This article is co-authored by Heard
Running a private practice helps clinicians unlock their career potential and reach new heights in providing care. But there can be some confusion once tax season comes around.
Tax preparation is much different once you’re a self-employed therapist instead of a W2 employee. Private practice owners need assistance ensuring they’re doing all they can to maximize their benefits come tax time.
And a good first step is to review and build a better understanding of all business entities and tax designations as they relate to them.
Overview of business entities and tax designations
What is a sole proprietor?
Sole proprietors are typically defined as someone who owns an unincorporated business by themselves, with no separation between the business and themselves. Sole proprietors are an unincorporated business with one owner who pays personal income tax on all profits earned. By default, self-employed therapists are always taxed as sole proprietors.
Benefits of sole proprietorship for clinicians include:
- Being able to start operating immediately and not having to spend time committing to a more complicated business entity.
- It’s often the easiest and cheapest business entity to start your private practice practice (less registration fees).
LLC vs. PLLC
A Limited Liability Company (LLC) is a business structure where business owners and members aren’t personally held responsible for any losses or risks the business faces. Though regulations depend on each individual state, it's important to check your area for specific rules that could affect your practice.
A Professional Limited Liability Company (PLLC) is similar to an LLC in that they have personal liability protections, and their owner’s personal assets are safe if they ever face legal issues. The main difference between these two is that PLLCs are a type of LLC that’s specifically made for licensed professionals like clinicians, therapists, doctors, lawyers, accountants, and more. Some states (e.g. Texas, New York) require clinicians to form a PLLC instead of an LLC.
If you form an LLC or PLLC, you’ll be taxed as a sole proprietor unless you elect to be taxed as an S corporation with the IRS.
An important note is that California is the only state that doesn't allow professionals to form LLCs or PLLCs, they're only allowed to form LLPs or professional corporations. For reference, professional corporations allow people within certain occupations (clinicians, accountants, lawyers, etc.) to incorporate their practice.
Benefits of LLC/PLLC for clinicians include:
- Can be taxed as a pass-through entity or corporation while receiving more liability protection.
- Similar to sole proprietors, LLC/PLLCs are relatively more straightforward and much less expensive to set up with fewer compliance requirements.
What is an S corporation?
S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders then report the flow-through of income and losses on their personal tax return and are assessed tax at their individual tax rates. This allows S corporations to avoid double taxation on the corporate income.It’s important to note that S corporation is a tax designation, not a business entity. Clinicians need to form a business entity first with their state (e.g. LLC/PLLC) and then elect to be taxed as an S corporation with the IRS.
Benefits of S corporations for clinicians includes:
- Access to the best liability protection possible
- Access to pass-through taxation, which is when businesses don’t pay taxes on the entity level, and instead, the income passes to the owners of the business who pays personal income taxes for their share of the business.
What’s the best choice for clinicians?
With all these choices, it’s understandable that clinicians may be confused as to their best option. The reality is that each person has their own circumstances that’ll ultimately influence and dictate which option is the best for them. It’s best to consult an accountant or other tax professional for relevant advice.
Organizing your books and tax documents
Catch up on bookkeeping
Categorizing your income and expenses is helpful in tracking where your money is going, and it makes it simpler to determine which tax deductions your practice is eligible for during tax time. At the end of the day, most clinician’s practices are small businesses, so you’ll want to claim every tax deduction available so your tax bill is as low as possible.
Depending on your preferences, you can use a spreadsheet to track expenses, or a software platform like Heard that can record and categorize transactions, identify tax-deductible expenses, and generate financial reports.
And to identify any possible fraudulent charges, resolve discrepancies, or identify missing transactions - clinicians need to reconcile their bank accounts by matching the cash balances on their balance sheet to the corresponding amounts on their bank statements. To avoid a heavy workload come tax time, make an effort to reconcile bank accounts for your private practice once a month ideally or quarterly at the least. Fraud is more common than you’d think, so don’t overlook this important step.
You’ll also want to gather and organize receipts for any business expenses for charges over $75. Most charges likely have an email or other digital reference point that you can easily pull from, so you shouldn’t have much issues here.
Gather your tax forms
Another tip to make your life easier is to gather your tax forms and bring them when meeting with your accountant or tax professional. Forms you should always keep on file include:
- Income statements (W2, 1099)
*Eligible Alma members will receive a 1099 every January that documents the total amount of payments made to the provider, by Alma, in the prior year.
- Prior year tax returns
- Personal documents (social security documents and preferably an EIN letter)
Issuing, paying, and filing taxes
Issue your 1099s
The 1099 form documents any non-employment income to the IRS. If you paid a freelancer or independent contractor at least $600 during the year, then you must issue them a form 1099. Clinicians must also report any non-employee compensation that meets the following four conditions:
- You made the payment to someone who is not your employee.
- You made the payment for services in the course of your trade or business (including government agencies and nonprofit organizations).
- You made the payment to an individual, estate, or, in some cases, a corporation.
- You made payments to the payee of at least $600 during the year.
You can issue 1099s electronically or through the mail using the IRS's digital statements, get started by clicking here. You can also download and print the PDFs yourself, or rely on your accountant to take care of it if you have the option.
How much should Clinicians set aside for taxes?
This question may attract a variety of responses, but a general rule of thumb is private practices should set aside roughly 30%-40% of their business profit for both state and federal income taxes. The amount paid in taxes ultimately depends on the state you live in.
For reference, there’s nine states that have no income tax - Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. So if you’re in the beginning stages of your private practice journey and are considering other states with a strong business friendly climate, you may want to consider the above areas to save some money come tax time.
Setting money aside for taxes can be harder than it sounds, use the strategies below to help you reach your goals:
1. Per-payment method
If you’re new to private practice, it can be difficult to estimate your income for the year because you have no previous years to pull information from and use as a reference. On top of that, your income may be unstable and vary heavily from month to month.
The per-payment method is best suited for clinicians dealing with the above scenario because it simply sets income aside from every payment from a client. In short, you’ll want to set about 30%-40% aside from every payment you receive.
2. Monthly method
The monthly method is best for clinicians if this is the first year you’re making a profit, or if your income has changed drastically so much that other years are no longer a good reference point for what you expect to earn that year.
This method works by first adding up your income each month between the current month and the beginning of the fiscal year, then dividing it by the number of months to get your average monthly income. Once you have this number, set aside 30% of it each month to go towards your taxes.
3. Yearly method
If you don’t expect a big change in your income from the previous year, then the yearly method is likely your best bet. It’s pretty straightforward, just divide your total income from the previous year by four, then calculate 30% of that total.The figure you get here will tell you how much money you should set aside for your quarterly tax payments.
When to pay taxes
Different pay periods have different due dates for taxes on earned income. The dates below provide more information on quarterly deadlines:
Payment period: January 1 – March 31, Due date: April 15
Payment period: April 1 – May 31, Due date: June 15
Payment period: June 1 – August 31, Due date: September 15
Payment period: September 1 – December 31, Due date: January 15 (of the following year)
Claim all tax deductions
A tax deduction is revenue the IRS doesn’t tax. For example, if you earned $60,000 revenue as a self-employed therapist last year, but spent $15,000 on deductible expenses, you would only pay income tax and self-employment tax on $45,000. Provided you reported the expenses, of course.
The term “tax deduction” can be misleading. In casual conversation, it’s often used as an umbrella term for three different types of deduction:
- Itemized deductions
- The standard deduction
- Deductible business expenses
When you file your personal tax return, you can choose between claiming the standard deduction or itemizing your deductions.
Itemized deductions include real estate and property taxes, mortgage interest, and medical and dental fees. They’re related to you as an individual, rather than to your business, and you report them on Schedule A (Form 1040).
Instead of itemizing these deductions, you can choose to claim the standard deduction. It’s a flat rate, changing year to year, that’s available to all individuals.
Deductible business expenses are distinct from itemized deductions or the standard deduction. They’re expenses you incur running your business. Only self-employed individuals or companies can file them.
For information on the most overlooked tax deductions, read Alma’s blog “The Most Overlooked Tax Deductions for Therapists”.
And for a complete list of the most common tax deductions for clinicians, check out Heard’s blog “The Complete List of Tax Deductions for Therapists”.
Closing thoughts
By being proactive with preparation year-round, clinicians can save themselves a lot of stress and money come tax time. These tips can work as a guide for clinicians looking to better equip themselves. And clinicians don’t have to tackle taxes by themselves. They can get help from Heard, an all-in-one financial solution for therapists that combines software with human support to handle bookkeeping, taxes, payroll, and more. Click here to schedule a free consultation.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult their own attorney, business advisor, or tax advisor with respect to matters referenced in this post.
