Do you run your own practice or hope to run your own practice in the near future? If your answer is “yes,” then you will want to pay close attention to the information within this Lesson. The purpose of this section of the article is to help you get the most—financially speaking—out of your practice. You will have to do more than the typical cookie-cutter planning that many CPAs and attorneys will suggest. As you learned in Lesson #3, an advisor who doesn’t specialize in the unique issues that Doctors face is likely to miss a number of key elements in their planning.
If your goal is to efficiently get the most out of your practice, you may find this Lesson to be the most valuable in this book. While intelligent planning can improve all aspects of your life, it is the impact on your practice that can be the most significant. You need to begin thinking about your practice not only as a treatment facility for patients, but also as a financial Fortress and a wealth-building Engine for you.
The Fortress analogy is important because we want to make sure that the practice is fortified. As the vehicle through which you will make most of your earnings in your career, the practice needs to be protected against all financial and legal threats. As you learned in the previous sections of the larger article, these threats are not just medical malpractice lawsuits. They include healthcare issues, employment risks, and other financial threats that can impact your ability to work and make money.
The Engine analogy is crucial because we want your practice to be an engine for wealth accumulation. You will want to apply the important concepts explained earlier in this book (e.g., Leverage and Efficiency) to your practice structure and operations. By doing so, you will finally be able to derive as much financial benefit as possible out of your practice—both during your working years and through your retirement.
In this Lesson, we will discuss ways to structure and operate your practice so it will act both as a Fortress and as an Engine. Specific articles will cover other risks to the practice not yet discussed, including the premature death or disability of a partner. This Lesson will also explain how to turn the practice into a Fortress by protecting your accounts receivable, real estate, and equipment. You will also be introduced to tools that can be used to transform your practice into a smooth-running Engine—including the use of qualified and nonqualified plans, friendly lease-back arrangements, and captive insurance companies. Finally, we will explain the ultimate wealth-building Engine—the million-dollar retirement buy-out.
How NOT to Structure Your Practice
Every year, we meet many Doctors who are practicing within a structure that offers very little, if any, protection for the assets of the practice. Even worse, we encounter Doctors who have put absolutely no barrier between the potential risks of their practice and all of their personal assets. In some cases, this is due to ignorance on the part of the Doctor. Other times, this is the result of poor advice. Many accountants have suggested that Doctors might not see enough benefit from incorporation to warrant the added time and expense corporations require. Other advisors still recommend general partnerships, although this practice form is all but extinct. In this chapter, we will discuss the pitfalls to avoid when structuring your medical practice.
It may be difficult to believe, but most Doctors who call us have practices that are structured with two things in common:
· Maximum lawsuit exposure
· Minimum tax-saving potential
In this chapter, we will discuss the common medical practice structural and operational mistakes that can cause these two highly undesirable outcomes. After you learn how not to structure your practice, you can continue reading the rest of this Lesson and learn how you can structure your practice for maximum flexibility and efficiency, enabling you to create the Fortress and Engine you desire.
The Worst Way To Structure A Practice: As A General Partnership
Fortunately, it is far less common for Doctors and their advisors to structure new medical practices as general partnerships today. Though new practices are rarely configured as general partnerships, we still come across dozens of mature (and profitable) practices every year that continue to be operated as general partnerships. There are rarely absolutes in medicine, finance, or the law. However, here is one simple rule: You should never operate any medical practice or other business practice as a general partnership. Why do we say this? The general (pun intended) reason is because a general partnership is a creditor’s or plaintiff attorney’s dream and a partner’s liability nightmare. More specifically, let’s consider the three hidden dangers of a general partnership:
1. Partners Have Unlimited Liability for Partnership Debts
This tragic fact goes unrealized by many Doctors who are involved in general partnerships. Without signing personal guarantees on every debt, the Doctors who are involved in a general partnership are, by default, personally guaranteeing every partnership debt and personally assuming the risk for malpractice, accidents, and other liability sources of the entire partnership. These Doctors fail to consider that their liability as a partner is joint and several with all other partners. A plaintiff who successfully sues the partnership can collect the full judgment from any one partner. Let’s look at an example to see how dangerous this arrangement can be:
Case Study: Jane and Ted’s Real Estate Venture
Jane and Ted were physician colleagues who wanted to increase their income by buying “fixer upper” houses, renovating them and then selling them. Events went well for a while, but the real estate market went sour and they defaulted on a $650,000 loan to the bank. Jane was much wealthier than Ted, so the bank pursued Jane for the full amount, ignoring Ted, under the theory of joint and several liability. To collect Ted’s share of the liability, Jane had to file suit against him, thereby destroying a long-term friendship.
2. Partners Have Unlimited Liability for Their Partners’ Acts
When your business is structured as a general partnership, you assume all risks that any partner in the partnership could cause. When a lawsuit arises from one partner’s acts or omissions in the ordinary course of practice, every other partner is personally liable. The dreaded joint and several liability then applies. This means that each partner can be 100% liable for the actions of any of the other partners. If you operate within a general partnership and one of your partners gets into trouble, you can be personally liable for the entire amount, even if you were neither involved in the alleged incident or even aware of it.
Think of the many ways a partner could get you into trouble: He commits (or is convicted of) malpractice, gets into a car accident while on partnership business/ time, defrauds someone through the practice, sexually harasses an employee, wrong¬fully fires an employee, directs an employee to improperly bill an insurance company or Medicare, etc. Multiply this risk times the number of partners in your partnership. You have a lawsuit liability nightmare! Here is a real-world example that should help illustrate the point further:
Case Study: Michael Gets Burned By His Partner
Michael was the founding partner in a successful three-owner surgery center. One of the firm’s employees sued the firm for sexual harassment. Settlement negotiations were unsuccessful and the trial jury awarded an extremely large verdict against the partnership. Of course, this was not covered by any malpractice policy. Since Michael was the wealthiest of the partners and his assets were unprotected, the plaintiff’s law¬yer pursued him first. This was the plaintiff’s quickest way to receive cash. Michael was forced to pay the entire $250,000 judgment from his personal savings. Although Michael had much less contact with this employee than his partners, he was stuck with the bill. Now, Michael has to begin his own costly legal battle against his partners to prove that they owe more than he does because they were more involved with this former employee. This is a no-win situation for Michael—who now understands the risks of a general partnership.
3. You May be an “Unaware” General Partner
A general partnership does not require a formal written agreement like a limited partnership does. You can verbally agree to start a venture with another person and, by default, create a general partnership, with all of its liability problems. Think about this whenever you start a new practice (or any other business) venture with someone.
Even if you make no agreement to partner with another person, the law may impose general partnership liability on you if the general public reasonably perceives the two of you as partners. You may already be part of a liability-ridden general partnership and not even know it.
Case Study: Roger Inadvertently Has Partners
Roger was one of four physicians who used a common office arrangement. They each had their own patients, which they did not share. They did, however, share a common waiting area, some support staff, and used the same in-house bookkeeper/ accountant to help them manage the costs of their practices. Each professional had his own practice methods, set his own hours, and was not otherwise accountable to the other Doctors.
When one of the Doctors was sued by a patient for professional misconduct, Roger and the two others had a rude awakening. Although only the patient’s physician was negligent, all four were defendants in the lawsuit. The court found that the patient could reasonably conclude the four professionals were partners together because of their office set-up and common support staff. Therefore, the court allowed the plaintiff to proceed with the suit against all four as a general partnership, with each jointly and severally liable for the plaintiff’s losses.
If your practice still operates as a general partnership or may be considered one as above, you should review the situation and alternative structures with experienced counsel as soon as possible.
The Second Worst Way to Structure a Practice: a Sole Proprietorship
While relatively few general partnership medical practices exist these days, we cannot say the same thing about practices that operate as sole proprietorships. Every week or two we speak to Doctors who have been operating their practice as a sole proprietorship. In other words, these practices have no legal entity and all income and expenses are recorded on the Doctor’s Schedule C of the personal tax return. These Doctors simply operate the practice in their own name, with their own social security number, often with a “DBA” in the name of a medical practice (i.e., “Smith Medical Practice”). At its most basic level, the flaw of a sole proprietorship is that it provides absolutely no barrier between the Doctor’s professional and personal life. As a result, any risks and liability from the medical practice threatens all of the Doctor’s personal assets and any personal lawsuit against the Doctor or the Doctor’s family (including teenage children) threatens the assets of the medical practice (including accounts receivable, real estate, and equipment). Let’s examine these problems more closely.
Drawbacks of Sole Proprietorship
The two significant drawbacks of sole proprietorships are the following:
1. There is no shield between practice liability and all of the Doctor’s personal assets. This is a crucial asset protection failure. Because there is no legal entity, there is no fortress at all. While no legal entity will protect the Doctor from personal liability for professional malpractice, medical malpractice is not the only risk from the practice. As you read earlier in this Lesson, employment liability can be significant. Healthcare-related lawsuits are increasingly common and judgments can be huge. Add to these premises liability and other non-medical claims and one would wonder why any Doctor would choose to expose all of his or her personal wealth to such risks!
2. Without a legal entity, the practice’s options for tax reduction are limited.
In addition to the asset protection drawbacks above, using a sole proprietorship also limits a Doctor’s tax planning options in the practice. A number of benefits plans and tax planning options are available to corporations and not to sole proprietorships. Every Doctor we have spoken to over the years wants to get more retirement dollars out of their practice and wants to legally reduce income taxes. Since you can’t accomplish these goals as efficiently with a sole proprietorship as you can with a corporation, you have to wonder why Doctors would ever continue to operate as sole proprietorships once they learn of these opportunities.
Why Doctors Get Stuck In Sole Proprietorships
Given the significant drawbacks of using a proprietorship to operate a medical practice, it does seem strange that thousands of Doctors would do so. In our combined experience, this cannot typically be blamed on the Doctor. In fact, what we have seen over the years is that Doctors who use proprietorships almost always have been told to do so by an accountant.
Unfortunately for their Doctor clients, there are a large number of accountants across the U.S. whose view of this issue is extremely limited. For these accountants, the costs and head-aches of using any kind of legal entity for a single Doctor medical practice is not “worth the trouble.” Thus, they advise their client to simply operate the medical practice as a proprietorship. Let’s examine their logic.
If the simple alternative to a proprietorship is to use a professional corporation (PC), a savvy businessperson would look at the costs and benefits of each strategy, weigh them, and make a choice. To do so here, you need to first understand the costs and headaches of such an entity (we will use PC throughout this chapter to also mean Professional Association or Professional Limited Liability Company).
You can expect the legal fees (drafting Articles of Incorporation if a corporation or Organization if an LLC, Bylaws if a corporation or Operating Agreement if an LLC and Organizational Minutes for either) and filing costs (Name Reservation for either a corporation or LLC, Articles of Incorporation or Organization and Filing Fees for either) of creating a PC to be between $3,000 and $5,000, depending on the state of formation, and annual state fees and legal and accounting costs to be roughly another $2,000 to $3,000.
If you pay such costs to a competent advisor, the only “headache” should be signing a few documents and making sure you use business checks for business expenses and personal checks and debit cards for personal expenses. Thus, the question becomes: Are the significant asset protection and tax drawbacks of the proprietorship worth saving about $2,000 per year… especially when those dollars are tax-deductible?
The key factor that many accountants seem to miss is the asset protection concern. Accountants typically focus on the fact that a PC cannot protect a Doctor from his or her own malpractice. While this is true, the PC can protect that Doctor from the following: patients or vendors who may slip and fall when they visit the practice, claims from acts of employees and many other risks we referenced in the first two chapters of this Lesson. Attorneys know about these tradeoffs and have a very similar issue. How many attorneys forego the “cost” and “hassle” of a PC and run their law practices as proprietorships? We rarely see one. If knowledgeable attorneys who understand legal risks never use proprietorships, why should Doctors be any different? It is unfortunate that some accountants have not learned the same lesson and continue to give bad advice to the Doctors who are relying on them.
If your practice still operates as a proprietorship, you should engage experienced counsel to remedy this as soon as possible!
The Protections Of Professional Corporations
If you are not in the minority of Doctors who are stuck in a general partnership or proprietorship, you are using some form of professional entity. This could be a professional corporation (PC), professional association (PA), or professional limited liability companies (PLLC). For simplicity, we will use “PC” for all of these. The most important benefits of a PC are.
· PCs can protect the Doctor from the acts or omissions of subordinates and associates. For instance, a Doctor can protect him or herself from the acts or omissions of nurses or other Doctors, if the Doctor at issue was not involved in the act of liability.
· PCs may protect Doctors from non-malpractice lawsuits. As we outlined earlier in this Lesson, there are many non-medical malpractice liability risks facing Doctors today. The PC may provide a shield for the Doctor’s personal assets in many situations.
· The PC may allow the Doctor to take advantage of certain tax-saving options not available for proprietorships. Deducting long-term care insurance premiums, plans authorized under Section 79 of the tax code, non-qualified deferred compensation plans—all of these options, as well as several others, are only available to practices that operate as PCs.
The Bare Minimum Way to Structure a Practice: Lone PC
You may be surprised, given the discussion above, that we would call the use of a PC as a “bare minimum” technique. Certainly, when compared to a general partnership or a proprietorship, the PC is much better. However, it is still far from ideal. The following diagram illustrates how nearly all medical practices are arranged in the United States. Perhaps yours is organized this way.
In this arrangement, there is one legal entity that operates the practice and hires all the employees. This same entity also owns all of the key assets of the practice—the accounts receivable (AR), the real estate (RE), and any valuable equipment. In addition, this same entity is the one that bills insurance companies, Medicare, and patients. Finally, this same entity offers the benefit plans to the Doctors and other employees. What is wrong with this picture below?
“ALL Eggs in One Basket” Practice Structure
“Practice” P.C., P.A., PLLC
The problem with this diagram, and the legal structure it represents, is fairly simple – all of the practice’s “eggs” are in one basket. In fact, not only are the “eggs” (assets) in the one basket, but so are all of the threats to those assets. Employees, partners, and all of the services provided by the practice are within the entity. As you will learn in Lesson #6 (personal asset protection), it is never a good idea to mix assets with liabilities. The crux of the problem is that all of the assets are exposed to all of the liability threats of the one legal entity. This means that one mistake from any of the risks could threaten all of the assets of the practice. This is obviously not a desirable condition. Also, with only one corporation, you only get the tax benefits of one type of taxed entity. With multiple entities, you might be able to benefit from two types of tax environments. In the next 2 chapters, we will examine ways to solve this problem.
In this chapter, we pointed out that many Doctors are still operating their medical practices in the worst ways possible—as general partnerships or sole proprietorships. We explained why these are terrible ways to run any business, not just a medical practice. We also explained that a Professional Corporation, Professional Association, or Professional Limited Liability Company are steps in the right direction, but still have serious problems. If the structure of your practice resembles any of these examples, you are subjecting yourself to unnecessary lawsuit risk and are sacrificing valuable tax deductions you may be able to receive from a more appropriate business structure. The good news is that, even if you have operated with a general partnership or sole proprietorship for fifty years, it is neither too late nor too difficult, to change your structure and start taking advantage of the benefits that alternative structures offer. If you truly want your practice to operate as a Fortress and a wealth-building Engine, you should first make sure that you are using the right type of entity for tax purposes.
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