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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Partnerships. Commencing business as a partnership is relatively straightforward, without formal requirements of filing documents or obtaining approval from the state. Partnerships differ from sole proprietorships, however, in that at least two "persons" (typically individuals, corporations, or other types of business organizations) must form the partner­ship. A partnership is commonly defined as "an association of two or more persons to carry on as co-owners of a business for profit." This means only that at least two professionals decide to practice together and intend to make a profit; it does not require that the partnership actually earn a profit right away. A partnership practice could operate at a loss, but that does not change the fact that the practice is legally organized as a partnership.

Even though forming a partnership does not require writ­ten documentation, it is highly recommended that the partners enter into a written partnership agreement, a private document that does not need to be filed with the state. It should describe each partner's rights and responsibilities. If there is no partnership agreement, a state's partnership laws define the partners' relationship. These laws set forth certain "default" rules that would decide (since there is no written agreement), how the partners will share profits, make decisions concerning the partnership's operations, and handle disputes, as well as what events cause termination of the partnership. But it is almost always wise to have a written partnership agreement so that the partners may tailor their specific relationship to suit their needs, as well as to guard against the impact of future unknown or undesirable changes in state partnership laws.

Partnerships are characterized either as general partnerships or as limited partnerships. All partnerships are subject to "pass-through" tax treatment meaning that unlike a corporation (which is a separate taxable legal entity), a partnership is not separately taxed. Therefore, all income or loss is passed through to the personal tax return of each partner. Another way to say this is that in a partnership, there is only one level of taxation -at the individual partner level. In a corporation, profits are taxed twice - first as corporate net income, and then again when the profits are distributed as dividends and received as personal income by the stockholders.

In general partnerships, each partner is a general partner and, as such, has unlimited liability for the obligations of the partnership. Often, one general partner is designated to manage the partnership and bind the partnership. But unless a partnership agreement provides otherwise, each general partner may bind the partnership, which can lead to operational problems (such as who can hire or fire staff, or sign contracts). Thus, the partners should discuss which partner will have responsibility for the different management aspects of the practice, and describe the division of management duties in the partnership agreement.

In limited partnerships, there are limited partners and at least one general partner. The general partner's) manage the partnership's business and have unlimited personal liability in the same manner as if they were general partners of a general­partnership. The limited partners are essentially investors whose liability is limited to the amount of their financial investment in the limited partnership. Limited partners forfeit their limited liability, however, if they participate in any significant way in the management of the practice. As a practical matter, limited partnerships are not feasible practice structures for professionals, because many state laws prohibit professionals from forming limited partnerships. (The theory behind this prohibition is that professionals should be responsible for their practice.) Furthermore, it is not practical to form a professional limited partnership because the limited partners cannot actively participate in the practice's management.

Typically, under state partnership laws, both general partnerships and limited partnerships dissolve automatically when a partner withdraws or dies. Partners may agree in the partnership agreement, however, that the partnership will continue despite such an event unless the remaining partners agree to dissolve the partnership. Similarly, partnership interests generally are not transferable to other people, and transfer (or attempted transfer) of a partnership interest dissolves the partnership.

Partnerships, like sole proprietorships, can sell their assets to another person or business organization. In some states, partnership laws provide that a sale of substantially all of the partnership's assets constitutes dissolution of the partnership.  As with most general rules governing partnerships, the partners can "contract around" this rule in the partnership agreement.

Corporations. The corporation, and for professionals such as psychologists, the professional corporation (some­times called a "professional association"), is the paradigm form of business organization. It offers psychologists many benefits that often outweigh its disadvantages.

A professional corporation, like a general corporation, is a legal entity that is distinct from the stockholders. To organize a professional corporation, the "organizers" must file articles of incorporation with the state and obtain the state's approval to conduct business. State law will indicate what information the articles need to include. It is important to stress that in order to maintain the legal status of the corporation and the insulation from liability it provides for the shareholders, a professional corporation must in fact perform corporate formalities, such as holding stockholder and board of directors meetings, adopting bylaws, and issuing shares of stock in exchange for something of value (i.e., "consideration"). If these requirements are ignored and it is operated simply from the "hip pocket" of the key shareholder, the corporate protection may be lost.

A professional corporation's stockholders, unlike stock­holders in a general corporation, may be only licensed professionals. In addition, with few exceptions (e.g., Maryland), the stockholders must be licensed to practice their profession in the state in which the professional corporation conducts business. Most professional corporation statutes, including those in New York and Florida, also require that all stockholders in a professional corporation practice within a single profession or be authorized to provide the same professional service. With the exception of a few states (e.g., CA), a psychologist and a physician may not both own stock in the same professional corporation. In an era of growing interdisciplinary practice, this restriction may seem antiquated, but it remains in the law. The theory underlying it is that if different professions subject to different licensing statutes were combined in one corporation, it would be unclear whether the corporation itself would be held responsible for fulfilling the duty of care applicable to doctors, or psychologists, or social workers, for example. Similarly, many states require that a professional corporation's directors and at least some of its officers be licensed in the same profession as the corporation's stockholders. However, a professional corporation still may employ, or engage as independent contractors, individuals who hold other professional licenses (e.g., nurses).

Articles of incorporation and bylaws define a professional corporation's governance structure and certain operational issues. These documents generally set forth when stockholder and director meetings will take place, notice, quorum and voting requirements for those meetings, and descriptions of the professional corporation's officers and their responsibilities.  Articles of incorporation are filed with the state and, thus, become public documents. Bylaws do not need to be filed with the state and tend to contain more specific details concerning how the professional corporation will operate.

In addition, stockholders in a professional corporation often enter into a stockholders agreement. A stockholders agreement, like bylaws, is a private document that need not be filed with the state. This agreement specifies restrictions concerning who may own stock (i.e., only a licensed psychologist), what happens when a stockholder dies or loses his/her license, and how a stockholder may transfer his/her ownership in the professional corporation. In many cases, stockholders agreements require all stockholders to consent to one stockholder's sale of his/her stock in the professional corporation (to prevent transfer to an unwelcome, new member). continued

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