“When selecting a business entity for their practice, physicians and their advisors often think that the only issues are taxes and ease of administration and reporting, believing that malpractice insurance will address the threat of liability to the business,” says Patricia Farrell, an attorney for Meyer, Unkovic & Scott based in Pittsburgh, PA, who has more than 24 years of experience advising medical practices and other small businesses.
She says many forget that, in addition to the fact that insurance coverage is sometimes denied, there are other kinds of liability not covered under their insurance—such as lawsuits from vendors or employees, malfunctioning office equipment or software, issues with landlords and cash flow challenges.
Taking some of these issues into consideration, below are the three types of legal structures to consider for your practice—sole proprietorship, partnership, or a corporation.
The sole proprietorship is perhaps the easiest corporate form to set up. As the proprietor, you are the business.
“There is no distinction between the proprietor and the business,” explains Eric Chen, assistant professor of business administration at Saint Joseph College in West Hartford, CT. “The proprietor is the boss. Because of this feature, the personal liability can attach for torts committed by the proprietor in the course of business dealing.”
This means that if you cause any harm in your role in the practice, the aggrieved can reach into your personal assets to satisfy a successful claim. Technically, they can come after your house as well, adds Chen.
“The sole proprietorship has flow-through taxation, which means that the earnings of the proprietorship flow through to your personal tax filings,” says Chen. “The sole proprietorship has a limited life because it generally does not survive if you leave the practice for whatever reason.”
As a result, sole proprietorships are generally mom and pop businesses; transferring ownership is relatively difficult. So, a one-physician medical practice can be a sole proprietorship.
Farrell doesn’t favor a sole proprietorship for a physician practice.
“Organizing as a sole proprietor will leave the physicians personally liable for all these business hazards,” she says.
A general partnership is even worse, says Farrell. “In addition to being personally liable, the physician is also potentially liable for the acts of his partners in the practice.”
In a partnership, partners have usually discovered that it is easier to do business as partners because two heads are better than one and three heads are better than two, notes Chen. The combined efforts of the partners are greater than what a single person can achieve alone. Typically, a partnership will divide duties along lines of expertise.
“The danger here is that each partner has a duty to the partnership and each partner has the authority to bind the business,” Chen says. “Sometimes, partnerships just don’t work out. If you are going to be partners with someone, you had better get to know that person really well. Going into partnership is a lot like getting married. Breaking up is hard to do. Breaking up a partnership can be disastrous for friends going into business with each other.”
Additionally, each partner has the ability to bind the business, warns Chen.
“If your partner absconds to Vegas and bets it all on black, you go down with the ship,” he says. “If a group of doctors, including Dr. Brown, have formed a partnership and a medical liability judgment prevails upon Dr. Brown that resulted from his partnership activities, then the entire partnership is on the hook personally. This is one of the reasons that professional practices—attorneys, accountants, and doctors, for example—have avoided the partnership form. There was unlimited liability as a result of not having corporate veil protection.”
If you are determined to become a partnership, it is imperative that the ground rules are set at the initial partnership formation. These rules are generally set forth in a partnership agreement. There should be a clear division of labor that says who is going to do what. There should be clear compensation arrangements. There should be provision for the dissolution of the partnership. For example, Chen says that in the event of a death of a partner there needs to be a plan for what to do with the deceased partner’s ownership position.
“Sometimes, upon a partner’s death, the partner’s spouse could end up stepping into the business,” he says.
Partnerships are also taxed on a pass-through basis like proprietorships. Each partner is issued a Schedule K to file with personal taxes. As a practical matter, sometimes partnerships file for extensions because the numbers take a little more time to prepare.
“There are also limited partners and general partners in certain partnerships,” says Chen. “A limited partner is usually just along for the ride as a passive investor. As such, the limited partner isn’t always liable for tort action resulting from the business. The general partner has management and oversight duties over the partnership and usually will be liable for harm that the business incurs.”
There are generally two kinds of corporations: the C-Corp and the S-Corp. The main difference between the two is that the S-Corp has pass-through taxation and the C-Corp does not. The corporation offers corporate veil protection and limited liability for owners. The corporation is a separate legal entity from the owners. Harm done by the corporation, if incurred in the ordinary course of business, does not reach the owners.
“For example, if Dr. Brown was a shareholder and an employee of the corporation and committed harm as part of his business activities, the aggrieved would not be able to take his house to satisfy damages,” says Chen.
This is called the corporate veil—so long as sound business judgment is exercised and the leeway for business judgment is liberal, the corporate veil protection will exist.”
“Thus, malpractice claims will likely not reach Dr. Brown personally if Dr. Brown followed recognized medical procedure, despite the fact that experts might disagree on what recognized medical procedure is,” adds Chen. “After all, healthcare treatment does vary by geography.”
Farrell recommends that physician practices organize either as a professional corporation with sub S election (S-Corp), or a limited liability company (LLC). Both of these legal structures protect the owners’ personal assets against the malfeasance or malpractice of partners and the non-medical liabilities of any business.
“Both are pass-through entities, which means the income passes through to the physician or physicians without being taxed first on the corporate level, thereby avoiding double taxation,” she says.
Tax and liability issues aside, Farrell says that the key issue for the practice group is flexibility.
“If the practice includes one physician, a subchapter S corporation works just fine,” she says. “But if the physician has partners or anticipates taking on partners in the future, forming an LLC will make it far easier, if desired, to establish and administer different classes of owners.”