By John Carruthers, staff writer, December 03, 2012
The business element of running a dermatology practice, whether a solo practice, small partnership, or large multi-office practice, has only increased in importance for dermatologists hoping to thrive despite increased regulatory and economic pressures. Choosing the right management and legal structure for one’s practice can create the foundation for efficiency and success in maintaining profits and achieving ongoing growth.
The dermatology practice of an individual or group represents a great deal of value and effort on the part of the practice principals. The most immediate benefit of finding the right legal structure, according to Philadelphia health care attorney Bill Kalogredis, JD, is shielding oneself and one’s partners from different forms of liability, whether medically originated or otherwise.
Practice owners have a number of options for legal structures, depending on their location and circumstances. Overall, there are four main distinctions sole proprietorships, partnerships, limited liability entities, and corporations. Each offers a different level of tax benefit, organization, and liability shielding.
Kalogredis, who advises physicians and practices, said the importance of protecting one’s personal assets has taken on increasing prominence over recent years. Sole proprietorships and general partnership agreements are usually not advisable in terms of risk, he said. [pagebreak]
Under an unincorporated sole proprietorship, a physician and his or her practice are treated as a single entity on Schedule C of IRS Form 1040. The physician pays debts from his/her own assets, and personal assets can be forfeit in judgments against the practice. It’s generally considered the highest-risk form of practice structure, which is why it’s fallen far out of favor as the medical field has become more sophisticated on matters of business structure and medical liability.
“Long gone are the days when a physician would just be in solo practice and not do some form of incorporated entity,” Kalogredis said. “There are obviously caveats, because different states have different regulations for practice ownership and different names for legal entities, but it all comes down to protecting the individual owners of a practice,” he added. “I would definitely not be unincorporated, and I would not be in the simple partnership arrangement that used to be more common.”
General and limited partnerships
In a general or limited partnership, two or more physicians associate to run the practice and share in both the profits and in potential liabilities of the practice, according to Miami board-certified health lawyer and former hospital administrator Sandra Greenblatt, JD, MBA.
In a general partnership, physicians share profit and may share management duties, as well as personal risk for the actions of partner physicians and employees. A malpractice judgment against one’s partner, for instance, can affect one’s personal assets regardless of fault for the triggering action. [pagebreak]
In a limited partnership, all but one of the partner physicians are relegated to a non-management role in the practice and therefore are not personally responsible for negligent actions undertaken by partners or employees. Partnership assets, however, are still at risk under liability circumstances.
Earnings from both types of partnerships are taxed through the owners, much like a sole proprietorship, on each owner’s personal income taxes. The partnership entity pays no taxes on earnings.
“In general partnerships, each partner has unlimited liability for the partnership and the right to fully participate,” Greenblatt said. “In a limited partnership, there must be at least one general partner. All other limited partners are mere passive investors but have no liability to the limited partnership beyond their investment.”
Kalogredis advises against use of such partnerships, pointing to the risk involved for partners. “Look at a hypothetical dermatology practice with two or three owners and a couple of employed doctors in a limited partnership agreement,” he said. “They have a partnership agreement and do not have limited liability. If you have one of these entities, owned by doctors A, B, and C, if there’s any kind of a claim vis-a-vis the practice, whether it’s malpractice, a creditor, or even a slip-and-fall, not only would the entity have a risk of responsibility of liability and damages, so would doctors A and B. Their personal assets are at risk because they’re partners with doctor C. A partnership is probably the worst way to go.” [pagebreak]
Most physicians, Greenblatt said, take things further when forming their practice structure, due to the benefits of liability protection offered by other practice types, including LLCs, LLPs, and S and C corporations.
“This shields them from third-party liability, other than for their own negligence/wrongdoing, and may have some tax advantages over sole proprietorship. Depending on the law of the state where they are located, solo physicians may also be able to form and work for other business entities that often permit non-physicians to be owners as well as the physicians,” Greenblatt said. “In states which do not prohibit the corporate practice of medicine, physicians may also joint-venture with hospitals and other providers and become employees of hospitals, managed care companies, and so on.” When reviewing these options, she said, it is critical to consult with a qualified health lawyer and accountant.
LLCs and LLPs
Two of the more common legal entities for practice are a limited liability company (LLC) or a limited liability partnership (LLP), which are alternatives to corporations that protect an owner or owners from personal liability stemming from liability from partner physicians or employees.
In a limited liability partnership (LLP), partner physicians are protected from personal liability due to partner negligence while still allowing for each partner to take an active management role. LLP owners must be physicians in most states. [pagebreak]
In a limited liability company (LLC), partners are also protected from liability and taxed like a sole proprietorship. LLCs, however, can have an unlimited number of owners, including non-physicians, another LLC, or a corporation. The distribution of profits can be structured however the partners desire.
LLCs, Kalogredis said, are advisable for the legal protection they offer partners.
“If you’re dealing with a small group, where there are other doctors in the practice, then the limited liability entity would protect the liability of the individual owner of the business as long as they are not the doctor who was involved in the care of the patient in the malpractice claim,” Kalogredis said. “Even as a solo practitioner, you would be personally protected against other liabilities, assuming that any of those creditors did not require the doctor to personally guarantee them. This would be something like a lease. If you sign as an individual, then you’re on the hook for that lease. If you sign as a corporation, or another limited liability type company, then the company is on the hook and the owner physician is not unless they guarantee it or the creditor can show that there’s fraud or misrepresentation.”
In addition, according to dermatologist Lucius Blanchard, MD, medical director of multi-state practice West Dermatology, LLCs can provide a way for larger practices to allow investment from non-physician owners in states that do not allow outside ownership of medical practices. [pagebreak]
“One of the advantages of an LLC, as we found out, is that in an LLC, any person can become a stockholder or a member of the LLC. That gave us an overall structure that could be modified or used in different ways,” Dr. Blanchard said. “Our separate management LLC has a contract with the West Medical Corporation. There’s a 30-year management contract where the LLC gets a fee from managing the West Corporation.”
Practices that have more than one physician are increasingly choosing to incorporate, according to both attorneys. The two main options for setting up a corporate practice each offer larger ownership pools and stratified management structure.
Incorporated practices are, in general, more technically complex arrangements than those listed above. They also provide more benefits for the physicians willing to devote the time and expense to forming them. The biggest benefit is that, other than personal negligence or malpractice judgments, each partner’s financial risk is limited to his or her stake in the practice; homes and other personal property would be unaffected by a corporate calamity unless they had been put up as collateral.
C corporations may issue stock, and must be operated under both a board of directors and corporate officers. Shares in a C corporation may be issued in both voting and non-voting denominations. Profits are taxed both to the corporation and to each individual owner. Profits can be allocated in varying denominations according to practice agreements between owners.
S corporations are limited to 75 stockholders and cannot issue non-voting shares. Profits are distributed according to each owner’s personal investment in the practice. Taxation is done directly to owners, and is not applied to the corporation. [pagebreak]
Kalogredis said he recommends corporations for any practice with more than one physician, and that most of his clients choose to incorporate as an S corporation.
“The S corporation does not pay taxes on its income — it’s more of a pass-through type entity. If at the end of the year there’s $100,000 of profit, and there are two owners, they can split the parts of the income differently. But if they’re equal owners, they’ll each get $50,000 taxable to them on that profit. The corporation itself doesn’t pay the tax, the owners do, even if they don’t take the money out. In a C corporation the taxes are paid by the corporation,” Kalogredis said. “A lot of our clients choose to go with an S corporation. It’s a way to differentiate between their pay as a practicing clinician and how they take out profit from the business. It’s still very much variable. You have to talk to each individual owner and go through the pros and cons in their state, and see what is recommendable in terms of your goals as a group and as individuals working together.”
In addition to profit and taxation benefits, Greenblatt said, incorporation, whether or the S or C variety, allows for owners to expressly outline the rights, duties, and responsibilities of each shareholder. “If a practice has more than one owner, I strongly recommend having a Shareholders’ Agreement or parallel governing document for other types of entities, including LLCs,” she said. “That sets out the rights and duties of the owners as to each other and to the entity, including governance, buy-outs, disability, retirement, dispute resolution, and so forth. Everyone has a roadmap to follow and this can avoid significant problems down the road.” [pagebreak]
One significant difference in the operation of a corporate medical practice, according to Dr. Blanchard, is the designation of physicians as W-2 employees. This, he said, can have an effect on the practice’s benefits structure. “Almost all of our doctors are W-2 employees, though some are still independent contractors. The disadvantage for those doctors [who are W-2 employees] is that they come under the 401(k) plan the corporation has for all of our 400-plus employees. Because the doctors are employees of the corporation, they come under that umbrella,” Dr. Blanchard said. “Some of them would like to go out and set up their individual retirement plans, but as W-2 employees that would be frowned upon by the IRS.”
The disadvantage, in short, is that while owners or physicians might prefer otherwise, the physician employees of the practice get less benefit from retirement plans that are scaled to be competitive for employees at the medical assistant or administrative pay grade than they would under a separate arrangement of their choosing.
In choosing which practice structure to pursue, it’s important to carefully consider and weigh the costs and benefits of each option.
“When you’re setting up your practice, the best advice is to consult with a good health care attorney and accountant,” Kalogredis said. “It’s important to know what’s going on with the laws at the time. Things can change quickly, especially at the state level.” [pagebreak]
Stark Law considerations
According to Miami attorney and former hospital administrator Sandra Greenblatt, JD, MBA, the Stark Law (and many parallel state self-referral laws) have exceptions that permit solo practitioners and properly formed group practices to provide ancillary or “designated health services” (“DHS”) to their patients within the practice that no longer can be done as outside investments by physicians. “If a physician intends to include DHS into his/her practice, compliance with the Stark Law and comparable state laws is a critical element that is best dealt with at the outset,” she said. “While the Stark Law deals only with Medicare patient referrals, many states have enacted similar self-referral laws that extend to all patients, regardless of payer source.
“There are explicit exceptions in the laws and regulations that must be followed precisely: the Stark Law is a strict liability statute with serious penalties. You either qualify for an exception or your DHS referrals will violate the law. There is no grey area and intent is not relevant to the analysis. Providing DHS can be very profitable for physician practices. Proper planning and structuring of practice ownership and physician compensation plans is far less costly in time, money and stress, than dealing with non-compliance at a later date.”
More discussion of the Stark Law and its ramifications for dermatology appeared in last December’s Dermatology World; visit www.aad.org/dermatology-world/monthly-archives/2011/december/stark-and-dermatology to read it.