Private Practice 101 (Week 3): What Type of Business Are You?

by Kimberly on March 23, 2010 · 15 comments

We are now in Week 3 of our “Private Practice 101” series! So far we’ve talked about determining why you want to start a practice (Week 1) and creating your business team (Week 2).

I encourage you to check out the comments sections of the previous posts. There have been some great questions and useful information provided by readers! A couple highlights:

  • When you develop a therapy private practice, you are a small business owner, you are in private practice, and you are self-employed. Just in case that’s confusing (as it was for me initially).
  • The initial meetings I recommended last week you set up should be free. Initial consultations typically are. I have never paid for one.

Now on to today’s topic…

What Type of Business Are You?

Today’s topic: a basic overview of different business structures, including (in my humble opinion) pros and cons for each.

Disclaimer: This is not legal advice. This information is for educational purposes only. You should consult with an attorney and a CPA to determine which type of business will best meet your needs.

The very first step before starting your own private practice is to decide what business entity best fits your needs. In the eyes of the law (and the IRS), a business is a separate entity that has it’s own taxes, rules, and laws–at least, most businesses. In this light, a business is, very literally, like your baby.

You have several options, each with pros and cons briefly outlined below:

1) Sole Proprietorship

This is definitely the easiest, lowest cost type of business to start. Basically, you are your business and your business is you. You file your business taxes with your personal taxes. There is no need for a separate business “social security number” (called an EIN, or Employer Identification Number). In the eyes of the law, there is no distinction between you and your business.

The main benefit of a sole proprietorship is that there is very little start up cost. I started with a sole proprietorship – it only cost me $15 to register my tradename with the state of Colorado (then, KMS Music Therapy).

Sounds straightforward, right? It is…but at a cost. Not a monetary cost, but a risk cost. You see, if something were to happen and you were to get sued, your personal assets would be at risk. Your home, your car, your retirement, your savings…all of it is at risk because your business is you.

And not only that, but it also has a tax disadvantage. There is a tax out there called the “self-employment tax,” a 15.3% tax similar to the Social Security and Medicare taxes employers pay. (I’ve given a basic overview of payroll taxes in 2 articles here and here).

Pros
Easiest and cheapest to start
Simple tax returns

Cons
Pay the self-employment tax
Increased liability
Not as credible

Partnerships
A partnership is just as it sounds – two (or more) people are in business together. This is kind of like a sole proprietorship for two or more owners. Like a sole proprietorship, a partnership is not a separate legal entity. The laws view the business as inseparable from the owners.

On the plus side, you get the advantage of working with another person. You can share the costs, share the profits, share the losses, share the work.

Beyond that, a partnership carries the same benefits and risks as a sole proprietorship.

Pros
Easy and cheap to start
Simple tax returns (each owner files with their individual taxes)
Shared start-up cost, shared liability, shared work

Cons
Pay the self-employment tax
Increased personal liability
Not as credible

Corporation (S- or C-corporation)
A corporation is it’s own business entity. In the eyes of the law (and of taxes), a corporation is it’s own “person” with it’s own “social security number,” or EIN. Any assets (e.g. property, instruments, textbooks) owned by the corporation belong to the company. They are not yours (and vice versa – any assets of yours belong to you and not the company). An incorporated business will include an “Inc.” at the end of the name, as in “My Music Therapy Business, Inc.”

Corporations have been around since the Romans. They were a way for people to protect their money and decrease their personal risk. People would invest in a venture together (for example, paying for a ship to sail to the Americas and look for gold), then share in the profits (receive a proportional “cut” of the treasure) and in the risk (don’t lose as much if the ship’s lost at sea).

So that’s the basics of a corporation: it’s a legal entity that people (or a person) invests money in so that one day they will make a profit on their investment. It’s also an entity that has to adhere by certain laws and has to pay it’s own taxes.

A corporation has it’s own structure. There are the owners of the corporation and managers. Most likely, as a small business, they will be one and the same for you, as they are for me. Here are the structural elements of a corporation:

  • Shareholders/Stockholders: Technically, the shareholders own the corporation. They are the ones who have invested the money. A corporation can have 1 shareholder or millions.
  • Board of Directors: The shareholders elect the board of the directors. The job of the Board is to act on behalf of the shareholders. The Board often includes high-ranking company managers (e.g. the CEO, CFO, etc.) and outside community members.
  • Officers: These are the managers of the company, the people responsible for the day-to-day management of the corporation (and the people responsible for making sure the company makes a profit). Types of officers you may be familiar with include CEOs (Chief Executive Officer), CFO (Chief Financial Officer), CNO (Chief Nursing Officer), or COO (Chief Operations Officer).
  • Employees: The employees are the nuts and bolts of a corporation, the people who make sure everything runs smoothly and is taken care of.

There are two types of corporations, a c-corporation and an s-corporation. The difference between them is a tax difference, so you should consult your lawyer and accountant to figure out which option works best for you (my business, Neurosong Music Therapy Services, Inc. is an s-corporation).

Pros
Increased credibility
Tax benefits
Limited personal liability

Cons
Heavier start-up costs
More complicated tax forms

Limited Liability Company (LLC)
This is a very popular option these days. Business that are LLCs will have that designation behind there name, e.g. “My Music Therapy Business, LLC.” You will read the following descriptions about LLCs: 1) they are a very flexible option, 2) they are the newest business entity (only available since the mid-1990s), and 3) the legal system doesn’t yet always know what to do with LLCs because they are so new.

An LLC is a hybrid between a corporation and a sole proprietorship: it is taxed liked a sole proprietorship (technically, you have several tax options) but with the liability protection of a corporation. Many lawyers consider an LLC a more flexible option for a business entity (especially one with a single owner) for tax reasons.

Again, an LLC is it’s own business entity, with it’s own EIN, it’s own taxes to pay, it’s own assets, and it’s own liabilities. It also has it’s own structure, which is more flexible than a corporation’s structure:

  • Members: The members own the LLC, just like shareholders own a corporation. The members are the ones who invest the money and the members are the ones who benefit from the profits.
  • Management: Here’s a difference between an LLC and a corporation – the day-to-day management of an LLC can be run by either the members or managers elected by the members.

Pros
Increased credibility
Tax benefits
Limited personal liability

Cons
Heavier start-up costs
More complicated tax forms

Non-Profit
All of the business entities listed thus far are “for profit” companies. Their sole purpose is to make money for their stockholders, shareholders, members, and themselves. A non-profit, however, is a business entity that does not distribute profits to it’s owners, but instead uses the money for a cause, to provide some sort of public benefit.

The non-profit status is how a business is viewed in the eyes of the law. There are many names that can be used to describe a non-profit business: NPO (non-profit organization), charity, foundations, and endowments. NPOs are often eligible to apply for grants and people who donate money to an NPO can use that money as a deduction on their taxes.

Like a corporation or an LLC, a non-profit is it’s own business entity. And in general, you have people who own the NPO and people who manage it. But there are many options available. It would be best to consult an attorney to figure out what would work best for you.

Pros
Increased credibility
Tax benefits
Limited personal liability

Cons
Heavier start-up costs
More complicated tax forms

ACTION STEPS:

In some ways, this week’s action steps are a continuation of last week’s steps:

  • During your interviews with various lawyers and accountants, ask each one for their opinion (after they have a feel for what you want) of which business entity would best meet your needs.
  • Rules for how to set up a business vary state by state. Ask your lawyer or accountant (or dig a little around your state’s Department of Revenue website) to create a list of the requirements needed to set up a practice in your state. Or pay them to do it for you (which may be expensive. It cost me about $600 for my attorney to file incorporation papers).
  • Submit (or ask your lawyers or accountant to submit) paperwork to apply for an EIN (not needed for a sole proprietorship or partnership).

NEXT WEEK: Next week, we’ll start digging into the fun stuff–getting paid!

P.S. I’m still accepting applications for a FREE month’s advertising space on the Music Therapy Maven. Applications are due by the end of the month. There are up to 4 spots available. For detail, click here.

P.P.S. It’s been an exciting week for me as a new blogger for Psychology Today. My blog is called Your Musical Self (you can find it here) and it’s dedicated to highlighting how you can use music to learn, heal, and live. The response to the first article have been overwhelming: PT highlighted the article as an “Essential Read” on their “Creativity” section last week and showcased it on their homepage all day yesterday. It’ll be fun to see where this journey takes me. Glad we’re on this ride together!

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{ 12 comments… read them below or add one }

Natalie March 23, 2010 at 11:13 am

Ooo! Ooo! Ooo! I’m already ahead on this one! My dad has ran his own business for forever, so of course, he is a corporation, but after a lot of deliberation, looking at my lovely house, and talking with an accountant about those awesome tax forms and the not that big of a deal start of cost, I’m choosing the ever popular LLC option as well ($115 to start and the taxes run the same as a sole proprietorship). Maybe one day when I’m a big bad giant of music therapy I’ll grow into some “, Inc.” pants, but not any time soon.

I’m still stuck back on last week. I talked to two awesome accountants. (accountant three never called me back. I think we know the answer on THAT one). One was super awesomely helpful and the first one I talked to so I had lots of questions. Two was also super awesomely helpful but I already knew a bit from number One. However, Two was knowledgeable about loans/grants/monies for female small business owners and getting in on state contracts etc, which I don’t know how useful that would be for me, but she sure seems to know her gender slant.

The prices are comparable, I just have to extract my bias from the interviews 🙂

Kimberly March 23, 2010 at 3:51 pm

Sounds like you can’t go wrong either way—lucky you! And an LLC is as grown up as an Inc. Not “big girl” pants to fill there;) ~Kimberly

Rachel March 24, 2010 at 11:09 am

Great great info- laid out so clearly and understandable.
Question: If I start a sole proprietoriship and purchase liability insurance, are my personal assets still at risk? ($150 to buy in IL, usually covers millions)

Thank you!

Kimberly March 25, 2010 at 10:38 am

My understanding is that, yes–if you have a sole proprietorship, you personal assets are at risk, even if you have liability insurance. BUT–check with your lawyer and accountant, just to be sure:D ~Kimberly

Laura March 26, 2010 at 1:30 pm

Kimberly-
First off, that is very exciting new about Psychology today. Your awesome. Second, I’ve been reading your blog for the past few weeks and love it! I’ve gain some great insight into the private practice world and simple enjoy reading everything. Keep up the good work.

Best,

Laura Hess, MA, MT-BC
Denver, CO

Kimberly March 30, 2010 at 8:09 am

Thank you, Laura! That means a lots. Hope you continue to enjoy it! ~Kimberly

Kathy Schumacher March 31, 2010 at 11:56 am

Thanks for the great info. I’m curious as to why you chose S-corp, if you’re willing to share? I personally am an LLC based in Wisconsin. I recently noticed that Amazon.com is an LLC – which really surprised me.

Kimberly April 1, 2010 at 8:35 am

In all honesty, I chose s-corp because, at the time, that’s what my attorney recommended (and my accountant said there was no big difference for me from a tax standpoint). So I went with that. If I were starting over this year, the situation in my state may be different and they may recommend an LLC instead. But an s-corp has worked just fine for me. ~Kimberly

Kristi September 16, 2010 at 12:08 pm

Question… starting a private practice with a partner… each will profit from clients seen… should we create two separate sole prop. or an LLC? Any feedback would be helpful.

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Kimberly May 9, 2013 at 11:00 am
Kathy December 29, 2015 at 5:00 pm

Hi,
I was just wondering what the benefit is of opening a PLC instead of an LLC or Corp?
Thanks!

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