tax deductions for professionals 3rd (2008)

Tax Deductions
for Professionals
By Attorney Stephen Fishman
3rd edition
Third Edition JANUARY 2008
Editor DIANA FITZPATRICK
Book Design TERRI HEARSH
Cover Design SUSAN PUTNEY
Proofreading ROBERT WELLS
Index SONGBIRD INDEXING SERVICES
Printing DELTA PRINTING SOLUTIONS, INC.
Fishman, Stephen.
Tax deductions for professionals / by Stephen Fishman 3rd ed.
p. cm.
Includes index.
ISBN-13 978-1-4133-0782-5 (pbk.)
ISBN-10 1-4133-0782-5 (pbk.)
1. Professions Taxation Law and legislation United States. 2. Professional
corporations Taxation United States. 3. Tax deductions United States. I. Title.
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Table of Contents
I
Your Tax Deduction Companion 1
1
Tax Deduction Basics
How Tax Deductions Work 6
The Value of a Tax Deduction 9
What Professionals Can Deduct 12
2
Choice of Business Entity
Types of Business Entities 19
Limiting Your Liability 26
The Four Ways Business Entities Are Taxed 33
Comparing Tax Treatments 39
Should You Change Your Business Entity or Tax Treatment? 63
3
Operating Expenses
Requirements for Deducting Operating Expenses 70
Operating Expenses That Are Not Deductible 75
Tax Reporting 76
4
Meal and Entertainment Expenses
What Is Business Entertainment? 80
Who You Can Entertain 81
Deducting Entertainment Expenses 82
Calculating Your Deduction 86
Expenses Reimbursed by Clients 91
5
Car and Local Travel Expenses

Deductible Local Transportation Expenses 94
The Standard Mileage Rate 99
The Actual Expense Method 101
Other Local Transportation Expenses 113
Reporting Transportation Expenses on Schedule C 114
When Clients Reimburse You 115
Professionals With Business Entities 115
6
Long Distance Travel Expenses
What Is Business Travel? 122
What Travel Expenses Are Deductible 127
How Much You Can Deduct 129
Maximizing Your Business Travel Deductions 139
Travel Expenses Reimbursed by Clients 142
7
The Home Office Deduction
Qualifying for the Home Office Deduction 146
Calculating the Home Office Deduction 158
How to Deduct Home Office Expenses 167
Audit-Proofing Your Home Office Deduction 171
8
Deductions for Outside Offices
If You Rent Your Office 174
If You Own Your Office 177
If You Lease a Building to Your Practice 187
9
Deducting Long-Term Assets
Long-Term Assets 191
Section 179 Deductions 194
Depreciation 204

Tax Reporting and Record Keeping for Section 179 and
Depreciation 226
Leasing Long-Term Assets 228
10
Start-Up Expenses
What Are Start-Up Expenses? 234
Starting a New Practice 235
Buying an Existing Practice 237
Expanding an Existing Practice 238
When Does a Professional Practice Begin? 239
How to Deduct Start-Up Expenses 241
Organizational Expenses 244
11
Medical Expenses
The Personal Deduction for Medical Expenses 249
Self-Employed Health Insurance Deduction 250
Deducting Health Insurance as an Employee Fringe Benefit 253
Adopting a Medical Reimbursement Plan 258
Health Savings Accounts 264
12
Retirement Deductions
Why You Need a Retirement Plan (or Plans) 280
Types of Retirement Plans 285
Individual Retirement Accounts—IRAs 286
IRAs for Businesses 291
Qualified Retirement Plans 295
Keogh Plans 298
Solo 401(k) Plans 299
Roth 401(k) Plans 300
13

Inventory
What Is Inventory? 302
Do You Have to Carry an Inventory? 305
Deducting Inventory Costs 306
IRS Reporting 308
14
More Deductions
Advertising 313
Business Bad Debts 315
Casualty Losses 321
Charitable Contributions 323
Clothing 325
Disabled Access Tax Credit 326
License Fees, Dues, and Subscriptions 327
Education Expenses 328
Gifts 331
Insurance for Your Practice 331
Interest on Business Loans 333
Legal and Professional Services 336
Taxes 337
Domestic Production Activities 341
15
Hiring Employees and
Independent Contractors
Employees Versus Independent Contractors 346
Tax Deductions for Employee Pay and Benefits 350
Reimbursing Employees 356
Employing Your Family 358
Tax Deductions When You Hire Independent Contractors 367
16

Professionals Who Incorporate
Automatic Employee Status 372
Paying Yourself 374
Employee Fringe Benefits 386
Shareholder Loans 394
17
How You Pay Business Expenses
Your Practice Pays 398
Using Personal Funds to Pay for Business Expenses 400
Your Client Reimburses You 407
Accountable Plans 409
18
Amending Tax Returns
Reasons for Amending Your Tax Return 414
Time Limits for Filing Amended Returns 415
How to Amend Your Return 416
How the IRS Processes Refund Claims 418
19
Staying Out of Trouble With the IRS
Anatomy of an Audit 420
The IRS: Clear and Present Danger or Phantom Menace? 422
How Tax Returns Are Selected for Audits 423
Tax Shelters, Scams, and Schemes 426
Ten Tips for Avoiding an Audit 430
20
Record Keeping and Accounting
Recording Your Expenses 436
Documenting Your Deductions 438
Accounting Methods 457
Tax Years 463

21
Help Beyond This Book
Secondary Sources of Tax Information 466
The Tax Law 472
Consulting a Tax Professional 478
Index 481
Introduction
Your Tax Deduction Companion
2 TAX DEDUCTIONS FOR PROFESSIONALS
I
f you’re a professional, no one needs to tell you that taxes are one
of your largest expenses. The best way to minimize your taxes and
maximize your take-home income is to take advantage of every tax
deduction available to you.
The IRS will never complain if you don’t take all the deductions you’re
entitled to—and it certainly doesn’t make a point of advertising ways to lower
your taxes. In fact, many professionals miss out on all kinds of deductions
every year simply because they aren’t aware of them—or because they neglect
to keep the records necessary to back them up.
That’s where this book comes in. Specially tailored for the unique needs of
professionals, it shows you how you can deduct all or most of your business
expenses from your federal taxes—everything from advertising to vehicle
depreciation.
This book, the first of its kind, is about tax deductions for all types of
professionals, including:
•accountants
•architects
•chiropractors
•consultants
•dentists

•doctors
•engineers
•lawyers
•marriageandfamilytherapists
•optometrists
•pharmacists
•psychologists,and
•veterinarians.
It can be used by professionals who work by themselves, or by those
involved in group practices. You can use this book no matter how your
practice is legally organized—whether you are a sole proprietor, or are
involved in a professional corporation, partnership, or LLC.
This is not a tax preparation guide—we do not show you how to fill out
your tax forms. (By the time you do your taxes, it may be too late to take
deductions you could have taken if you had planned the prior year’s business
spending wisely and kept proper records.) Instead, this book gives you all
the information you need to maximize your deductible expenses—and avoid
YOUR TAX DEDUCTION COMPANION 3
common deduction mistakes. You can (and should) use this book all year
long, to make April 15th as painless as possible.
Even if you work with an accountant or another tax professional, you need
to learn about tax deductions. No tax professional will ever know as much
about your business as you do; and you can’t expect a hired professional to
search high and low for every deduction you might be able to take, especially
during the busy tax preparation season. The information in this book
will help you provide your tax professional with better records, ask better
questions, obtain better advice—and, just as importantly, evaluate the advice
you get from tax professionals, websites, and other sources.
If you do your taxes yourself (as more and more small business owners
are doing, especially with the help of tax preparation soft ware), your need for

knowledge is even greater. Not even the most sophisticated tax preparation
program can decide which tax deductions you should take or tell you
whether you’ve overlooked a valuable deduction. This book can be your legal
companion, providing practical advice and information so that you can rest
assured that you are not paying more to the IRS than you need to.
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n
Chapter 1
Tax Deduction Basics
How Tax Deductions Work 6
Types of Tax Deductions 6
You Pay Taxes Only on Your Profits 7
You Must Have a Legal Basis for Your Deductions 8
The Value of a Tax Deduction 9

Federal and State Income Taxes 9
Social Security and Medicare Taxes 10
Total Tax Savings 11
What Professionals Can Deduct 12
Start-Up Expenses 13
Operating Expenses 13
Capital Expenses 14
Inventory 15
6 TAX DEDUCTIONS FOR PROFESSIONALS
T
he tax code is full of deductions for professionals—from automobile
expenses to wages for employees. Before you can start taking advantage
of these deductions, however, you need a basic understanding of how
businesses pay taxes and how tax deductions work. This chapter gives you all
the information you need to get started. It covers:
•howtaxdeductionswork
•howtocalculatethevalueofataxdeduction,and
•whatprofessionalscandeduct.
How Tax Deductions Work
A tax deduction (also called a tax write-off) is an amount of money
you are entitled to subtract from your gross income (all the money you
make) to determine your taxable income (the amount on which you
must pay tax). The more deductions you have, the lower your taxable
income will be and the less tax you will have to pay.
Types of Tax Deductions
There are three basic types of tax deductions: personal deductions,
investment deductions, and business deductions. This book covers only
business deductions—the large array of write-offs available to business
owners, including professionals.
Personal Deductions

For the most part, your personal, living, and family expenses are not
tax deductible. For example, you can’t deduct the food that you buy
for yourself and your family. There are, however, special categories of
personal expenses that may be deducted, subject to strict limitations.
These include items such as home mortgage interest, state and local
taxes, charitable contributions, medical expenses above a threshold
amount, interest on education loans, and alimony. This book does not
cover these personal deductions.
CHAPTER 1: TAX DEDUCTION BASICS 7
Investment Deductions
Many professionals try to make money by investing money. For example,
they might invest in real estate or play the stock market. They incur all
kinds of expenses, such as fees paid to money managers or financial
planners, legal and accounting fees, and interest on money borrowed
to buy investment property. These and other investment expenses (also
called expenses for the production of income) are tax deductible, subject
to strict limitations. Investment deductions are not covered in this book.
Business Deductions
Because a professional practice is a profit-making enterprise, it is a
business for tax purposes. People in business usually must spend
money on their business—for example, for office space, supplies, and
equipment. Most business expenses are deductible, sooner or later, one
way or another. And that’s what this book is about: How professionals
may deduct their business expenses.
You Pay Taxes Only on Your Profits
The federal income tax law recognizes that you must spend money
to make money. Virtually every professional, however small his or
her practice, incurs some expenses. Even a professional with a low
overhead practice (such as a psychologist) must pay for office space and
insurance. Of course, many professionals incur substantial expenses,

even exceeding their income.
If you are a sole proprietor (or owner of a one-person LLC taxed as
a sole proprietorship), you are not legally required to pay tax on every
dollar your practice takes in (your gross business income). Instead, you
owe tax only on the amount left over after your practice’s deductible
expenses are subtracted from your gross income (this remaining
amount is called your net profit). Although some tax deduction
calculations can get a bit complicated, the basic math is simple: the
more deductions you take, the lower your net profit will be, and the
less tax you will have to pay.
8 TAX DEDUCTIONS FOR PROFESSIONALS
EXAMPLE: Karen, a sole proprietor, earned $100,000 this year from
her child psychology practice. Fortunately, she doesn’t have to pay
income tax on the entire $100,000—her gross business income.
Instead, she can deduct from her gross income various business
expenses, including a $10,000 office rental deduction (see Chapter
3) and a $5,000 deduction for insurance (see Chapter 14). These and
her other expenses amount to $20,000. She can deduct the $20,000
from her $100,000 gross income to arrive at her net profit: $80,000.
She pays income tax only on this net profit amount.
The principle is the same if your practice is a partnership, LLC, LLP,
or S corporation: business expenses are deducted from the entity’s
profits to determine the entity’s net profit for the year, which is passed
through the entity to the owners’ individual tax returns.
EXAMPLE: Assume that Karen is a member of a three-owner LLC,
and is entitled to one-third of the LLC’s income. She doesn’t pay tax
on the gross income the LLC receives, only on its net income after
expenses are deducted. This year, the LLC earned $400,000 and
had $100,000 in expenses. She pays tax on one-third of the LLC’s
$300,000 net profit.

If your practice is organized as a C corporation, it too pays tax only
on its net profits.
You Must Have a Legal Basis for Your Deductions
All tax deductions are a matter of legislative grace, which means that
you can take a deduction only if it is specifically allowed by one or
more provisions of the tax law. You usually do not have to indicate on
your tax return which tax law provision gives you the right to take a
particular deduction. If you are audited by the IRS, however, you’ll have
to provide a legal basis for every deduction the IRS questions. If the IRS
concludes that your deduction wasn’t justified, it will deny the deduction
and charge you back taxes, interest, and, in some cases, penalties.
CHAPTER 1: TAX DEDUCTION BASICS 9
The Value of a Tax Deduction
Most taxpayers, even sophisticated professionals, don’t fully appreciate
just how much money they can save with tax deductions. Only part of
any deduction will end up back in your pocket as money saved. Because
a deduction represents income on which you don’t have to pay tax, the
value of any deduction is the amount of tax you would have had to pay
on that income had you not deducted it. So a deduction of $1,000 won’t
save you $1,000—it will save you whatever you would otherwise have
had to pay as tax on that $1,000 of income.
Federal and State Income Taxes
To determine how much income tax a deduction will save you, you
must first figure out your marginal income tax bracket. The United
States has a progressive income tax system for individual taxpayers with
six different tax rates (often called tax brackets), ranging from 10% of
taxable income to 35% (see the chart below). The higher your income,
the higher your tax rate.
You move from one bracket to the next only when your taxable
income exceeds the bracket amount. For example, if you are a single

taxpayer, you pay 10% income tax on all your taxable income up to
$7,825. If your taxable income exceeds $7,825, the next tax rate (15%)
applies to all your income over $7,825—but the 10% rate still applies
to the first $7,825. If your income exceeds the 15% bracket amount, the
next tax rate (25%) applies to the excess amount, and so on until the top
bracket of 35% is reached.
The tax bracket in which the last dollar you earn for the year falls
is called your marginal tax bracket. For example, if you have $150,000
in taxable income, your marginal tax bracket is 28%. To determine
how much federal income tax a deduction will save you, multiply the
amount of the deduction by your marginal tax bracket. For example, if
your marginal tax bracket is 28%, you will save 28¢ in federal income
taxes for every dollar you are able to claim as a deductible business
expense (28% x $1 = 28¢). This calculation is only approximate because
an additional deduction may move you from one tax bracket to another
and thus lower your marginal tax rate. For example, if you’re single
and your taxable income is $77,500, an additional $1,000 deduction will
10 TAX DEDUCTIONS FOR PROFESSIONALS
lower your marginal tax rate from 28% to 25%. The first $400 of the
deduction will save you $112 in tax (28% x $400 = $112); the remaining
$600 will save you $150 (25% x $600 = $150). So your total tax saving is
$262, instead of the $280 you would get if, say, your taxable income was
$80,000.
The following table lists the 2007 federal income tax brackets for
single and married individual taxpayers.
2007 Federal Personal Income Tax Brackets
Tax Bracket
Income If Single Income If Married Filing Jointly
10% Up to $7,825 Up to $15,560
15% $7,826 to $31,850 $15,561 to $63,700

25% $31,851 to $77,100 $63,701 to $128,500
28% $77,101 to $160,850 $128,501 to $195,850
33% $160,851 to $349,700 $195,851 to $349,700
35% All over $349,700 All over $349,700
Income tax brackets are adjusted each year for inflation. For current
brackets, see IRS Publication 505, Tax Withholding and Estimated Tax.
You can also deduct your business expenses from any state income
tax you must pay. The average state income tax rate is about 6%,
although seven states (Alaska, Florida, Nevada, South Dakota, Texas,
Washington, and Wyoming) don’t have an income tax. You can find a list
of all state income tax rates at www.taxadmin.org/FTA/rate/ind_inc.html.
Social Security and Medicare Taxes
Everyone who works—whether a business owner or an employee—is
required to pay Social Security and Medicare taxes. The total tax paid is
the same, but the tax is paid differently depending on whether you are
an employee of an incorporated practice or a self-employed owner of a
partnership, LLC, or LLP. Employees pay one-half of these taxes through
payroll deductions; employers must pony up the other half and send the
entire payment to the IRS. Self-employed professionals must pay all of
these taxes themselves. These differences don’t mean much when you’re
an employee of a business you own, since the money is coming out of
your pocket whether it is paid by the employee or employer.
CHAPTER 1: TAX DEDUCTION BASICS 11
These taxes are levied on the employment income of employees, and
on the self-employment income of business owners. They consist of a
12.4% Social Security tax on income up to an annual limit; in 2007, the
limit was $97,500. Medicare taxes are not subject to any income limit
and are levied at a 2.9% rate. This combines to a total 15.3% tax on
employment or self-employment income up to the Social Security tax
ceiling. However, the effective self-employment tax rate is somewhat

lower than 15.3% because (1) you are allowed to deduct half of your
self-employment taxes from your net income for income tax purposes,
and (2) you pay self-employment tax on only 92.35% of your net self-
employment income. The following chart shows the effective self-
employment tax rates.
Income Tax Bracket Effective Social Security Tax Rate
15% 13.07%
25% 12.36%
28% 12.15%
33% 11.80%
Like income taxes, self-employment taxes are paid on the net profit
you earn from a business. Thus, deductible business expenses reduce
the amount of self-employment tax you have to pay by lowering your
net profit.
Total Tax Savings
When you add up your savings in federal, state, and self-employment
taxes, you can see the true value of a business tax deduction. For
example, if you’re single and your taxable business income (whether
as an employee of an incorporated practice or a self-employed owner
of a partnership, LLC, or LLP) is below the Social Security tax ceiling, a
business deduction can be worth as much as 28% (in federal taxes) +
12.3% (in self-employment taxes) + 6% (in state taxes). That adds up to
a whopping 43.3% savings. (If you itemize your personal deductions,
your actual tax saving from a business deduction is a bit less because it
reduces your state income tax and therefore reduces the federal income
tax savings from this itemized deduction.) If you buy a $1,000 computer
12 TAX DEDUCTIONS FOR PROFESSIONALS
for your practice and you deduct the expense, you save about $433
in taxes. In effect, the government is paying for almost half of your
business expenses.

Additional business deductions are worth less if your income is above
the Social Security tax ceiling, since you don’t have to pay the 12.4%
Social Security tax. For example, if you’re in the 33% income tax bracket,
an additional deduction will be worth 33% (in federal taxes) + 6% (in
state taxes) + 2.9% in Medicare taxes. This adds up to 41.9%. Still not bad.
This is why it’s so important to know all the business deductions you
are entitled to take and to take advantage of every one.

Don’t buy things just to get a tax deduction. Although tax deductions
can be worth a lot, it doesn’t make sense to buy something you don’t
need just to get a deduction. After all, you still have to pay for the item, and
the tax deduction you get in return will only cover a portion of the cost. For
example, if you buy a $3,000 computer you don’t really need, you’ll probably
be able to deduct less than half the cost. That means you’re still out over
$1,500—money you’ve spent for something you don’t need. On the other
hand, if you really do need a computer, the deduction you’re entitled to
is like found money—and it may help you buy a better computer than you
could otherwise afford.
What Professionals Can Deduct
Professionals are business owners, and as such they can deduct four
broad categories of business expenses:
•start-upexpenses
•operatingexpenses
•capitalexpenses,and
•inventorycosts.
This section provides an introduction to each of these categories
(they are covered in greater detail in later chapters).
CHAPTER 1: TAX DEDUCTION BASICS 13

You must keep track of your expenses. You can deduct only those

expenses that you actually incur. You need to keep records of these
expenses to (1) know for sure how much you actually spent; and (2) prove to
the IRS that you really spent the money you deducted on your tax return, in
case you are audited. Accounting and bookkeeping are discussed in detail
in Chapter 20.
Start-Up Expenses
The first money you will have to shell out will be for your practice’s
start-up expenses. These include most of the costs of getting your
practice up and running, like license fees, advertising costs, attorney and
accounting fees, travel expenses, market research, and office supplies
expenses. Start-up costs are not currently deductible—that is, you cannot
deduct them all in the year in which you incur them. However, you can
deduct up to $5,000 in start-up costs in the first year you are in business.
You must deduct amounts over $5,000 over the next 15 years. (See
Chapter 10 for a detailed discussion of deducting start-up expenses.)
EXAMPLE: Cary, an optometrist who has recently graduated from
optometry school, decides to open his own practice. Before Cary’s
optometry office opens for business, he has to rent space, hire and
train employees, and obtain all necessary optometric equipment.
These start-up expenses cost Cary $50,000. Cary may deduct $5,000
of this amount the first year he’s in business. The remainder may
be deducted over the first 180 months that he’s in business—$3,000
per year for 15 years.
Operating Expenses
Operating expenses are the ongoing day-to-day costs a business incurs
to stay in business. They include such things as rent, utilities, salaries,
supplies, travel expenses, car expenses, and repairs and maintenance.
These expenses (unlike start-up expenses) are currently deductible—that
is, you can deduct them all in the same year in which you pay them.
(See Chapter 3.)

14 TAX DEDUCTIONS FOR PROFESSIONALS
EXAMPLE: After Cary’s optometry office opens, he begins paying
$5,000 a month for rent and utilities. This is an operating expense
that is currently deductible. When Cary does his taxes, he can
deduct from his income the entire amount he paid for rent and
utilities for the year.
Capital Expenses
Capital assets are things you buy for your practice that have a useful
life of more than one year, such as land, buildings, equipment, vehicles,
books, furniture, and patents you buy from others. These costs, called
capital expenses, are considered to be part of your investment in your
business, not day-to-day operating expenses.
Large businesses—those that buy at least several hundred thousand
dollars of capital assets in a year—must deduct these costs by using
depreciation. To depreciate an item, you deduct a portion of the cost in
each year of the item’s useful life. Depending on the asset, this could be
anywhere from three to 39 years (the IRS decides the asset’s useful life).
Small businesses can also use depreciation, but they have another
option available for deducting many capital expenses—they can
currently deduct up to $125,000 in capital expenses per year under a
provision of the tax code called Section 179. Section 179 is discussed in
detail in Chapter 9.
EXAMPLE: Cary spent $5,000 on examining chairs for his office.
Because the chairs have a useful life of more than one year, they
are capital assets that he will either have to depreciate over several
years or deduct in one year under Section 179.
Certain capital assets, such as land and corporate stock, never wear
out. Capital expenses related to these costs are not deductible; the
owner must wait until the asset is sold to recover the cost. (See Chapter
9 for more on this topic.)

CHAPTER 1: TAX DEDUCTION BASICS 15
Inventory
Inventory is merchandise that a business makes or buys to resell to
customers. It doesn’t matter whether you manufacture the merchandise
yourself or buy finished merchandise from someone else and resell the
items to customers. Inventory doesn’t include tools, equipment, or other
items that you use in your practice; it refers only to items that you buy
or make to sell.
Whether professionals sell inventory for tax purposes can be a tricky
question. Materials that are an indispensable and inseparable part of the
rendering of a service are not inventory—for example, gold that a dentist
places in patients’ teeth is not inventory.
You must deduct inventory costs separately from all other business
expenses—you deduct inventory costs as you sell the inventory.
Inventory that remains unsold at the end of the year is a business
asset, not a deductible expense. (See Chapter 13 for more on deducting
inventory.)
EXAMPLE: In addition to providing optometric services, Cary stocks
and sells eyeglasses to his patients. In his first year in practice, Cary
spent $15,000 on his inventory of eyeglasses, but sold only $10,000
worth of them. He can deduct only $10,000 of the inventory costs
for the year.
n
Chapter 2
Choice of Business Entity
Types of Business Entities 19
Sole Proprietorship 20
Limited Liability Company (LLC) 21
Limited Liability Partnership (LLP) 22
Corporation 23

Partnership 25
Limiting Your Liability 26
What Is Liability? 26
Liability for Professional Malpractice 27
Liability for Business Debts 29
Other Types of Liability 31
The Role of Insurance 32
The Four Ways Business Entities Are Taxed 33
Tax Treatment Choices 33
Sole Proprietorship Taxation 34
Partnership Taxation 35
S Corporation Taxation 37
C Corporation Taxation 38
Comparing Tax Treatments 39
Tax Deductions 39
Tax Rates 40
Owners’ Employment Status 48
Fringe Benefits 52
18 TAX DEDUCTIONS FOR PROFESSIONALS
Allocating Profits and Losses 54
Deducting Business Losses 55
Retaining Earnings in Your Business 57
State Taxes 61
IRS Audit Rates 62
Should You Change Your Business Entity or Tax Treatment? 63
The Cost of Converting to Another Business Form 63
Changing Your Tax Treatment 66
Automatic Conversion of Your Business Entity 68
CHAPTER 2: CHOICE OF BUSINESS ENTITY 19
T

his chapter is about how your tax life is affected by the form of
business entity you use to conduct your professional practice. If you’re
already in practice, you will learn the pros and cons of the business
form you have chosen—and you may decide to convert to another type of
entity or tax treatment. If you’re just starting your practice, you will need to
figure out which business entity and tax treatment is best for you.
Types of Business Entities
Every business has a legal form, including a professional practice. If
you’re in practice right now, your business almost certainly falls into one
of the following categories:
•soleproprietorship
•partnership
•corporation
•limitedliabilitycompany(LLC),or
•limitedliabilitypartnership(LLP).
The sole proprietorship and partnership are the default business
entities—they come into existence automatically unless a business’s
owners take the steps necessary to form one of the other entities.
The following chart gives you an idea of the breakdown for the types
of business entities professionals use. (It does not include professionals
who provide health services—doctors, dentists, and so on.)
Tax Returns Filed by Professionals—2004
Type of Entity Number of Tax Returns Filed in 2004
Sole Proprietors 2,950,964
Partnerships (including LLPs) 67, 279
LLCs 96,766
C Corporations (2003 returns) 760,087
S Corporations 537,892