bank is as if the dentist advanced his or her own money to the dental practice. With the S Corporation, it does not work that way. This means that if there is a taxable loss in the LLC, it would appear on the dentist’s personal tax return and the income tax of the dentist would be reduced. With the S Corporation, the loss would not appear on the dentist’s personal tax return until a later year and the dentist could not take the loss in the current year. The tax of the dentist would be higher if the business entity was an S Corporation.

2.    What happens when a dentist loans personal funds to the practice?

Any funds advanced by the dentist to the practice counts as the additional basis for the dentist in either format. Some advisors suggest that the dentist borrow funds directly from a conventional lender and lend that same sum to the dental practice in the event that its business format is that of an S Corporation, so that there will be no basis issue. The terms and conditions of the loan from the dentist to the dental practice would be identical to the loan from the lender to the dentist.

3.    What is different when it comes to the dentist earning a salary?

In the case of salaries, the dentist with an S Corporation must take a salary and pay the income tax and payroll taxes when the compensation is paid. If the dentist gets paid every week, his or her taxes would be paid every week. There is then the question of “reasonable compensation.” The dentist’s advisor should be questioned about the term, “reasonable compensation.” Some dentists try to report as little compensation as possible and take a “dividend” from the practice for any balance of earnings not taken as compensation. There is an attitude with the IRS that it is not permissible to take low salaries. If you do so to avoid payroll tax liabilities, watch for a reasonable compensation payroll audit by the IRS.

These issues do not occur with an LLC. As an LLC, the owner gets no salary. The payment is listed as either a draw or a guaranteed payment. There is no payroll tax paid by the practice. The owner should pay a quarterly estimated tax payment that is a flexible amount based on the earnings for the year. This payment may be changed based on the actual earnings of the practice so there is an increase in cash flow and budgeting ability for the dentist with the LLC.

4.    What if the practice has multiple owners?

If the dental practice has more than one owner, the LLC and the S Corporation financial comparisons become even greater for cash flow management and payment of taxes. Each dentist can multiply his or her tax payment times the number of partners to determine an estimate of money involved.

Making the Right Choice

These are material differences between the LLC and the S Corporation. You should speak with to your individual advisor to discuss your exposure to basis issues and to enhance cash flow management with no salaries to protect a tax loss that could reduce your personal income and tax.

About the Author

Bruce Bryen is a certified public accountant with more than 40 years of experience. He is the managing partner of the accounting firm Bryen & Bryen, LLP, which is based in southern New Jersey. Mr. Bryen specializes in retirement planning design, income and estate tax planning, determination of the proper organizational business structure, asset protection, and structuring loan packages for presentation to financial institutions. He can be contacted by calling 856-985-8550, ext. 112, emailing bbryen@bbllp.net, or visiting www.Bryen-BryenLLP.com.