Legal and Tax Options for a Practice’s Structure

Dermatology TimesDermatology Times, February 2022 (Vol. 43. No. 2)
Volume 43
Issue 2
Pages: 11

Both legal and tax factors come into play when deciding on the best corporate structure for a dermatology practice.

This article provides a high-level overview of the choices available, from the perspectives of both an attorney and a tax accountant.


Before determining the ideal legal entity for a dermatology practice, one must first understand inside risks vs outside risks.

Inside risks are threats that a practice faces because of its activity, such as a lawsuit against the practice by its patients for malpractice or by its employees for wrongful termination. No legal entity can shield the practice and its assets from these inside claims—that is why insurance is so important.

Outside risks, on the other hand, are potential claims against the interests of the owner(s) of the practice itself. For example, an outside claim might be a successful car accident lawsuit against a dermatologist in which the plaintiff now wants to get to the practice’s assets or cash flow to satisfy the judgment decided by the court.

For outside risks, a limited liability company (LLC) is superior to a corporation because corporation stock is vulnerable to outside claims. In other words, a plaintiff with a successful lawsuit against the owner of a corporation can come after that corporate stock. Worse, depending on the ownership percentage, the plaintiff may be able to gain access to all the assets of the corporation simply by taking the stock.

However, as discussed in more depth in our books, LLC ownership interests are not in a position to outside claims if the LLC is properly structured and maintained. LLCs are generally shielded by the charging order rules and do not allow the level of vulnerability to outside claims that corporations do. Therefore, attorneys today typically recommend LLCs over corporations.

Although a corporation is generally not recommended with a medical practice, this may not pose much of a concern because of licensure restrictions. In other words, local law may allow only a licensed physician to own a medical practice. Thus, in many states, a nondoctor cannot own the corporation stock even if awarded it in a lawsuit. In some states, these protections also apply to ancillaries, such as surgery centers and medical spas. The key is to confirm with local counsel. In general, from a protection perspective, LLCs are preferred over corporations in all states.


Before getting into the specifics on tax treatment options, it is essential to explain that choosing a corporation as a legal entity involves 2 options—taxation as an S corporation or as a C corporation. Choosing an LLC adds a third option: either disregarded tax treatment for solely owned LLCs or partnership tax treatment for multiowner LLCs.


When a C corporation earns a profit, it must pay tax at the corporate level. Compensation paid to physicians or executives, as long as it is reasonable, is deductible by the corporation on its tax return and is therefore not taxable to the corporation. The owner’s salary is taxable to the owner as wages. After the C corporation pays taxes, distributions of earnings already taxed at the corporate level can be paid to the physician owners in the form of dividends. These are generally taxed to the owners as qualified dividends, creating double taxation of these earnings. Qualified dividends are currently taxed at long-term capital gains rates—15% for persons not in the highest tax bracket and 20% for those in the highest individual income tax bracket. Therefore, a C corporation owner will pay 21% corporate tax on the practice’s net profits plus either 15% or 20% tax on the dividends distributed by the corporation, resulting in up to 41% federal tax on profits. Both corporate and capital gains tax rates could change under the proposed tax legislation.


An S corporation also must file a separate tax return but is a pass-through entity: Rather than being taxed at the corporate level, all income and deductions pass through to the shareholders, who must pay tax on any S corporation income at their individual rates. Whether an S corporation’s income is paid to the physician owners as salary or distributions does not affect the federal or state income tax rates. However, currently, owner wages are subject to both Social Security and Medicare taxes, whereas distributions of profits are not. There is never any tax to the corporation; therefore, there is no double taxation.

When an S corporation owner provides services to the entity—such as a physician owner practicing medicine—the owner must be paid reasonable compensation in the form of W-2 wages. These wages are a deductible expense for the corporation and are also taxable on the owner’s tax return at their individual income tax rate.


In addition, a person who owns 100% of an LLC can choose to have it taxed as a disregarded entity. With this election, the LLC will not file its own tax return, and all reporting of income goes on a schedule of the owner’s personal return. The significant benefit here involves saving the cost of filing a tax return; the negative is that the entity cannot take advantage of the benefits of either S or C corporation tax treatments, described above, and all net income is subject to self-employment tax.

Multiple owners of an LLC can choose to be taxed as a partnership. Like the S corporation, a partnership is a flow-through entity—it will not pay any tax, but all losses/income will flow through to its owners. The 1 significant benefit of partnerships is that they can make distributions that are not pro rata based on ownership—as long as this is allowed by the LLC operating agreement—whereas S corporation distributions must be pro rata.


Choosing the type of legal and tax structure to employ for a practice is an important decision. This overview is not meant to provide a comprehensive analysis of options or planning considerations, but it does offer some basic working knowledge for dermatologists. To make the best decision for your practice, become more educated and work with a trusted, experienced adviser.

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