In this post, we will explain why a dental service organization attorney often recommends forming DSOs as partnerships, why this arrangement works operationally, and how it offers legal and tax advantages.
Scenario: At the beginning of this year, we helped set up a DSO for a practice in Kentucky. In our initial discussions with the client, the inevitable tax question came up, and the client wanted to know how the DSO entity would be taxed and which tax election would be most beneficial for the DSO entity.
As you will see, making the choice carries implications – tax, legal, organisational, and compliance-related, which is why it is always a good idea to consult legal professionals who have experience working with DSOs.
As Dental Service Organizations (DSOs) continue to grow, one question arises quite frequently:
Why are most DSOs taxed as partnerships?
To explain it, we first need to understand the nature of DSOs: A Dental Service Organization is a business entity that provides non-clinical services to dental practices.
These services usually include billing, marketing, operations, HR, but never clinical care or treating patients. This is a crucial distinction as the corporate practice of dentistry is forbidden.
As a result, DSOs usually operate as LLCs (limited liability companies) and partner with and contract with independently owned dental practices that provide clinical and treatment services.
Hiring a dental service organization attorney at the business formation stage ensures the structure is fully compliant with state laws and ethical and industry standards.
Even though DSOs are formed as LLCs, they elect to be taxed as partnerships under the IRS's partnership taxation rules. The key benefit of this approach is that it avoids entity-level taxation. Instead, the income is passed directly to the owner.
This type of structure is ideal for DSOs as they often work with several types of stakeholders - dentists, private equity investors, management companies, and similar. Choosing partnership taxation gives DSOs greater flexibility, as the structure closely mirrors the business's economic and operational realities.
As explained, the main benefit of partnership taxation is the pass-through treatment, which provides added flexibility.
Subchapter K of the Internal Revenue Code states that the DSO will not pay federal income tax, as profits and losses are reported on each owner's return.
The added flexibility of partnerships is ideal for customized ownership and compensation arrangements, as profits can be distributed in ways that don't always follow ownership percentages, as is often the case when clinicians and investors are involved.
Lastly, DSOs expand quickly, and partnerships are much easier to scale. Location and ownership changes, adding new partners, all of that can be easily handled without corporate restructuring. Working with an experienced DSO lawyer will help draft agreements that navigate the business's turbulent nature. You will be fine.
While DSO taxation as a partnership offers significant advantages, ensuring proper structure and ongoing compliance is an absolute must. To avoid costly issues, DSOs need to balance tax efficiency with legal requirements, primarily the corporate practice of dentistry doctrine.
Whether you are forming a DSO or joining one, working with a dental service organization attorney ensures your DSO remains compliant while simultaneously preserving the beneficial partnership tax status, spurring future growth.
Contact Finn Legal today to schedule your personalized consultation and ensure your DSO is structured for long-term success.
