How to Properly Restructure a Dental Practice

Taxes affect us all and, as small business owners we need to realize the benefits of proper tax planning more than most. Many dentists are restructuring their dental practices to maximize the tax advantages offered by a customized business structure. A Practice restructure allows them to better manage the flow of their revenue, increase profitability, and enhance the organization of their dental practice. One of the most popular business structure enhancements is to establish a management company to help with the operations side of your dental practice. Of the utmost importance, however, is to enter these new business structures with a holistic view toward fully integrating these changes into your overall dental practice procedures and processes. Attempting to restructure as a half-measure is ultimately not the right path to follow, as evidenced by the recent federal court case of a California dentist and the management company he created.

The Case

In January 2016, the U.S. Court of Appeals for the Ninth Circuit decided against a dentist who had sought to claim fees charged by his management company as expenses to be deducted from his federal income taxes. The Court agreed with the US Tax Court in disallowing the expense deductions in Wiley M. Elick DDS, INC v. Commissioner of Internal Revenue, 117 AFTR 2d 2016-457. The U.S. Supreme Court has denied review of this case, finalizing the federal court of appeals ruling.

In the Elick case, a dentist from California established a company to manage his Practice’s operations. The management agreement stated that the management company would provide various services such as: produce annual budgets; investigate and document in writing customer complaints; develop policies and procedures; recruit, supervise and train employees; perform fiscal services; and ensure regulatory compliance. All of these services are vital and necessary to the operation of a dental practice and must be performed in the ordinary course of the functioning of a dental practice. Management companies can be a great tool to enhance your dental practice’s productivity, bottom line and income. But, as the Elick case proves, the business structure that puts these entities in place and integrates them into your dental practice operations must be done properly.

This case stated that the Tax Court disallowed the deduction of the management company fees from the dentist’s federal income taxes as not being “ordinary and necessary” expenses. As mentioned earlier, the services the management company purported to offer were all matters that are necessary to the operations of a dental practice and must be done in the ordinary course of business for a dental practice. What happened? What went wrong and how could it have been avoided?

How Could This Have Been Avoided?

The facts set out by the Court indicate that there were several failures with regard to actually integrating the management company into the overall business structure of the dental practice. The first failure was that the management company had no functioning employees. The dentist was designated as a “co-employee” of the management company and his main dental practice entity, but was then also listed as a full-time employee of the Practice. The dentist employed an office manager who was also the dental practice bookkeeper. However, that person was not an employee of the management company. This failure could have been avoided if the office manager, and other Practice employees, had been properly moved to be employees of the management company, which is a fairly easy matter to handle.

The second failure is related to the fact that there were no records or other indications that the management company actually provided the management services it claimed to offer. Having sound procedures in place to help your office staff keep appropriate records is not only vital to your operational success; it is required under numerous federal laws that impact the dental profession, such as HIPAA.

The third failure was that the management company never issued monthly invoices. The Court found that it was compensated at the end of the year with a lump sum amount calculated solely by the dentist that owned the Practice. The lump sum amount was not based upon invoices, services performed, or the advice/estimate of his accountant. If you are operating your management company properly, issuing invoices for services rendered will become a very easy and standard process, and allow for successful documentation of the management company expenses without issue. The invoices will track the expenses for the services rendered and allow for appropriate calculation of those expenses at year end without the need to generate numbers to make them fit.

Conclusion

The failures to properly integrate the management company into the dental practice were foreseeable and could have easily been avoided, as mentioned above. The best way for your dental practice to avoid failures of this type, and others like them, is to work with an experienced team of dental professionals that can help you properly and fully integrate your new business structure into your dental practice. It would not make sense to buy a new piece of equipment for your dental practice, planning not to use it or intending to use it improperly. Entering into a business restructuring to receive all of the benefits the new structure offers, and then not implementing it properly also wouldn’t make sense. The new business structures for dental practices can offer enhanced profitability, asset protection and increased organization. The experienced dental attorneys at Nardone Limited can help you create a new business structure that works for your dental practice. We are available to help you make certain that the new structure is properly integrated into your dental practice so that you receive all of its benefits, and avoid any potential pitfalls.