Reconsidering Choice of Entity For Blue Cross Blue Shield Employees

Healthcare Provider Update: Healthcare Provider Information for Blue Cross Blue Shield Blue Cross Blue Shield (BCBS) operates as a federation of independent health insurance companies across the United States. Each individual organization under the BCBS umbrella serves specific geographical regions, offering a range of health insurance products and services, including individual and group health plans, dental and vision coverage, and more. Notable regional affiliates include Blue Cross Blue Shield of Illinois, Blue Cross Blue Shield of Texas, and Blue Cross Blue Shield of Florida, among others, facilitating comprehensive healthcare management and coverage options for millions of members nationwide. Healthcare Cost Increases in 2026 In 2026, significant increases in health insurance premiums are anticipated, particularly for plans available through the Affordable Care Act (ACA) marketplaces. Record hikes, as high as 66% in some states, are expected as a result of rising medical costs, the potential expiration of enhanced federal premium subsidies, and aggressive rate adjustments by major insurers like Blue Cross Blue Shield. The Kaiser Family Foundation warns that a staggering 92% of marketplace enrollees could see their out-of-pocket premiums surge by over 75% due to this confluence of factors, which will likely price many middle-income Americans out of affordable health coverage. Click here to learn more

What Is It?

If you are a business owner, reconsidering your choice of entity should be an ongoing process. Don't wait for a crisis or a triggering event to think about it. Your original choice of entity [whether sole proprietorship (SP), partnership, S corporation, C corporation, limited liability company (LLC), or other] was not necessarily a permanent selection. You should regularly evaluate a number of business issues, including liability exposure, tax considerations, the ability to raise capital, and employee compensation. The type of business entity you choose impacts these issues. If you are anticipating or experiencing changes in these areas, your business may benefit from a change of entity.

Tip:  You may decide that only a portion of your business needs a change of entity. In such a case, you may be able to arrange a tax-free spin-off, split-off, or split-up of your business to facilitate the change.

When Does Reconsidering Choice of Entity Make Sense?

We'd like to remind our Blue Cross Blue Shield clients that, as mentioned, you should be evaluating your choice of business entity on an ongoing basis. You may want to give it serious consideration if it will:

•  Substantially reduce your personal liability exposure
•  Help you achieve favorable tax results for you and your business
•  Help you raise needed capital for your business, or
•  Improve your compensation package at a time when this is a priority

A change of entity may positively affect one of these areas while negatively affecting another. You should look at the totality of circumstances when making a decision.

Caution:  Changing entity can involve significant costs. You may incur filing fees, attorney's fees, new taxes, and the expense of changing your accounting system, among others. You should include these costs as part of the totality of circumstances you are evaluating.

Liability Exposure Influencing Choice of Entity

You may become concerned about personal liability exposure. Perhaps your business is expanding into new territories, or maybe you may have begun producing and selling a new, somewhat unproven product. Or perhaps the company may be taking on new debts or undertaking new construction. All of these could give rise to new concerns about personal liability. Our Blue Cross Blue Shield clients should be aware of the following:

Liability Concerns That Cannot Be Resolved By Changing Entity

•  Personally guaranteed loans. If you or other owners have personally guaranteed loans to the business, perhaps out of necessity, you will be personally liable for the company's debts, regardless of the entity chosen. Even if you are a corporate shareholder or an LLC member, you face liability beyond your financial investment in the company when you have personally guaranteed loans. If creditors require such personal guarantees, you need to evaluate the liability risk independent of the entity form, consulting your attorney or other advisors for guidance.
•  Your own negligence. If you personally have committed a negligent act, such as medical malpractice, no form of entity will protect you from personal liability for your own actions.

Entities That Offer Greatest Personal Liability Protection

If liability exposure is a major concern, then you might choose a corporation, LLC, LLP, or limited partnership. Among these four, corporations and LLCs offer the greatest protection to active owners. LLPs shield you from individual liability for other partners' negligence but, depending on the state, still leave you open to varying degrees of exposure for actions other than your own negligence. Limited partnerships don't offer comparable protection to active owners. They do, however, provide liability protection to inactive limited partners.

Alternatives to Changing Entity for Reducing Risk of Liability

You may not have to change your business entity to reduce liability exposure. For instance, insurance might offer satisfactory protection in some circumstances. Further, hold harmless agreements may enable you to shift risk to purchasers of your products or others with whom you deal.

Tax Considerations Influencing Choice of Entity

Tax Issues That Might Trigger a Change

Business circumstances may also raise important tax issues that could justify a change of entity. The following are among the situations that might trigger an evaluation of the pros and cons of changing entity:

•  Your business's profits are growing substantially, or conversely, your business is experiencing substantial losses
•  You or one of your fellow owners has experienced a major change in personal income, either favorable or unfavorable
•  You, and perhaps other owners, plan to contribute substantial property to the business
•  Your business is instituting or expanding a fringe benefit program
•  Your business is preparing to liquidate

Typically, these issues will most affect the owner of a C corporation because C corporations face double taxation (tax at the entity level and at the owner level), while other forms of business entity face taxation strictly at the owner level. Not only are C corporations subject to double taxation, but corporate tax rates differ from individual tax rates. However, most corporation shareholder-owners receive fringe benefits tax free, while partners, LLC members, and 2% S corporation shareholders may pay taxes on their fringe benefits.

Note:  Double taxation may be less of a drawback in 2018 and beyond, thanks to the Tax Cuts and Jobs Act of 2017, which reduced the business income tax rate that C corporations pay to a flat 21% (from a high of 35%). Moreover, individual owners of pass-through entities may be entitled to up to a 20% deduction on their share of qualified business income. Also, keep in mind that as a result of the Affordable Care Act of 2010, an additional 3.8% Medicare tax applies to some or all of the investment (e.g., dividend) income for married filers whose modified adjusted gross income exceeds $250,000 and single filers whose modified adjusted gross income is above $200,000.

Further Considerations for Partnerships and LLCs That Are Taxed As Partnerships

In addition to the preceding list of events that might suggest a change in corporate entity, there are additional considerations if you own a partnership or LLC that is taxed as a partnership:

•  Partners, LLC members, and S corporation shareholders can deduct business losses from their taxable income. Since partnerships, LLCs, and S corporations are generally treated as pass-through entities (unlike C corporations) and business profits are personal income to their owners, they can also deduct business losses from their individual income, subject to limitations in the tax code.
•  Only partners and LLC members can specially allocate deductions so that owners in the highest tax bracket can take disproportionately higher deductions.

Example(s):  Liz is a 25% general partner, and the partnership agreement allocates 50% of all losses to her so as to save her some money in taxes. The partnership has had $50,000 in losses this year alone. Liz can deduct 50% of this $50,000 ($25,000) on her personal tax return. If, instead, Liz were an S corporation shareholder, her deduction would be limited to her percentage of ownership in the corporation (25%).

Caution:  The IRS may question a disproportionate allocation of losses to one or a few partners, particularly if you can't show a business rationale for doing so. Loss allocations must also have substantial economic effect or they will not be respected for tax purposes.

•  Partners and LLC members can increase the tax basis for their ownership interests by their share of any entity recourse liabilities (liabilities for which the partner or member bears an economic risk of loss). In addition, to the extent that no partner or member bears an economic risk of loss for a liability (called a nonrecourse liability), the liability is generally allocated to all partners or members in the same proportion as they share profits. The more basis is increased, the more losses that can be deducted. (While basis may increase with increased liabilities allowing more losses to be deducted, basis will be subsequently reduced as liabilities are paid down or when the business is sold and the liabilities are paid off.)

Example(s):  Ken paid $1,000 for his 50% general partnership interest. Thus, Ken's basis in the partnership is $1,000.  Subsequently, the partnership borrows $20,000 from a third party. Ken, who assumes partnership liabilities in proportion to his ownership interest, now has a basis of $11,000 ($1,000 + $20,000/2).

•  Partners and LLC members can more easily contribute appreciated property to their businesses tax free. You can contribute property to an LLC, for instance, in exchange for an ownership interest. Such a contribution is tax free even if the property has appreciated in value since you first purchased it. An example of such a transfer is when a member exchanges an office building she owns--for use by the LLC--for an ownership interest in the LLC. However, there may be later consequences for a partner or member who contributes appreciated property, including possible recognition of gain. Note that it is also possible for shareholders to contribute appreciated property tax free to corporations, but such arrangements are subject to strict limitations.

Ability to Raise Capital as Factor Influencing Choice of Entity

If your business is planning to raise capital through either debt financing or equity financing (selling shares of stock to investors), you may want to reconsider your choice of entity. These Blue Cross Blue Shield clients should keep in mind several considerations.

Corporations May Offer the Most Flexibility for Raising Capital

Corporations offer the widest set of options for raising capital. While any business form can issue debt, corporations are typically the better vehicle for equity financing. With the corporate form, you can periodically issue stock to attract new investors (unless agreements in place forbid doing so). Partnerships and corporations are in a better position to attract venture capital financing than sole proprietorships.

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The corporate form may be more likely to undertake a public stock offering ('going public'). C corporations have greater flexibility than S corporations for attracting new investors or going public, as they do not have restrictions on numbers of shareholders and classes of stock. With most large public offerings in particular, the S corporation is impractical, as the goal is to attract a large number of investors. However, partnerships can also engage in equity offerings. Although there is no physical stock to issue with a partnership, it can engage in a master limited partnership, which is treated like a public stock offering and may be actively traded.

Caution:  Accepting new investors, venture capital, and going public can reduce your control over the business.

How Other Entities Raise Capital

Contributions from shareholders and debt financing are the usual methods. Sole proprietorships (SPs) cannot issue stock to attract equity financing. In an SP, you and your business are, by definition, one and the same; there can be no other investors to add equity financing. Typically, partnerships do not issue stock but they may have units for ownership purposes. If your business is a partnership, it may have to dissolve and be reformed whenever you wish to expand the number of partner-owners. If your partnership agreement permits admitting new partners without a dissolution, then you can get around this hurdle.

Partnerships are thus, at best, awkward mechanisms for equity financing. LLCs, which frequently structure themselves much like partnerships, face the same limitation. Practically speaking, if your business is an SP, partnership, or LLC, you add equity through additional direct contributions by you and any current partners or members. In a partnership or LLC, you have the advantage of a larger number of owners who can make direct contributions. Besides this limited means, though, you generally have to rely on debt financing.

Tip:  LLCs and limited partnerships often face the general limitations of partnerships in attracting equity financing. They have one slight advantage, though. By offering limited liability, they may more easily attract investors. LLPs to a lesser degree can offer this limited risk.

When form of Entity Is Less Important Than Number of Owners and Their Creditworthiness

Frequently, banks and other lenders require owners of small businesses to personally guarantee loans. Therefore, regardless of your choice of entity, it is important that you and your co-owners are creditworthy so that you can obtain the necessary debt financing. Of course, the more co-owners you have, the more opportunities you have for obtaining loans.

Employee Compensation Influencing Choice of Entity

Salary and fringe benefits (together constituting 'compensation') are both a substantial cost for your business and an important means for attracting and retaining employees. The extent to which you can offer good compensation while keeping your business costs down figures into your business's future prospects. Salary and fringe benefit planning is therefore important and may have some bearing on your future choice of entity.

Tip:  This said, compensation probably won't be the decisive factor behind a decision to change entity, but as you reconsider your   choice of entity, note the impact of your various choices on the area of compensation, especially relating to federal taxation.

Tax Deductions for Employee Salaries

Corporations, partnerships, and LLCs that are taxed as partnerships generally can deduct salary payments as well as premium payments for employee health, life, and disability insurance.

Withholding Tax and Salaries of Owners

In corporations, salary payments to shareholder-owners, in almost all cases, have income tax and Federal Insurance Contributions Act (FICA) tax (Social Security and Medicare tax) withheld. Partners, 2% S corporation shareholders, and members of LLCs taxed as partnerships must pay self-employment tax on salary. Of course, sole proprietors must also pay self-employment tax.

C Corporations and Tax Treatment for Fringe Benefits

C corporations can deduct payments for health, life, and disability insurance premiums made for their employees, including shareholders. S corporations can deduct these payments for employees who aren't 2% owners. Unincorporated entities can deduct these payments for nonowner employees only. Their 'self-employed' owners, though, can claim a full deduction for premiums paid for medical insurance for the self-employed owner (including the owner's spouse and family). We suggest these Blue Cross Blue Shield clients consult their tax attorney for more details on the tax treatment of specific fringe benefits.

Corporation Owners and Qualified Retirement Plans or Cafeteria Plans

Shareholders in corporate retirement plans can borrow, subject to certain limitations, from their qualified retirement plan account, whereas noncorporate owner-employees in Keogh plans cannot. We suggest these Blue Cross Blue Shield clients check with their attorney, accountant, and/or financial advisor for details and guidance.

Corporation owner-employees, with the exception of 2% S corporation shareholders, can participate in cafeteria plans. These plans permit employees to choose to allocate part of their compensation among cash and various fringe benefits. Sole proprietors, partners, and members of LLCs taxed as partnerships are ineligible for cafeteria plans.

Tip:  All entity choices can offer cafeteria plans to nonowner employees.