Historically, practicing physicians have done business as a sole proprietorship or as a small group of physicians organized as a partnership. In many cases, this was because of physicians' desire for a simple form of organization and their perception that they were physicians, not a business. However, as the business of providing medical services has become more complex and tax rates have increased, more and more professionals, including physicians, have begun to organize as corporate entities.
The organization of professionals into corporations was opposed by the Internal Revenue Service (IRS) for many years. The issue first came up in the United States in the 1930s, and it was fought in tax court for 30 years until the states took it up and began to legalize professionals incorporating. The IRS continued the fight, until they lost in court in a string of defeats in the late 1960s. In 1969, the IRS finally conceded that professional organizations formed under state incorporation laws would be taxed as corporations for federal income tax purposes.
Many physicians incorporated in the 1970s and not only received some of the legal protection that corporations provided, but also funded large retirement plans that had not been previously available to sole proprietors. Then, late in the decade, limited liability companies were legalized in many states, providing even more alternatives for corporate structure.
Currently, a new practice may use one of several forms of legal organization available to other types of business, although not every form is available to physicians in every state. One restriction is that in many states, the entity must be organized as a professional or personal service entity and may be required to have some form of designation as a professional or personal service entity in their name.
The legal forms of organization that a medical practice can consider are sole proprietorship, general partnership, limited partnership, C corporation (standard corporation), S corporation, limited liability company (LLC), and limited liability partnership (LLP). The key things that should be considered when choosing a form of legal organization are:
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Potential risks and liabilities of your business;
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Costs and administrative requirements of maintaining the entity;
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Limitations on number of owners;
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Permanence and transferability;
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Tax ramifications of the entity; and
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Tax ramifications and benefits to the owner.
Each of these items should be examined with a tax advisor and legal advisor before choosing a corporate structure. The selection of what entity would work is very individual and should be made with care. In addition, the designation as a professional corporation or service corporation does not generally affect the level of risk or taxation for a physician. It is a separate designation based on the specific requirements of each state.
Professionals, such as physicians, tried for many years to insulate themselves from malpractice suits by lobbying to get the right to incorporate, but legislators would not permit it. After many years of lobbying, professionals were finally given the right to form professional service corporations, which provided them with the tax advantages of a C corporation; however, it did not provide them with limited liability.
The Table provides a brief summary of each entity and its key elements.
Table. Business Structures
Laws differ from state to state. The following chart represents a majority of laws in most states, but you'll need to consult with legal counsel before choosing a practice entity in any state.
| Entity | Individual Risk | Key Advantages | Key Disadvantages |
|---|---|---|---|
| Sole proprietorship | Unlimited Requires malpractice insurance |
Simple and inexpensive One owner |
Unlimited business risk Employment taxes on all remaining income Owner does not get a W-2 and must pay estimated taxes |
| General partnership | Unlimited Requires malpractice insurance |
Two or more owners Relatively simple to operate Profits and losses are attributed to individual partners Income is generally allocated the same as ownership but can be different |
Unlimited business risk Employment taxes on all medical service income Dissolves if a partner leaves Owners do not get a W-2 and must pay estimated taxes |
| Limited partnership | Limited to individuals Requires malpractice insurance for all partners |
Income can be allocated different from ownership Limited liability for business risk for limited partners Centralized management of businesses Protects against personal liability for business claims but does not protect against malpractice claims |
Employment taxes on all medical service income Owners do not get a W-2 and must pay estimated taxes |
| C corporation (standard corporation) | Protects against business risks except for malpractice claims Protects personal assets from liability Requires malpractice insurance |
Protects against personal liability for business claims, except for malpractice claims Exists separate from owners, with no specified end Owner gets a W-2 |
Possible double taxation More expensive to operate |
| S corporation | Limited to individuals Requires malpractice insurance |
Protects against personal liability for business claims but does not protect against malpractice claims Exists separate from owners, with no specified end Owner gets a W-2 Provides for taxation of profits and losses as partners, while providing a corporate shield against business claims |
Income must be allocated the same as ownership More expensive to operate Must have medical malpractice insurance |
| LLC | Requires malpractice insurance Depending on the state, can consist of individuals, corporations, or other LLCs |
Not taxed as a separate entity Can provide protection against personal liability for business risks like a corporation and be taxed like a partnership; this is the most popular form of entity in most states |
More expensive to create and maintain Professional service income is all subject to employment taxes Owner does not get a W-2 and must pay estimated taxes |
| LLP | Requires malpractice insurance | Protects against liability for acts of other partners | Owner does not get a W-2 and must pay estimated taxes More expensive to create |
LLC = limited liability company; LLP = limited liability partnership
If you choose a corporation as the form of legal ownership, it is critical to open a bank account in the name of the company and deposit all revenue and pay all bills from this new account. Any personal revenue or bills must not be deposited into or paid from the corporation's account, or it could be argued that the company is not legitimate, and someone trying to get at the owner's assets could assert there is not an official corporation. This is referred to as "piercing the corporate veil" and will open up owners of a corporation to personal business liability.
Professional service corporations are regulated by the state and often require that all of the professionals who own stock in this type of entity are in the same profession. In other words, a nurse practitioner could not own a medical corporation with a physician directly. If these two professions wanted to go into business, they could do it through a multitiered entity but this can add complexity and cost.
In some cases, physicians form individual corporations as well as a share of a joint management organization. These multitiered entities were initially devised to allow the physicians to set up rich retirement plans for themselves and limit the cost of plans for the staff. The tax rules for retirement plans for corporate entities now include regulations that any group of entities holding itself out as a combined business must have comparable retirement plans.
Once a legal entity is started, it is immediately accountable to the federal, state, and local government for all relevant taxes; this includes income, employment, sales, and other business taxes. It is therefore crucial to take the time to evaluate the key concerns of the owners and make sure the entity structure meets their needs. It is also important to reevaluate the corporate structure at least once every 5 years and determine whether it is still optimal.