Corporate vision: Deciding what works for you

Christina McAlpin, MD, isn't shy about seeking advice. When the ear, nose and throat surgeon decided to open a solo practice in Los Angeles last year, she read books, talked to other physicians and asked relatives for help in choosing which legal structure she should use to form her practice. Then -- just to be sure -- she got input from two attorneys, an accountant and a financial planner.

The consensus was that a professional service corporation was the right fit for Dr. McAlpin's situation, partly because it would accommodate expansion but also because it would provide her with liability protection.

"The things you keep hearing are all these horror stories about doctors who aren't separate from their practices. Even though I haven't had any malpractice lawsuits, I'm still terrified about it," she said. "My priority was protecting both my practice and me."

Scores of physicians have wrestled with the same dilemma. For many, trying to distinguish between practice structures with acronyms and abbreviations such as LLP, LLC, S corp and C corp is enough to make them cross-eyed. But there is no room for blurry vision when it comes to this choice. That's because using the right structure can determine the financial viability of a practice.

Each structure might have different tax advantages, provide varying levels of liability protection or require more or less administrative work to maintain. Some might work better for smaller practices, while others are suited to big groups. Some are cut out for practices that intend to expand, and others are designed for the physician who plans to remain independent. Some are restricted in certain states.

"It's important to get help when evaluating these structures, but also use common sense. You don't need to create a structure for 100 physicians if you're only going to be one or two physicians," said Michael Levinson, MD, an attorney with the health care practice arm of law firm Zuckerman Spaeder LLP in Miami.

Sole proprietorship

Known as the simplest business form, sole proprietorships were once common among solo physicians. Few requirements must be met to qualify for this structure, which essentially is an unincorporated business owned by a single individual.

"It's nothing more than a doctor hanging up his shingle. There's no legal entity used to separate the practice from the physician," said Bruce Johnson, an attorney with Faegre & Benson LLP in Denver, and a consultant with the Medical Group Management Assn. Consulting Group.

Every transaction related to the practice would be conducted on behalf of the physician under a sole proprietorship, so the physician would be responsible for leasing office space or opening an account with a utility company. Taxes are paid with the physician's income taxes.

But all that means is there is essentially no separation between the physician's personal and business interests, so there is no liability protection from claims made against the practice. In other words, if the practice were sued, the physician's personal assets might be at risk.

That lack of protection has raised alarm with many physicians and has made sole proprietorships fall out of favor. "It really is a dying breed," said Dr. Levinson.

Still, others say the risk might be acceptable to some doctors. "If you're working by yourself, you don't have to worry about any risks triggered by your employees. Then maybe that's an acceptable risk for you to have," said Joy Butler, a business and licensing attorney in Washington.

General partnership

Not far behind on the simplicity scale is the general partnership, in which two or more physicians form a practice and share profits and losses.

Johnson said this structure is essentially "nothing more than a couple doctors saying they're going to work together."

Typically the partners will enter into some sort of agreement spelling out how the profits and losses will be shared and any rules affecting how the partnership is run.

As in the sole proprietorship, income flows through a general partnership to its partners, who pay taxes on it as part of their income taxes. Though the partnership must file an income tax return, it does not pay taxes. Johnson said this can be an advantage over corporation structures in which income is taxed twice -- at both the corporate level and personal level.

But these entities don't offer liability protection, so each partner could be held responsible for the acts of the partnership. Also, because it's an unincorporated model, "there's no shield between the doctor's personal assets and the rest of the world. So his house and his wife's diamonds could be at risk," Johnson said.

While some physicians are in general partnerships because at the time they formed the practice there were few other choices, experts say switching to a newer type of structure that affords liability protection is easy. "With the advent of the LLP, partnerships could just file a form and automatically convert it, conveying upon it that added liability protection," said Barbara Weltman, an author, attorney and small-business adviser in Millwood, N.Y.

Limited-liability partnership

Like general partnerships, limited-liability partnerships avoid the double taxation corporation structures face by allowing income to pass through to the individual partners.

What makes them stand out is their ability to potentially afford liability protection. Though state statutes might vary, Levinson said, they typically limit the liability of the practice to the assets of the partnership, not each partner's personal assets.

Also, in contrast to general partnerships, LLPs can provide different voting rights to partners, meaning certain individuals might have more power in the partnership. Levinson said this can be advantageous to practices that want to reward founding partners while bringing on new ones.

Some states require physician LLPs to be designated as PLLPs, or professional limited-liability partnerships. In fact, the same rules might apply to other structures, which is why it is not unusual to see PLLCs, PCs, PSCs and more. They are all variations on basic business structures relegated to certain professionals, including physicians. Their requirements might vary with state law.

Corporation

There are different kinds of corporations, but in broad terms they are businesses in which the owners are shareholders who own a certain amount of stock in the entity. These structures are available to solo physicians and group practices alike, and can be created with multiple classes of stock for different levels of ownership.

One of the main advantages to corporations is they provide a liability shield between the owners and claims made against the practice.

But a drawback is that some are subject to double taxation because the corporation's profits are taxed once, then the profits are passed on, typically in the form of dividends, to shareholders, who must pay income tax on those profits.

To create a corporation, owners must file articles of incorporation with the state. They also might need to create a shareholder agreement and bylaws spelling out ownership shares, rules and responsibilities. It also might be necessary to have a board of directors, annual meetings and more.

All of that work might add up to make corporations more expensive than other structures in terms of legal and accounting fees, Butler said.

Physician practices that use the corporation structure tend to use either of two subsets -- the C corporation, and the S corporation.

The C corporation structure is common. It functions like the generic corporation described above. On the upside, it provides a liability shield, but it is also subject to double taxation.

Some practices choose this structure for its benefits and aim to eliminate the effect of the double taxation by "zeroing out," or distributing all profits as salary, benefits and other compensation, so there is nothing left upon which the corporation could be taxed.

"If there's no profit at the C corporation, there's no [corporate] tax," said Jonathan Feldman, a health and business attorney with Phoenix Law Group in Scottsdale, Ariz.

The disadvantage is that at the end of the year, there has to be little left in the coffers.

Sometimes referred to as subchapter S, S corporations combine the function and liability protection of other corporations with the tax advantages of a partnership.

Under Internal Revenue Service rules, S corporations are generally exempt from most federal income tax. The profits flow through the corporation tax-free, ultimately being taxed only after they are distributed at the personal level.

Those benefits make S corporations attractive to scores of physicians. But they do not fit all practice types because of legal restrictions.

For starters, S corporations are limited to 100 shareholders or fewer. Also, Johnson said, these structures don't allow nonresident aliens to be owners, so they might not work for practices with foreign-born doctors. Also, S corporations are restricted to one class of stock ownership.

Limited-liability company

To avoid those restrictions, physicians might be more inclined to choose a limited-liability company, a relatively new form of business allowed by state statutes.

Like corporations, LLCs offer owners limited personal liability for claims against the business. Yet they differ from corporations and seem more like partnerships because of their management flexibility and pass-through taxation.

"They combine the best part of the corporation with the best part of the general partnership," Butler said.

Most states don't restrict ownership of LLCs, so there could be any number of members (as owners are called). It isn't typically necessary to have a board of directors or bylaws, though an LLC could opt for a governing document called an operating agreement.

One potential downside is it might be more difficult to use certain individual tax-saving strategies with LLCs than, say, S corporations, Feldman said.

Still, they can be tailored to provide the right fit for some practices. "You can customize them," Butler said. And if they still don't fit, you can continue shopping for another size.