When starting your therapy or counseling practice, you’ll face many decisions. Among the most important is which business structure to choose.
A private practice’s business entity has legal, tax, and administrative impacts, so it’s critical to research the pros and cons of the options available. Talking with a trusted attorney and tax advisor can ensure you make an informed decision, so I encourage you to enlist their guidance. In the meantime, I’ll share an overview and the pros and cons of some common business structures you might consider.
Possible Business Entity Types for Therapy and Counseling Practices
As you learn more about each entity, consider your specific situation, needs, and goals. What may be an ideal entity for one therapy practice may not be a great choice for another!
By default, a business with one owner (i.e., an individual or married couple) is considered a sole proprietorship if it hasn’t been registered as a different entity type. All assets and liabilities are tied to the owner of the business. In other words, there is no legal or financial separation between the company and the owner.
Pros of operating a counseling practice as a Sole Proprietorship:
- Easy and Inexpensive to Set Up – No entity formation paperwork is required to operate as a Sole Proprietorship. Typically the only compliance formalities are obtaining any required business and professional licenses and permits and filing a DBA (a fictitious name that allows the company to operate under a name other than the owner’s first and last name — e.g., instead of Lara Woodson Counseling Services, Lara might file a DBA to market her practice as Moving Onward Counseling and Therapy.
- Tax Simplicity – Tax filing is relatively simple for a Sole Proprietorship. The owner is responsible for reporting and paying taxes on the business income; the business itself is not considered a tax-paying entity. Business profits and losses pass through to the individual owner’s tax return (on Schedule C of IRS Form 1040).
- Minimal Ongoing Business Compliance Requirements – Aside from renewing business and professional licenses, permits, and the company’s DBA (if applicable), a Sole Proprietorship does not have ongoing obligations (such as annual reports, annual meetings, etc.) like some other business structures.
Cons of operating a counseling practice as a Sole Proprietorship:
- Unlimited Personal Liability – Because a Sole Proprietorship and its owner are legally considered the same entity, the owner’s personal assets are at risk if someone sues the company or the business defaults on its debts.
- Heavy Self-Employment Tax Burden – All business profits in a Sole Proprietorship are subject to Social Security and Medicare taxes — not just the money the owner pays themselves (via owner’s draws).
- Difficulties Getting Funding to Fuel Growth – Investors and financial institutions often avoid loaning money to businesses not set up as registered entities. Moreover, Sole Proprietorships cannot sell company stock. Therefore, counselors may struggle to raise external capital to grow their therapy practice.
A General Partnership (GP) is similar to a Sole Proprietorship, except it is a business with multiple owners (partners). If a multi-owner business isn’t registered as a different entity type, it will be considered a General Partnership by default. No separation exists between the company and its owners. All assets and liabilities are tied to the business partners personally.
Pros of operating a counseling practice as a General Partnership:
- Simple and Low-Cost to Set Up – No business formation paperwork is required to operate as a General Partnership — although some states have optional paperwork for registering a Partnership. Compliance formalities typically include securing any required licenses and permits and filing a DBA if the partners wish to use a business name other than one that contains all of their last names — for example, they might file to use the fictitious name Moving Onward Counseling and Therapy rather than Woodson, Smith, Juarez, and Jones Counseling Services. Although not required, it’s helpful for a General Partnership to have a partnership agreement that states the partners’ roles, rights, and responsibilities and includes details about how the business should be managed.
- Pass-through Tax Simplicity – A General Partnership’s profits and losses flow through to the partners’ individual tax returns; the business itself is not considered a tax-paying entity. Although the company does not pay taxes, it must file an annual information return (Schedule K-1, IRS Form 1065) with the IRS to report the Partnership’s income, deductions, gains, and losses. Each partner then uses information from Form 1065 to report their share of the partnership’s income or loss on their individual tax returns.
- Few Ongoing Business Compliance Requirements – The Partnership structure has fewer compliance obligations than registered business entities. Requirements typically include renewing professional and business licenses (and the DBA, if using one) and filing IRS Form 1065 annually.
- Growth Potential via Adding Partners – General Partnership may have an unlimited number of owners. A General Partnership may add new partners and use their financial contributions to fund the growth and expansion of the business.
Cons of operating a counseling practice as a General Partnership:
- Personal Liability Risks – Because a Partnership and its owners are legally considered the same legal entity, the partners have unlimited liability for the business’s debts. Partners’ personal assets are in jeopardy if the company is sued or the business faces financial difficulties.
- All Profits Subject to Self-Employment Taxes – All business profits in a GP are subject to Social Security and Medicare taxes — not just the money the owners pay themselves (via owner’s draws).
- Profit and Liability Divided Equally – By default, a partnership’s profits and degree of personal liability are divided equally among its partners. If partners wish to have the profits and liability distributed differently, the partnership agreement must include those details.
- Limited Growth Potential – GPs may not sell stock, and investors may be leery of funding a company that isn’t a registered business entity.
Limited Liability Partnership
This form of partnership is a popular choice among licensed professionals. A Limited Liability Partnership (LLP) is essentially a General Partnership that registers for limited liability status in the state.
Pros of operating a counseling practice as a Limited Liability Partnership:
- Liability Protection – Each partner’s personal assets are protected from the business’s liabilities (except for their own personal malpractice or negligence). The degree of liability protection can vary depending on the state.
- Simple to Maintain – Compliance requirements are typically minimal for LLPs. The business will need the necessary licenses, permits, insurance, etc. to operate legally and ensure it complies with any other federal, state, county, or local requirements.
- Tax Simplicity – A Limited Liability Partnership is a pass-through entity. Profits and losses flow through to the owners’ individual tax returns. Although the LLP entity doesn’t pay income tax, it must file an information return (IRS Form 1065) to report its income, losses, deductions, credits, etc.
- Management Flexibility – All partners in a Limited Liability Partnership have a voice in managing the company’s operations. The partners’ roles, rights, and responsibilities should be documented in an LLP partnership agreement.
Cons of operating a counseling practice as a Limited Liability Partnership:
- Not Available Everywhere – Not all states recognize the LLP structure.
- Not Available to Everyone – Some states restrict who may form an LLP, allowing only certain professions to register as a Limited Liability Partnership.
- Self-Employment Tax Obligations – All of the LLP’s profits are subject to Social Security and Medicare taxes. Each partner must pay that self-employment tax on their share of the profits, even if they leave some money in the business.
Limited Liability Company
Many small business owners choose the Limited Liability Company (LLC) structure because it combines the simplicity of the Sole Proprietorship or Partnership with some of the characteristics of a C Corporation. An LLC, which is registered at the state level by filing formation paperwork ( Articles of Organization or a Certificate of Organization) and paying the associated fees, is considered its own legal entity but not a separate tax entity. Profits and losses flow through to the LLC owner (member) and are reported on their personal income tax returns. LLCs may have one owner (single-member LLC) or more (multi-member LLC).
Pros of operating a counseling practice as an LLC:
- Limits Owner’s Personal Liability – An LLC is a separate and distinct legal entity, so, under most circumstances, the members are not held personally responsible if someone sues the business.
- Growth Potential and Ownership Flexibility – An LLC may have an unlimited number of members, and members may divide the business’s profits and losses among themselves however they agree to do so (as documented in their LLC Operating Agreement). So, owners can tailor their ownership percentages according to not only members’ financial contributions but also their investments of time, effort, and expertise. Also, states don’t have many restrictions on who can own an LLC. Typically, LLC members may be individuals (including non-residents of the U.S.), groups, corporations, and even other LLCs.
- Tax Treatment Options – By default, an LLC is considered a disregarded entity, so it does not file its own tax return; profits and losses flow through to members’ individual tax returns. Eligible LLCs have the option of electing to be treated as an S Corporation or C Corporation for tax purposes. (I’ll explain that in more detail in this article’s S Corporation and C Corporation sections!)
- Minimal Compliance Formalities: LLCs have few ongoing compliance requirements. Many need one or more business licenses or permits, and some states require LLCs to file annual reports and hold annual member meetings. Members must also obtain the necessary professional licensing needed to legally practice in their field. In addition, LLCs must maintain a registered agent in their state (an authorized individual or company to accept service of process and other official notices on behalf of the company).
- Flexible Management Structure – A multi-member LLC can be run in one of two ways: member-managed or manager-managed. In a member-managed LLC, the company’s owners are hands-on and actively involved in the day-to-day management and operations of the business. In a manager-managed LLC, members elect one or more managers to run the daily business operations. Most states consider an LLC member-managed unless otherwise stated in the formation documents.
Cons of operating a counseling practice as an LLC:
- Social Security and Medicare Tax Obligations – Generally, all of an LLC’s business earnings are subject to self-employment taxes, which the individual members must pay. Depending on how much the LLC makes, that dollar amount can add up quickly because Social Security and Medicare taxes apply to all the money the business makes, not just the dollars members personally draw from that income.
- Potential Growth Challenges – While an LLC can have multiple owners, the company may not issue shares of stock like a corporation. Also, some investors might hesitate to finance Limited Liability Companies.
Professional Limited Liability Company
A Professional Limited Liability Company (PLLC) is a type of LLC for licensed professionals (such as accountants, physicians, architects, engineers, therapists, and counselors). Some states require certain professionals to form a PLLC (or other professional entity) rather than a regular LLC or Corporation.
Pros of operating a counseling practice as a PLLC:
- Personal Asset Protection – A PLLC is its own legal and tax entity. Therefore, the PLLC members’ personal assets are protected from the liabilities of the business entity.
- Flexible Tax Treatment – PLLCs are taxed similarly to LLCs. By default, they are taxed as a Sole Proprietorship or Partnership, or the members can elect to be taxed as S Corporations (if the PLLC meets the IRS’s eligibility requirements).
- Management Flexibility – PLLC members can choose whether their entity is member-managed or manager-managed.
- Authority – Operating a therapy practice as a PLLC may instill confidence in clients, lenders, and suppliers that the practice is legitimate and trustworthy.
Cons of operating a counseling practice as a PLLC:
- Possible Ownership Restrictions – States’ rules for who may own a PLLC vary. Some states require that all members have specific professional licensing related to the business’s services, while others allow a combination of licensed and unlicensed members.
- Social Security and Medicare Tax Obligations – Generally, all of a PLLC’s business earnings (including income the members personally draw from the company) are subject to self-employment taxes. That can potentially result in a lofty Social Security and Medicare Tax bill for the PLLC’s owners.
- Growth Challenges – While a PLLC can have multiple owners, it cannot issue shares of stock like a corporation does to grow and expand the company. When seeking outside funding, PLLC owners may find that investors are hesitant to finance a company that isn’t established as a Corporation.
A C Corporation is a legal and tax-paying entity separate from its owners (shareholders). Its ownership is through the issuance of company stock (held privately or publicly). To incorporate as a C Corporation, the business’s organizers must file formation paperwork (Articles of Incorporation or Certificate of Incorporation) with the state and comply with the state’s other requirements for legally forming a corporation.
Pros of operating a counseling practice as a C Corporation:
- Highest Degree of Legal Protection – As a separate legal and tax entity, a C Corporation protects shareholders and directors from lawsuits and creditors’ claims against the company.
- Potential Tax Advantages – A C Corporation must file a tax return and pay corporate tax on its profits. In some situations, the federal corporate income tax rate is lower for corporations than individuals, which could be advantageous. Also, C Corporations may be eligible for tax deductions that LLCs, Sole Proprietorships, and Partnerships may not claim. C Corporations (provided they have 100 or fewer shareholders) may opt to be taxed as an S Corporation to get pass-through taxation instead.
- Greater Growth Opportunities – C Corporations can sell stock and have an unlimited number of shareholders. That’s an attractive feature for companies with their sights set on expansion. Also, customers, vendors, lenders, and investors may view C Corporations as more credible and trustworthy.
- Perpetual Existence – Whereas other business entities may cease to exist after their owners pass away, retire, or otherwise leave the company, C Corporations can more readily survive. Ownership interests can be transferred by selling, gifting, or bequeathing shares of stock to others.
Cons of operating a counseling practice as a C Corporation:
- More Complex and Costly Business Formation – Typically, forming a C Corporation is more involved than starting an LLC, which may increase the legal fees to get a practice off the ground. In addition to filing Articles of Incorporation, a C Corporation must appoint a board of directors and adopt bylaws, and it may have to file an initial report.
- Double Taxation – A C Corporation pays taxes on its profits at the corporate income tax rate. When profits are distributed as dividends to the company’s shareholders, the shareholders must also pay taxes on their share of the profits at the applicable individual income tax rate. You’ll hear this referred to as double taxation because the corporation is paying taxes on all profits and then shareholders are paying taxes on their portion of those profits.
- Higher Degree of Government Oversight – C Corporations have more compliance formalities to deal with than LLCs. They must follow internal and external corporate rules — such as filing annual reports, holding shareholder and board of directors’ meetings, maintaining a registered agent, and following bylaws — to operate legally and remain in good standing with the state.
An S Corporation is what an LLC or a C Corporation is called when it elects tax treatment under Subchapter S of the Internal Revenue Code by filing IRS Form 2253. S Corporation election allows a C Corporation to be treated as a pass-through tax entity and an LLC to remain a pass-through entity while gaining the ability to put its members on the company payroll. All other aspects of operating the underlying LLC or C Corporation business entity type remain in place.
Pros of operating a counseling practice as an S Corporation:
- Owners’ Assets Protected – Because the registered entity is an LLC or C Corporation, business owners have legal protection against the debts of and claims against the company.
- Reduction in Self-Employment Tax Burden – With an S Corporation election, LLC members may be put on the company payroll. Only the wages and salaries paid through payroll are subject to Social Security and Medicare taxes; the remaining business income paid as profit distributions to the business owners are not.
- Double Taxation No More – Normally, some of a C Corporation’s earnings get taxed twice: once at the corporate level and then again at the shareholder level when the company pays dividends. With S Corporation election, the company becomes a pass-through entity. The business does not pay tax at the corporate level, and all profits and losses flow to the shareholder’s personal tax returns.
Cons of operating a counseling practice as an S Corporation:
- Limitations on Ownership – Only LLCs and C Corps with 100 or fewer owners may choose S Corporation election. Also, no partnerships, corporations, or non-resident aliens may own an S Corporation.
- Limited to One Class of Stock – A corporation may only have one class of stock if it elects S Corporation tax treatment. This means less flexibility in allocating income or losses to shareholders.
- IRS Scrutiny – The IRS may watch S Corporations more closely to make sure they aren’t trying to game the system by paying their owners unreasonably low wages and salaries to minimize their Social Security and Medicare tax obligations.
A Professional Corporation (PC) is an entity option for licensed professionals. Some states require certain professionals to form a PC (or other professional entity).
Examples of occupations that form Professional Corporations include doctors, attorneys, accountants, architects, and mental health professionals.
Pros of operating a counseling practice as a Professional Corporation:
- Personal Asset Protection – A Professional Corporation is a separate legal and tax entity from its owners. Therefore the owners’ personal assets are protected from the liabilities of the business operations.
- Tax Flexibility – Professional Corporations are taxed similarly to C Corporations, but they can elect to be taxed as S Corporations (if they meet the IRS’s eligibility requirements).
- Transferability – Ownership of a Professional Corporation can be easily transferred through selling stock.
- Credibility – Clients, lenders, and vendors may have more confidence in a practice formed as a Professional Corporation than they might in some other entity types.
Cons of operating a counseling practice as a Professional Corporation:
- Complexity – Filing requirements vary and can be rather complicated depending on the state. Also, Professional Corporations have compliance obligations similar to those of C Corporations.
- Ownership Limitations – Many states require that Professional Corporations are owned only by individuals licensed in the same occupation.
- Double Taxation – Like a C Corporation, a Professional Corporation pays tax on its profits at the corporate level and then profits distributed to shareholders are taxed again and paid by the individuals at the applicable personal income tax rates.
The Bottom Line
As you can see, there’s a lot to consider when deciding which business structure will best serve your needs now and in the future.
Some guiding questions to ask yourself:
- Are you concerned about protecting your personal assets from the liabilities of your practice?
- Do you want to run a solo practice or have partnerships?
- If you have business partners, will they all be involved in managing your practice’s day-to-day operations?
- Do you envision growing and expanding your business?
- Which is more important to you: convenience and simplicity or personal liability protection and tax flexibility?
This food for thought is just the tip of the iceberg! Getting legal and tax advice from experts can increase your understanding so you make an informed choice.
Also, consider talking with other counseling and therapy professionals to learn about their experiences in setting up and managing their business entities. They may have some valuable insight that can help you avoid potential pitfalls along the way.
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