LAW OFFICE OF
HUBERT BELL, JR.
ATTORNEYS515 CONGRESS AVENUEOF COUNSEL
______ 2000 BANK OF AMERICACENTER______
HUBERT BELL, JR., CPAAUSTIN, TEXAS 78701ANDRÉ HAMPTON
MICHAEL Z. STERN, CPAPHONE NO. (512) 469-9006 / FAX (512) 480-5644JANET L. BRAY
MARK J. JUNG
DEVETHIA NICHOLS-THOMPSON
llp's, llc's, pa's, and other initials
By Michael Z. Stern
Law Office of Hubert Bell, Jr.
515 Congress Ave., Suite 2000
Austin, Texas 78701
Telephone (512) 469-9006
Facsimile (512) 480-5644
I.Introduction
Physicians who are self-employed or in business with others are faced with many decisions, not the least of which is the choice of the organizational structure, or type of business entity, in which to practice. Our firm routinely fields inquiries from physicians as to what is the "standard way" or "best way" to organize.
It would be nice if there was one standard answer and a standard set of forms to use in order to choose the type of business entity in which to practice. In reality, however, each situation is different; and every client has different desires, goals, and objectives. Therefore, each situation must be individually analyzed in order to determine what type of organizational structure best fits the needs and objectives of the client. (It is somewhat akin to the patient who calls the physician asking for a diagnosis and medication over the phone -- that is, there may be several common reasons for the patient's symptoms, and even common methods of addressing the patient's problem; however, each patient must be examined and treated individually in order to ensure that the appropriate diagnosis is obtained, and the proper treatment is chosen.)
Numerous factors need to be considered in choosing an organizational structure, including the complexity and expense of the entity to form, maintain, and dissolve; the type(s) of activities to be conducted by the entity; transferability of ownership interests; taxation (both federal income tax and state franchise tax); limiting the liability exposure of the owners; the number of owners; the anticipated duration of the business; the management and operational flexibility desired by the owners; desired divisions of profits and losses; etc.
The following is an overview of some of the various types of organizational entities and structures in which the physician may choose to practice. This is intended to give the reader a general understanding of some of the more common features of the basic types of organizational entities; and is not intended to be an exhaustive analysis, or a substitute for legal representation. Obviously, the reader is well advised to work within his/her field of expertise, and to leave the legal advice to lawyers.
II.Proprietorship
A proprietorship (sometimes called a "sole proprietorship") is an unincorporated business consisting of one owner (or husband and wife). It is the simplest form of entity. Other than obtaining the appropriate licenses and permits as may be necessary to carry on the business (e.g., sales tax permit, medical license, drug permit), there are no filings or documents required to begin this type of organization. There are no separate state or federal taxes imposed upon the proprietorship organization itself, other than any applicable sales taxes, property taxes, employment taxes, etc., imposed on any business engaged in this type of activity. The proprietorship is not subject to the Texas Franchise Tax; and the owner is responsible for reporting all of the business's income and deductions, and paying federal income taxes, on the proprietor's own Form 1040.
In spite of its simplicity to form and operate, the proprietorship structure has the disadvantage of exposing the physician owner to full liability for all of the problems of the business. For example, if an employee commits malpractice, or causes an automobile accident while on the job, all of the business and personal assets of the physician (other than the Physician owner's exempt property) are at risk.
III.Partnership
A partnership, or "general partnership", is an unincorporated business comprised of two or more owners. As with the proprietorship, there are no filings or documents required to begin this type of organization other than obtaining the appropriate licenses and permits as may be necessary to carry on the business. There are no separate state or federal taxes imposed upon the organization itself, other than sales taxes, property taxes, employment taxes, etc., which would be imposed on any business engaged in that type of activity. The partnership is not subject to the Texas Franchise Tax, and is generally not subject to federal income tax. The Partnership is, however, required to file an annual federal "information income tax return" which details the partnership's items of income and deductions; and lists the names and social security numbers of the partners. The individual partners are then required to reflect their respective proportionate shares of the partnership income and deductions on their own personal income tax returns each year -- and to pay any federal income tax thereon.
Also like a proprietorship, the partnership has the disadvantage of exposing the partners to full liability for the problems of the business. For example, if an employee or partner commits malpractice, or causes an automobile accident while on the job, then not only are the partnership's assets at risk, the personal assets of all of the partners (except for each partner's exempt property) are also at risk. Thus, a significant detriment to the use of the partnership organizational structure in that each of the partners in a partnership is potentially liable for all of the partnership debts and liabilities of the partnership, including those incurred by the other partners. For this reason, many persons are leery of operating a professional practice as a partnership.
The partnership structure provides great management and operational flexibility; and it is advisable, but not always legally necessary, to have a written partnership agreement that explains in detail the rights and responsibilities of the partners. If there is no partnership agreement, the partners rights and duties will be governed by the provisions of the Texas Revised Partnership Act.
Issues to consider in forming a partnership -- as well as in drafting the partnership agreement -- will include the division of profits and losses, initial and subsequent capital contributions and withdrawals, termination and dissolution, assignment and assignability of interests, additions of other partners, management of the partnership, procedures and votes necessary to vote on partnership matters, etc. Also because of the flexibility, it may be more expensive and complicated to form this type of entity, as opposed to a corporation.
IV.Limited Liability Partnership
The "limited liability partnership" (sometimes referred to as a "registered limited liability partnership") ("LLP" or "RLLP") is a 1991 creation of the Texas Legislature; and is codified at Tex. Rev. Civ. Stat. Art. 6132b-§3.08, et seq. The LLP is a general partnership in which the individual physician partners are insulated from the liability caused by the other partners (except in cases in which the "non-involved" partner had supervisory control or direction over the "involved" partner, or if the "non-involved" partner knew of the personal injury at the time of the occurrence but did not take steps to prevent or cure the problem).
In order to avail themselves of the LLP, the partners are required to annually file a registration form with the Secretary of State, along with the payment of an annual fee (currently $200.00 per partner). The partnership must also maintain liability insurance in the minimum amount of $100,000.
Therefore, while the LLP will provide some liability protection to the physician, it may not provide as broad a protection as the P.A. or LLC.
V.Corporation/Professional Association
A Corporation is a legal entity separate and distinct from its owner(s). The term for a corporate entity providing professional medical services in Texas is a "Professional Association" ("P.A."). The Texas Professional Association Act is found at Tex. Rev. Civ. Stat. Art. 1528f. Aside from the restriction that the stock of a P.A. may only be owned by physicians, there is no practical difference between a corporation and a P.A. The P.A. is widely utilized as an organizational structure because of the well known "liability protection" afforded its owner(s). While the P.A. organizational structure will not shield a practitioner from his/her own acts of negligence or for negligent supervision of subordinates, it will shield the physician from the acts of others. Generally, if the P.A. incurs a debt, or if an employee or other owner of the P.A. commits a personal injury, then the P.A. itself will be held liable; but the "non-involved" owner(s) will not be held personally liable. Therefore, the P.A. structure generally has this distinct advantage over the proprietorship and the partnership.
Generally, the shares of stock in the P.A. are freely transferable, subject to the requirement that ownership interests may not be owned by non-physicians. In other words, the individual owners can sell their shares to others. While this may be a desirable feature for large companies trying to raise capital, the owners in a closely-held business may not want the other owners to be able to "sell out" to strangers. Therefore, this attribute of "free-transferability" can and should be restricted and limited in appropriate instances through the selective use of buy-sell provisions between or among the owners.
At this time, the P.A. will not be subject to the Texas Franchise Tax. For federal income tax purposes, a distinction must be made between two (2) types of corporations: a "C Corporation", and an "S Corporation", both of which are equally applicable to the P.A.
A.C Corporation
Generally, for federal income tax purposes, a corporation is a taxable entity separate and apart from its owners. This is the case with a C Corporation. Therefore, when a C corporation realizes a profit, it must pay tax on that profit; and when that profit is distributed to its shareholders (owners), that profit is again taxed to the owners as dividends. In many situations, advance financial planning (such as the distribution of all profits as salaries or and/or bonuses prior to year-end) may reduce or eliminate the corporation's profits, and thereby reduce or eliminate some or all of the negative effects of this "double taxation".
In other respects, the use of a C Corporation may be of financial benefit to the owner(s). For example, health insurance benefits currently greater deductibility in a C Corporation. As well, C Corporations generally enjoy more favorable retirement plan possibilities.
B.S Corporation
Certain corporations, known as S Corporations, are treated for federal income tax purposes as proprietorships/partnerships. In other words, the S Corporation receives the corporate benefit of liability protection to the owner(s), while not suffering the double taxation generally attributed to C Corporations. (The S Corporation is, however, subject to Texas Franchise Tax.)
The use of the S Corporation, while rather restrictive in scope, is often available to physicians who choose to operate within the P.A. organizational structure. For example, the Internal Revenue Code restricts the S Corporation to one class of stock, and a maximum of 75 shareholders all of whom must be individuals and U.S. residents. These types of restrictions are not usually problematic for physicians when organizing their medical practices.
C.5.01(a) Non-Profit Health Corporations
The Certified "5.01(a) Non-Profit Health Corporation" ("5.01(a) Corporation") is authorized by Section 5.01(a) and (b) of the Texas Medical Practice Act, Tex. Rev. Civ. Stat. Art. 4495b. These corporations are organized on a not for profit basis.
Whereas the typical nonprofit corporation is organized in order to avoid taxation, the 5.01(a) Corporation is utilized by hospitals and other non-practitioners in developing integrated physician-hospital networks which avoid "corporate practice of medicine" issues involving non-profit hospitals.
In short, the Texas "corporate practice of medicine" prohibits any person or entity other than physicians and P.A.'s from engaging in the practice of medicine. Generally, Section 5.01 of the Texas Medical Practice Act allows non-physicians to own all or part of a 5.01(a) Corporation; however, all officers and directors of the 5.01(a) Corporation must be licensed, practicing physicians, and all issues pertaining to medical decisions and treatment must be made solely by the licensed, practicing physicians. The 5.01(a) Corporation may contract with or hire physicians who will practice medicine.
In order to be a tax-exempt organization, the practice must be established as a non-profit entity; however, merely establishing the practice as a Texas non-profit entity will not guaranty tax-exempt status. The Internal Revenue Service closely monitors and scrutinizes entities seeking federal tax-exempt status. Most physician practices will not qualify for federal tax-exempt status.
V.Limited Liability Company
The limited liability company ("LLC") is a recent creation of the Texas legislature (authorized in 1991), and is found at Tex. Rev. Civ. Stat. Art. 1528n. As of 1998, the LLC is available as a choice of entity in more than 11 other states. This entity has a hybrid structure, having certain attributes of a corporation and certain attributes of a partnership.
The utilization of the LLC organizational structure, as opposed to a corporate/P.A. structure, is to obtain the liability protection of the corporate structure and achieve the federal income tax benefits of the "S Corporation", while not being subject to some of the strict organizational requirements imposed on S Corporations by the Internal Revenue Code.
For example, if several individual physicians or groups of physicians practicing as individual P.A.'s choose to affiliate or merge their practices, the S Corporation would not be allowable; since only individuals and not corporations, can be shareholders in an S Corporation. However, the LLC could be utilized and structured to achieve the same benefits as the S Corporation. This entity would also afford greater flexibility in management, capital contributions and withdrawals, and divisions of profits and losses than would be available in a corporation.
Caution should be exercised in creating a LLC because this type of entity is not strictly recognized by the Internal Revenue Service. Depending on how the LLC is structured and the particular attributes bestowed upon a LLC and its owners, the IRS will treat the entity either as a partnership (i.e. taxation only upon the owners), or corporation (i.e. imputing the "double taxation" upon the entity and its owners). Therefore, there is some risk that any particular LLC will be retroactively determined by the IRS to be a corporation that would be liable for the corporate level tax. As stated above, in most instances, "S Corporation” status will be available for most professional associations, so that the LLC will not usually be necessary. And like the S Corporation, the LLC is subject to the Texas Franchise Tax.
VII.Other Organizations
This outline intentionally omits coverage of other types of organizational structures, such as the joint venture ("J.V.") and limited partnership ("L.P." or "Ltd."), which are vehicles suited for certain types of investments and businesses, but which are not well suited to the professional practice situation.
This article also omits coverage of other types of medically "related" organizations, such as independent physicians organizations ("IPA"'s) and management services organizations ("MSO"'s), which are beyond the scope of this article.
VIII.Conclusion
In conclusion, one or more of the described organizational structures may or may not be suitable for a given situation. The physician and the attorney will need to analyze the specific situation, and to choose an organizational structure that best suits that situation. Once the appropriate organizational structure is chosen, care must be taken in drafting the appropriate organizational documents so that the physician's desired needs and objectives may be achieved.
Hopefully, this overview will give the physician a general understanding of some of the more common features of the basic types of organizational structures and entities. In this way, the physician can be more knowledgeable in discussing and choosing the appropriate type of entity.
TYPES OF BUSINESS ENTITIES
I.Proprietorship: A one owner, unincorporated business (includes husband & wife).
II.Partnership: A multiple owner, unincorporated business.
A.General Partnership
B.Joint Venture
C.(Registered) Limited Liability Partnership
D.Limited Partnership
III.Corporation / Professional Association (P.A.): a business entity that is separate and distinct from its owners.
A."C" Corporation
B."S" Corporation
C."501(a)" Corporation
IV.Limited Liability Company (LLC or LC). Hybrid entity, having attributes of partnerships and corporations.
I. PROPRIETORSHIP
A one owner, unincorporated business (includes husband & wife).
(A)Easy to form and dissolve
(B)Not subject to Texas Franchise Tax
(C)Owner pays all federal income tax
(D)Owner fully liable for all business debts and liabilities
(E)Limited medical deductions allowed to owner
(F)Limited deductions available for retirement plans
II.A. GENERAL PARTNERSHIP
A multiple owner, unincorporated business.
(A)Can be easy to form; however more time and expense utilized during formation will alleviate even greater time, expense, and potential litigation involved in dissolution
(B)Not subject to Texas Franchise Tax
(C)Partnership files "information federal income tax return", but pays no tax. Partners are taxed on their shares of partnership income and loss (whether received or not).
(D)Partners fully liable for all business debts and liabilities, including the partnership liabilities and the torts (personal injuries) incurred by the other partners.
(E)Limited medical deductions allowed to partners
(F)Limited deductions available for retirement plans
II.B. JOINT VENTURE
A general partnership formed to conduct a single endeavor, venture, or purpose of limited duration. Generally utilized to invest in and/or develop property. Not suited for ongoing business such as a medical practice.
II.C. (REGISTERED) LIMITED LIABILITY PARTNERSHIP
"LLP" or "RLLP"
A general partnership, but with the following difference:
(A)partnership pays $200.00 per partner per year to the Secretary of State; and the partners will then be shielded from liability for the torts (malpractice / personal injuries) caused by others
(B)The LLP must maintain liability insurance coverage (currently, with minimum limits of $100,000);
(C)The partners are still liable for the contractual debts and other liabilities and obligations of the partnership.
(D)Not subject to Texas Franchise Tax
II.D. LIMITED PARTNERSHIP