5 Business Organizations

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Business Organizations


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There are four types of business organizations

that can be used for the practice of optometry:

general partnership limited liability company (LLC) professional association or corporation (PA or PC) subchapter S corporation

The most common choices today are limitedliability companies and subchapter Scorporations.


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Partnership


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A partnership can be created through 4different types of business organizations:

General partnerships Limited liability companies

Professional associations or corporations Subchapter S corporations

A general partnership is the traditional method.


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General Partnership

A partnership can be defined as an association of 2or more persons to carry on as co -owners abusiness for profit .

Partnerships are quasi-legal entities: they can holdtitle and exercise certain property rights butpartnerships cannot sue in their own name and donot pay taxes.

Partnerships are regulated in all states (exceptLouisiana) by the Uniform Partnership Act, whichcontrols many aspects of the partnership but allowsthe partners to modify some provisions.


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General Partnership

The financial issues (and other aspects of operation of the partnership) are controlled bythe partnership agreement (or articles of

partnership), which describes the manner inwhich the partnership is run and theresponsibilities of the partners.

The partnership agreement must provide forthe formation, maintenance, and dissolution of the partnership (because all partnerships end).


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General Partnership

The liability of partners is "joint and several";each partner is considered to be the agent of theother, and thus all partners are liable for the acts of a single partner.

A partnership pays no taxes; it is a conduit for taxpurposes. The partnership does file a federal taxreturn, on Form 1065; this form reports thepartnership's income, its expenses, and thepartners' profit (or loss).

There are distinct advantages and disadvantages togoing into a partnership arrangement.


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Going into Partnership

AdvantagesGenerally higher earnings than solo optometristsShared overhead, less capital outlay per partner

compared to solo optometristsOffice coverage during vacations, illness, personal

holidays

Consultation with partners for business and patientmanagement decisions

Expanded hours, convenience for patientsInvestment in career protected and equity established

for retirement, disability, or death


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Going into Partnership

Disadvantages

Loss of independence

Personality conflicts with partners or the spouses of partnersDifferences in professional ideas and philosophiesUnequal distribution of patient load

Unequal distribution of income based on productivityof the partners


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Professional Associationsor Corporations


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Corporations are artificial creations of law,endowed with certain characteristics:

right of perpetual succession separation of ownership and management

transfer of ownership through sale of shares of stock right to hold title, sue, claim tax benefits obligation to pay income tax liability for acts or omissions of employees


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Corporations enjoy certain advantages anddisadvantages when compared to other types

of business organizations: Advantages

Tax benefits (deductible insurance, retirementplans)

Medical expenses reimbursement plans Employee insurance plans Sick pay

Better administrative organization Transferability of ownership Continuity of existence Limitations on legal liability


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Disadvantages Cost of formation and operation are comparatively

greater Increased taxes (35% for PAs and PCs) Accumulated earnings tax (39.6% over $150,000) Increased retirement plan costs Greater business complexity Loss of independence Disclosure requirements comparatively greater Licensees with different degrees (OD and MD)

cannot be shareholders in some states


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Articles of incorporation are filed in the state by the

incorporators (only one is needed) to describe thepurpose of the corporation, its stockholders, and itsmanagement.

In a professional association (PA) or corporation(PC) the PA or PC may be formed by one or morelicensed professionals, who constitute both ownershipand management. Only licensed professionals canown stock and serve on the Board of Directors;however, non-professionals can be Officers.


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Structure of Corporations

Shareholders(owners)

electBoard of Directors

(long term management)who electOfficers

(day-to-day management)


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Structure of ProfessionalAssociations/Corporations

Shareholders(owners; may be one person;must be professional licensee)

electBoard of Directors

(long-term management; may be one person;must be professional licensee)

who electOfficers

(day-to-day management; may be one person; doesnot have to be professional licensee)


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The PA or PC is responsible for its contracts, debts,and the negligence of its employees.

The shareholders (owner) are not responsible fordebts or liability claims, although in a one licenseePA or PC if the licensee is negligent he or she will beindividually responsible and the PA or PC will alsobe responsible as employer.


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PAs or PCs pay a federal income tax; a "double tax" ispossible, if the PA or PC has a profit (35% bracket)and the shareholder-employee is paid a salary (10% to35% bracket). PAs or PCs must file an annual taxreturn, on Form 1120.

Most states also charge an income tax for corporations.In Alabama, for example, the tax rate is 5% of taxableincome.

A business privilege tax is also levied in Alabamaagainst corporations and LLCs, at the rate of $1 per$1,000 of taxable income, or a minimum of $100.


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Subchapter S Corporations


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Small corporations may elect to be taxed underSubchapter S of the tax code.

S Corporations pay no income tax, rather being

taxed in the same manner as a partnership or LLC. Shareholders of an S Corporation do not have to be

like-kind professional licensees; thus an optometristmay share ownership with another professional(such as an optician) or nonprofessional (such as aspouse).

An S Corporation is limited by law to 100

shareholders.


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To create an S Corporation, first a businesscorporation must be formed, then it must electSubchapter S status.

The election must be unanimous among theshareholders.

The election must be made during the first

month of the tax year (or in the monthpreceding).


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Because an S Corporation pays no taxes, it avoidsthe "double tax" imposed on earnings of a PA orPC. Employees of an S Corporation are paidsalaries, on which individual income tax isimposed.

Employees of S Corporations may participate intax-deferred retirement plans, such as Keoghdefined benefit and defined contribution plans,and 401(k) plans, thus providing tax benefitssimilar to those offered by PAs and PCs.


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Potential tax savings can be realized in an SCorporation by the payment of dividends (a returnof profit earned by the business) to the owners.

If an annual dividend is paid, although the amount

is subject to income tax, it is not subject to SocialSecurity/Medicare tax. Example: after all expensesand salaries are paid, there is a profit of $20,000,which is taxable income for the 2 owners but not

subject to Social Security/Medicare withholding. This represents a savings of 15.3%, which is the

Social Security/Medicare tax percentage for self-employed individuals.


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Tax writeoffs are not the same for S Corporations asfor PAs and PCs; for example, life and disabilityinsurance premiums may be deducted by aprofessional association or corporation, but not byan S Corporation.

Liability is similar to that of a professionalassociation or corporation: an optometrist-

shareholder is not personally liable for thenegligence of another optometrist-shareholder;rather, the S Corporation is responsible.


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Subchapter S Corporations are occasionallychosen as the business organization for opticaldispensaries that are separate from privatepractices.

Because laypersons (opticians, spouses) can bestockholders in S Corporations, theseindividuals can be co-owners of the

dispensary even though the optometristpractices as a PA or PC and they areprohibited from being stockholders (co-owners)of the PA or PC.


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Limited Liability Companies


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Limited Liability Companies Limited Liability Companies are a relatively new

type of business organization (first authorized inAlabama in 1993).

An LLC may be formed by 1 or more individuals,partnerships or corporations, and may haveperpetual duration.

Articles of Organization and an LLC operating

agreement are used to establish the purpose,conduct and management of the company.


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An LLC can be used to render professionalservices; thus, optometrists can form an LLC.

Special provisions apply to the personal liability of members and to the transferability of members'ownership to successors (these rules are similar tothe rules for professional associations orcorporations).

Members of the LLC control management unlessthe Articles of Organization provide otherwise.


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The LLC is treated like a partnership for taxpurposes; the LLC pays no income taxes and profit(or loss) is allocated to the members of the LLC

just as in a partnership. Members of the LLC are not liable as individuals

for the debts or negligence of the LLC or for thedebts or negligence of other members. In this, the

LLC is like a professional association orcorporation.


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The formation of LLCs is controlled by statelaw (the state's Limited Liability CompanyAct), found in all states.

For tax reporting purposes, the LLC may electto be classified as a corporation or apartnership (for 1 person LLCs, as acorporation or a sole proprietorship); thiselection is made by filing Form 8832.


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Which is easiest, LLC or Subchapter S?

Formation of an LLC requires less formality LLCs do not have to hold formal meetings and

record minutes Only Sub S corporations must issue stock Tax reporting for one person LLCs is Schedule

C; for LLC partnerships is Form 1065; for Sub Scorporations tax reporting is on Form 1120S

Sub S shareholders share profits as dividends; anLLC splits profits in accordance with theoperating agreement


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Keogh Plans

Retirement plans for partnerships include KeoghPlans. These plans have achieved parity with the

retirement plans allowed the employees of professional associations or corporations.

Contributions to a Keogh Plan are tax deductible.The earnings are tax sheltered until withdrawn.

Withdrawals must be made between ages 59 and70 years or a penalty will be imposed.

Withdrawals can also be made without penalty if due to disability or death.

Keogh accounts can be used for loans under certaincircumstances.


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Keogh Plans

There are 2 basic types of plans: defined contribution: an established amount is

contributed each year in a profit sharing plan, upto 25% of income, to a maximum of $46,000 (for the2008 tax year); the amount is based on profits andmay be changed from year-to-year.

defined benefit: the actuary-determined amount

necessary to fund a retirement income equal to100% of earnings, up to $185,000 a year (as of 2008); yes, that means you can put everything youearn into the Keogh to fund your retirement!


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Keogh Plans

Defined contribution profit-sharing plans mustinclude eligible employees; up to 25% of incomemay be contributed, and the employer determines

the percentage of profit-sharing to contribute tothe plan. Again, the limit is $46,000. If a Keogh Plan is established, all full time

employees are eligible to participate ("full time" isdefined as an employee who has been employed for2 years and works more than 1000 hours a year).


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Keogh Plans

Vesting is the length of time needed for eligible employees tobe entitled to 100% of investment income (the amount inexcess of what the employee has contributed). Cliffvesting requires 3 years to reach 100%, while gradedvesting takes 6 years (0% first year, then 20% a year after).

Plans may vary with respect to vesting. If an employee quitsbefore being 100% vested, the employee forfeits the non-vested portion of the fund.

Example: An employee has contributed $5,000 to a Keogh

plan over 4 years, after which time the accumulated value of the employee's share is $7,000. The employee is 60% vestedin the plan. If the employee withdraws from the plan, theemployee may take the $5,000 contributed to the plan, plus60% of the $2,000 accumulated value, for a total of $6,200.


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Keogh Plans

As the example illustrates, the contributions madeby employees are irrevocably theirs, even if theemployees quit or are fired.

The percentage contribution for definedcontribution plans must be the same for all.Example: if 25% of income is contributed, anemployer earning $100,000 contributes $25,000,while an employee earning $20,000 contributes$5,000.


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Keogh Plans

Because of the large annual contributionspermissible under Keogh Plans (particularlydefined benefit plans), they tend to be used byindividuals who start a retirement plan rather

late in their careers. Or paradoxically they can be used by high-

earning individuals who want to retire early(withdrawals can start at 59 years without

penalty). The requirement that full-time employees be

permitted to participate in the plan increasesthe cost and complexity of plan administration.

Self Employed Business Related Tax Deductions


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Self-Employed Business-Related Tax DeductionsIndividualPractitioner

Partnership LimitedLiabilityCompany

ProfessionalAssociation/Corporation

Subchapter SCorporation

HealthInsurancePremiums

DEDUCTIBLE

1040, line 29

DEDUCTIBLE

1040, line 29

DEDUCTIBLE

1040, line 29

DEDUCTIBLE

Form 1120

DEDUCTIBLE

1040, line 29

Health SavingsAccounts

DEDUCTIBLE

1040, line 25

DEDUCTIBLE

1040, line 25

DEDUCTIBLE

1040, line 25

DEDUCTIBLE

1040, line 25

DEDUCTIBLE

1040, line 25

Malpracticeand LiabilityInsurance

DEDUCTIBLE

Schedule C

DEDUCTIBLE

Form 1065

DEDUCTIBLE

Schedule C orForm 1120

DEDUCTIBLE

Form 1120

DEDUCTIBLE

Form 1120S

DisabilityInsurance

NOTDEDUCTIBLE

NOTDEDUCTIBLE

NOTDEDUCTIBLE

DEDUCTIBLE

Form 1120

NOTDEDUCTIBLE

Life Insurance NOTDEDUCTIBLE

NOTDEDUCTIBLE

NOTDEDUCTIBLE

DEDUCTIBLEForm 1120

NOTDEDUCTIBLE

TraditionalIRA

DEDUCTIBLE1040, line 32





SEP IRA,SIMPLE IRA,

Keogh Plan,401(k) Plan







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