Dental practice owners are trusted professionals in the medical world, but the business side of running a practice can impose many difficulties on dentists. These challenges can hinder their ability to grow their practices and achieve long-term goals. One of dentists’ most common pain points is managing cash flow.
Business formalities such as entity type, income structure, and debt structuring are often overlooked but can greatly affect a dental practice’s cash flow even before the team has serviced its first patient. Here are three steps to set up your dental practice for success when it comes to income and debt structuring.
Choose the right business entity
There are two main entity options for running a dental practice. Dental practice owners typically run their practices as a limited liability company (LLC) or an S-corporation entity. An LLC is a legal structure for a business that separates personal assets from business assets and protects personal life from business liabilities, which can save practice owners hassle should a lawsuit occur. An LLC offers flexibility on the taxation of earnings and the distribution of money if the practice is a partnership. However, the downside of an LLC is that members are considered self-employed and must pay self-employment tax contributions toward Medicare and Social Security.
Related articles
The certainty of uncertainty: What can you really control?
Strategic and financial planning through the dental practice life cycle
On the other hand, an S-corporation allows profits and losses to be passed through directly to owners’ personal income without ever being subject to corporate tax rates. Most dentists prefer this entity. As an S-corporation, a practice owner's income is taxed at the shareholder level rather than the corporate level, which means avoiding double taxation. If this entity structure and income structure (see next section, “Know your options for income structure”) are done appropriately, this can save well into the five digits in taxes.
Need to restructure your dental practice? Reorganizations are common and can be done easily. It is important to find an experienced CPA to guide you, as well as a knowledgeable attorney in your state to set it up.
Know your options for income structure
What is often skimmed over when it comes to owning a dental practice, or any business for that matter, is how business owners pay themselves. This might seem insignificant; however, the route you take could determine if you’re set up for maximum savings or are paying more out of pocket. With an S-corporation, there are two options for income structure: W-2 and shareholder distribution.
Most are familiar with the W-2 income structure, which is how most employees are paid—through payroll. As an S-corporation using a W-2, the dentist can take a portion of their income from a W-2 that is withheld from taxes on every paycheck while the remaining the practice owner.
Another option allowed in an S-corporation to take income is through shareholder distribution. Instead of getting paid through payroll, shareholder distribution allows dentists to physically receive a check from the practice while also limiting Medicaid tax, which is 2.9%, so owners save on every dollar that they pay themselves; however, taxes will not come out.
What is often skimmed over when it comes to owning a dental practice, or any business for that matter, is how business owners pay themselves.
Choosing the best income structure for you and your practice is imperative to improve overall cash flow, and it’s a good idea to look to a dental attorney while weighing these options. Striking a good balance between both income structures of an S-corporation is the ideal long-term goal. However, if you’re currently out of balance in evaluating the best strategy with your tax professional, you can yield to tax savings as you work toward that long-term target.
Create balance in debt structuring
As you’ve heard and had taught to you, getting rid of debt is supposedly the universal key to financial freedom. It may seem obvious that if you’re in debt, you should pay it off as soon as possible, but that is not always the case.
It may go against everything business owners have learned, but debt is essential to building a healthy practice while also building your retirement fund. Some debt is deemed bad while some is good. An example of good debt is your mortgage or a loan to buy a new piece of equipment, and bad debt could be a high-interest credit card. Bad debt should be eliminated, and good debt can be managed gradually.
Dentists take on a lot of debt to purchase expensive equipment, their office space, and often six-figure student loans as well. Many new dentists with a student loan in excess of $300,000 try to get out of debt quickly; however, it’s best to pay off debt slowly and steadily for ample investment opportunities at the same time. Learning to leverage practice debt properly to stretch it out over the long term ultimately increases cash flow.
Dentists are naturally debt-averse, which sounds a lot better than it is. For instance, practice owners are likely to cut a check for a large purchase rather than financing, which can quickly deplete their checking account. It’s critical to always have a baseline level of cash to deal with unexpected expenses.
Paying for equipment and planned expenses upfront can be stressful. Debt might not be ideal, but it allows practice owners to invest before it’s too late or continue to pay themselves normally and not have to lower their pay due to the self-imposed cash crunch. Once on your way to a healthy retirement fund, you can build a strategy to pay off your good debt, as long as you’re also able to save what you need for retirement.
Managing your cash flow as a dental practice owner can be taxing. Your practice will be well-structured in the long run if you keep these aspects of your business top of mind and make sure these areas are balanced.
This article originally appeared in DE Weekend, the newsletter that will elevate your Sunday mornings with practical and innovative practice management and clinical content from experts across the field. Subscribe here.
