Business Organizations

1. Business Organizations

2. 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 limited liability companies and subchapter S corporations.

3. Partnership

4. A “partnership” can be created through 4 different types of business organizations: • General partnerships • Limited liability companies • Professional associations or corporations • Subchapter S corporations A general partnership is the traditional method.

5. General Partnership • A partnership can be defined as “an association of 2 or more ‘persons’ to carry on as co-owners a business for profit.” • Partnerships are quasi-legal entities: they can hold title and exercise certain property rights but partnerships cannot sue in their own name and do not pay taxes. • Partnerships are regulated in all states (except Louisiana) by the Uniform Partnership Act, which controls many aspects of the partnership but allows the partners to modify some provisions.

6. General Partnership • The financial issues (and other aspects of operation of the partnership) are controlled by the partnership agreement (or “articles of partnership”), which describes the manner in which the partnership is run and the responsibilities of the partners. • The partnership agreement must provide for the formation, maintenance, and dissolution of the partnership (because all partnerships end).

7. General Partnership • The liability of partners is "joint and several"; each partner is considered to be the agent of the other, and thus all partners are liable for the acts of a single partner. • A partnership pays no taxes; it is a conduit for tax purposes. The partnership does file a federal tax return, on Form 1065; this form reports the partnership's income, its expenses, and the partners' profit (or loss). • There are distinct advantages and disadvantages to going into a partnershiparrangement.

8. Going into Partnership Advantages Generally higher earnings than solo optometrists   Shared overhead, less capital outlay per partner compared to solo optometrists   Office coverage during vacations, illness, personal holidays   Consultation with partners for business and patient management decisions    Expanded hours, convenience for patients   Investment in career protected and equity established for retirement, disability, or death

9. Going into Partnership Disadvantages Loss of independence   Personality conflicts with partners or the spouses of partners   Differences in professional ideas and philosophies   Unequal distribution of patient load   Unequal distribution of income based on productivity of the partners

10. Professional Associations or Corporations

11. 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

12. Corporations enjoy certain advantages and disadvantages when compared to other types of business organizations: Advantages • Tax benefits (deductible insurance, retirement plans) • Medical expenses reimbursement plans • Employee insurance plans • Sick pay • Better administrative organization • Transferability of ownership • Continuity of existence • Limitations on legal liability

13. 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

14. Articles of incorporation are filed in the state by the incorporators (only one is needed) to describe the purpose of the corporation, its stockholders, and its management.In a professional association (PA) or corporation (PC) the PA or PC may be formed by one or more licensed professionals, who constitute both ownership and management. Only licensed professionals can own stock and serve on the Board of Directors; however, non-professionals can be Officers.

15. Structure of CorporationsShareholders(owners)electBoard of Directors(long term management)who electOfficers(day-to-day management)

16. Structure of Professional Associations/CorporationsShareholders(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; does not have to be professional licensee)

17. The PA or PC is responsible for its contracts, debts, and the negligence of its employees. The shareholders (owner) are not responsible for debts or liability claims, although in a one licensee PA or PC if the licensee is negligent he or she will be individually responsible and the PA or PC will also be responsible as employer.

18. PAs or PCs pay a federal income tax; a "double tax" is possible, if the PA or PC has a profit (35% bracket) and the shareholder-employee is paid a salary (10% to 35% bracket). PAs or PCs must file an annual tax return, on Form 1120.Most states also charge an income tax for corporations. In Alabama, for example, the tax rate is 5% of taxable income. A “business privilege tax” is also levied in Alabama against corporations and LLCs, at the rate of $1 per $1,000 of taxable income, or a minimum of $100.

19. Subchapter S Corporations

20. Subchapter S Corporations • Small corporations may elect to be taxed under Subchapter 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 optometrist may share ownership with another professional (such as an optician) or nonprofessional (such as a spouse). • An S Corporation is limited by law to 100 shareholders.

21. Subchapter S Corporations • To create an S Corporation, first a business corporation must be formed, then it must elect Subchapter S status. • The election must be unanimous among the shareholders. • The election must be made during the first month of the tax year (or in the month preceding).

22. Subchapter S Corporations • Because an S Corporation pays no taxes, it avoids the "double tax" imposed on earnings of a PA or PC. Employees of an S Corporation are paid salaries, on which individual income tax is imposed. • Employees of S Corporations may participate in tax-deferred retirement plans, such as Keogh defined benefit and defined contribution plans, and 401(k) plans, thus providing tax benefits similar to those offered by PAs and PCs.

23. Subchapter S Corporations • Potential tax savings can be realized in an S Corporation by the payment of dividends (a return of 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 Social Security/Medicare tax. Example: after all expenses and 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.

24. Subchapter S Corporations • Tax writeoffs are not the same for S Corporations as for PAs and PCs; for example, life and disability insurance premiums may be deducted by a professional association or corporation, but not by an S Corporation. • Liability is similar to that of a professional association or corporation: an optometrist-shareholder is not personally liable for the negligence of another optometrist-shareholder; rather, the S Corporation is responsible.

25. Subchapter S Corporations • Subchapter S Corporations are occasionally chosen as the business organization for optical dispensaries that are separate from private practices. • Because laypersons (opticians, spouses) can be stockholders in S Corporations, these individuals can be co-owners of the dispensary—even though the optometrist practices as a PA or PC and they are prohibited from being stockholders (co-owners) of the PA or PC.

26. Limited Liability Companies

27. Limited Liability Companies • Limited Liability Companies are a relatively new type of business organization (first authorized in Alabama in 1993). • An LLC may be formed by 1 or more individuals, partnerships or corporations, and may have perpetual duration. • Articles of Organization and an LLC operating agreement are used to establish the purpose, conduct and management of the company.

28. Limited Liability Companies • An LLC can be used to render professional services; 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 to the rules for professional associations or corporations). • Members of the LLC control management unless the Articles of Organization provide otherwise.

29. Limited Liability Companies • The LLC is treated like a partnership for tax purposes; 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 the debts or negligence of other members. In this, the LLC is like a professional association or corporation.

30. Limited Liability Companies • The formation of LLCs is controlled by state law (the state's Limited Liability Company Act), found in all states. • For tax reporting purposes, the LLC may elect to be classified as a corporation or a partnership (for 1 person LLCs, as a corporation or a sole proprietorship); this election is made by filing Form 8832.

31. 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 S corporations tax reporting is on Form 1120S • Sub S shareholders share profits as dividends; an LLC splits profits in accordance with the operating agreement

32. Keogh Plans • Retirement plans for partnerships include Keogh Plans. • 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 ½ and 70 ½ 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 certain circumstances.

33. Keogh Plans • There are 2 basic types of plans: • defined contribution: an established amount is contributed each year—in a profit sharing plan, up to 25% of income, to a maximum of $46,000 (for the 2008 tax year); the amount is based on profits and may be changed from year-to-year. • defined benefit: the actuary-determined amount necessary to fund a retirement income equal to 100% of earnings, up to $185,000 a year (as of 2008); yes, that means you can put everything you earn into the Keogh to fund your retirement!

34. Keogh Plans • Defined contribution profit-sharing plans must include eligible employees; up to 25% of income may be contributed, and the employer determines the percentage of profit-sharing to contribute to the plan. Again, the limit is $46,000. • If a Keogh Plan is established, all full time employees are eligible to participate ("full time" is defined as an employee who has been employed for 2 years and works more than 1000 hours a year).

35. Keogh Plans • Vesting is the length of time needed for eligible employees to be entitled to 100% of investment income (the amount in excess of what the employee has contributed). “Cliff” vesting requires 3 years to reach 100%, while “graded” vesting takes 6 years (0% first year, then 20% a year after). • Plans may vary with respect to vesting. If an employee quits before 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% vested in the plan. If the employee withdraws from the plan, the employee may take the $5,000 contributed to the plan, plus 60% of the $2,000 accumulated value, for a total of $6,200.

36. Keogh Plans • As the example illustrates, the contributions made by employees are irrevocably theirs, even if the employees quit or are fired. • The percentage contribution for defined contribution plans must be the same for all. Example: if 25% of income is contributed, an employer earning $100,000 contributes $25,000, while an employee earning $20,000 contributes $5,000.

37. Keogh Plans • Because of the large annual contributions permissible under Keogh Plans (particularly defined benefit plans), they tend to be used by individuals 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 ½ years without penalty). • The requirement that full-time employees be permitted to participate in the plan increases the cost and complexity of plan administration.

38. Self-Employed Business-Related Tax Deductions