Beyond Flying Solo: A Guide to Options in Structuring the Practice By Clifford Stromberg and Julie Mathews Schuetze of the Law Firm of Hogan & Hartson, Washington, D.C. Edited by Judy E. Hall, Ph.D., Originally published in June 1997

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A psychologist may notice little difference in his/her day-­to-day practice based on whether he/she practices as an employee or as an independent contractors and employees relate to taxes, benefits and malpractice liability. With respect to taxes, the entity engaging the psychologist as an employee is responsible for withholding social security, income, and unemployment taxes for the employee, while an independent contractor psychologist has the sole responsibility for ensuring that these taxes are paid. Employers usually do, and sometimes are obligated, to provide fringe benefits (such as health insurance) to employees but not to independent con­tractors.

Potential malpractice liability also is affected by the employee/independent contractor distinction. A person ordinarily is responsible for the negligent acts of his/her employees, but not for those of independent contractors. But recently, this distinction has become less important as plaintiffs have sued health care entities for negligent selection of practitioners, negligent supervision, negligent record keeping, or negligent management which apply to all practitioners they utilize.

Practicing psychology as an employee versus an independent contractor also could have ramifications with respect to federal and state anti-kickback and self-referral2 laws. Generally, unless an exception or "safe harbor," applies, these laws restrict the types of financial relationships (such as ownership interests and compensation arrangements) that certain health care providers may have with other providers if they are in a position to refer patients to, or order ancillary services from, each other. The laws usually contain broader exceptions or safe harbors for relationships among employees or members of the same legal group practice, than for those who are more loosely affiliated. Employment relationships or partnerships also allow for a greater range of permissible compensation arrangements, such as payment of incentive compensation based upon a percentage of revenues or profits.

The psychologist also should be aware of what type of corporation -- general business or professional -- seeks to engage the psychologist. Many states continue to adhere to the antiquated "corporate practice of medicine" doctrine. This doctrine prohibits a general business corporation from employing (and, in some states, engaging as independent con­tractors) physicians, or certain other licensed professionals, to provides services for the corporation. The doctrine is based on the rationale that a corporation can only act through its employees and agents, that a corporation cannot qualify to obtain a license to be a doctor or another licensed health professional, and, therefore, that a corporation acting through licensed employees or agents really is practicing without a license.

Psychologists may, however, practice their profession as employees of, or independent contractors to, a variety of health care entities (private practices, hospitals, nursing homes, HMOs). Most states carve out of the licensure laws employment for such entities, but sometimes only if they are non­profit.

Employment and independent contractor relationships may be coupled with the "ownership" relationships discussed below. For example, the professional corporation in which a psychologist is a stockholder also may (and probably will) employ the psychologist to provide services for the professional corporation.

IPA and PHO Affiliations. A combination of ownership and non-ownership affiliations with other psychologists also may be achieved through an independent practice association ("IPA") or physician-hospital organization ("PHO"). These alliances integrate a large number of practitioners (who may practice as sole proprietors or through one of the other forms of business organizations discussed below) to combine bar­gaining strength with third-party payors. Essentially, IPAs and PHOs provide a forum for payors to access a group of providers through one contracting agent, which has the authority to negotiate (and sometimes bind) its member practitioners.

With the importance today of managed care contracting, joining an IPA or PHO may be a useful step for psychologists who wish to remain autonomous in their own practice, but who need negotiating power with payors. Since the IPA/PHO affiliation is a contractual relationship, a psychologist retains relative flexibility to discontinue his/her affiliation.

Ownership of a Practice

Sole Proprietorships. A sole proprietorship is an unincorporate business and, as such, is the simplest form of conducting business. By definition, "sole proprietor" means that only one psychologist "owns" the business. Unlike the other structures discussed below, very few "formal" steps are required to begin conducting (or terminating) business as a sole proprietor or begin seeing patients. The psychologist need not file any organizational documents (such as articles of incorporation) with the state before he or she can conduct business. However, the psychologist should inquire whether there are specific business permits or licenses that the state, county, or city may require for any type of profession or business operating in that area. Additionally, if a psychologist desires to conduct his or her practice under a name other than his or her own name, some states require that the psychologist register to use a "fictitious" or "trade" name.

A principal characteristic of sole proprietorships is that the revenues from the psychologist's practice are treated as personal income to the psychologist and are taxed at the psychologist's individual income tax rate. However, the psychologist's income will not be subject to "double taxation", as is income to some corporations (see below). How­ever, some of the tax savings may be lost due to the psychologist's self-employment tax liability.

Not only do sole proprietorships offer psychologists tax benefits and simplicity of form, but they also preserve full management authority and control over the practice's operations. As a sole proprietor, the psychologist answers only to himself/herself, and does not need to obtain the agreement of other psychologists concerning practice operations.

Despite these benefits, sole proprietorships carry a substantial risk -- virtually unlimited personal liability of the sole proprietor for the obligations of the sole proprietorship. Because there is no separate legal entity distinct from the sole proprietor-owner, the assets of the sole proprietorship are treated as the owner's assets. Thus, aside from insurance coverage, the sole proprietor is personally liable for obligations of the sole proprietorship and stands to lose his/her investment in the sole proprietorship, as well as personal assets (e.g., house, automobile, savings) to satisfy liabilities and obligations (e.g., debts) incurred by the practice.

Sole proprietors may limit this personal liability some­what by purchasing malpractice, general liability, and other forms of business insurance. Nevertheless, there is always the risk that a claim will exceed coverage limits or will be excluded from coverage altogether because of any of the many exclusions in the policy. Thus, a sole proprietor cannot be certain that insurance will fully protect him or her from claims against personal assets.

Terminating business as a sole proprietor also is an easy process that does not require state filings or approval: the sole proprietor just decides to stop conducting business. Of course, the sole proprietor would be responsible for all unpaid bills and other practice obligations, and for winding up the clinical obligations of the practice in an ethical and responsible manner. Alternatively, the sole proprietor psychologist could decide to sell the practice assets to another psychology practice. continued

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