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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The main benefit of the corporate form is limited personal liability of the corporation 's stockholders for claims against the corporation. Generally, corporate stockholders are not responsible for the corporation's obligations. If the corporation defaults on those obligations, only the corporation's assets -not the personal assets of the stockholders -would be used to satisfy claims against the corporation. In this case, stockholders stand to lose only the amount of their investment in the corporation (i.e., the amount that the stockholders paid in exchange for their stock); the stockholders' personal assets (house, car, savings account) are not at risk.

It is essential to be aware, however, that in most states a professional corporation's stockholders (as well as agents and employees) remain personally liable (to the extent not covered by malpractice insurance) for their own negligent or wrongful acts or misconduct, as well as for the malpractice of other employees or supervisees whom the psychologist personally supervises. In this way, stockholders' personal liability is only partially limited. As a matter of public policy, states thought it imprudent to permit professionals to rely upon the corporate form to protect themselves from negligence claims but not if their own conduct gave rise to the claim. However, the corporate form does protect them from liability for the conduct of the corporation's other professional stockholders and employees.

It is also important to obtaining this protection of the corporate form to advise the public (i.e., patients) that the psychologist is practicing his/her profession through a professional corporation. Psychologists should be careful to use the full "official" corporate name of the professional corporation. For instance, advertisements and stationery should refer to "Jane Smith, Ph.D. & John Doe, Ph.D., P.A." rather than only "Jane Smith, Ph.D." As a related matter, some states require that professional corporations obtain approval from a professional licensing board prior to operating under any name (i.e., a fictitious or trade name) not containing the surname of one or more of the corporation's stockholders.  Psychologists operating under the name "Psychology Associates of Centreville" thus would need to seek state approval. Often, the state still requires that a professional corporation's fictitious/trade name contain designation as to professional corporation status such as "P.A." or "P.C." (e.g., "Psychology Associates of Centreville, P.C.").

As noted above, operating your psychology practice as a professional corporation also results in the "double taxation" problem that is characteristic of corporations. When the professional corporation earns revenue through the psychologists' treatment of patients, the corporation is taxed on that revenue (at a corporate income tax rate which could be higher than personal income tax rates). Also, when the professional corporation distributes the professional corporation's revenue to its stockholders as dividends, the stockholders again are taxed on the revenue (this time at the stockholders' personal income tax rate).

However, practices also may enjoy the corporate form's benefits by electing "S corporation" status under the Internal Revenue Code. Tax differences distinguish between S corporations, which are pass-through tax entities like partnerships, and "C corporations," which are subject to the double tax dilemma. The Internal Revenue Code places certain restrictions on S corporations -- for example, S corporations may have no more than 35 stockholders and may have only one class of stock (although this stock may have different voting rights) -- but allows S corporation revenues to be taxed at the personal income tax rate of the corporation's stockholders. Organizing an S corporation requires the same steps as forming a C corporation, with one additional filing with the Internal Revenue Service to opt for ("elect") S corporation status.

Other benefits of a corporate form are that the corporation does not need to be reformed (and have documents prepared) every time a shareholder leaves or joins-which is required in a partnership. Another advantage is the ease of transferring a stockholder's interest in a professional corporation. Once formed by filing articles of incorporation with the state, corporations exist in perpetuity until dissolved by filing articles of dissolution with the state. Thus, a psychology practice organized as a professional corporation may endure even if the psychologist who originally founded the practice has retired or moved to another geographic area.

A professional corporation's longevity also results from the ease with which ownership in the corporation may be transferred to a new owner. Transferring a psychologist's ownership interest in a professional corporation is accomplished simply by transferring stock. Of course, the stock­holder who desires to transfer his or her stock needs to satisfy any requirements in a stockholders agreement or under state law, such as transferring the stock only to another licensed psychologist.

Limited Liability Companies/Partnerships. Limited liability companies and professional limited liability companies (collectively, "LLCs") are hybrid legal entities that possess characteristics of both partnerships and corporations. Close cousins to LLCs are limited liability partnerships and professional limited liability partnerships (collectively "LLPs").3 In recent years, these types of business organizations have offered health care professionals, including psychologists, new ways to organize their practice that present greater flexibility than professional corporations.

The LLC provides a vehicle for psychologists to take advantage of the best features of both corporations and partnerships. An LLC's owners -- called its members -- like a professional corporation's stockholders, have limited personal liability for the LLC's debts and other liabilities, provided that the members operate the LLC as required. As with professional corporations, members are responsible (to the extent not covered by insurance) for their own malpractice and the malpractice of those professionals under their personal supervision. Moreover, management of an LLC is more flexible than management of a professional corporation: an LLC may be managed by its members or a board of managers similar to a board of directors. This permits hired professionals business managers or financial people to be in board positions if desired.

For tax purposes, an LLC may elect to be treated as a partnership, so that the LLC's members may benefit from pass-through tax treatment and avoid the double taxation of corporations. With respect to federal taxation, the Internal Revenue Service recently adopted the position that any LLC that elects partnership tax treatment will be taxed as a partnership. The new federal tax rules also provide that LLCs with two or more members automatically will be taxed as partner­ships, unless the majority request to be taxed as corporation. Previously, the Internal Revenue Service treated an LLC as a corporation for tax purposes, regardless of whether the LLC wanted to be taxed as a partnership, if it possessed three or more of the following four "corporate" attributes, (1) continuity of life; (2) centralization of management; (3) limited Liability of the members; and (4) free transferability of owner­ship interests. Often, LLCs simply would include provisions in their organizational documents to limit the LLC's existence to thirty years and to restrict the member's ability to transfer their membership interests to the LLC. Despite the change in federal law, some states still may follow the four factor test noted above; therefore, psychologists desiring to form LLCs should consult with an attorney or an accountant to determine the tax rules for LLCs followed by the state in which the LLC wishes to conduct business.

Forming an LLC is largely the same as forming a professional corporation; articles of organization (as opposed to articles of incorporation) must be filed with and approved by the state. Instead of bylaws, an LLC's members enter into an operating agreement, which is a private contract similar to a partnership agreement. Like state partnership laws, state LLC laws set forth the rules that will govern the LLC's operations unless there is an agreement to the contrary. It is recommended that psychologists forming an LLC enter into a detailed operating agreement to delineate each member's rights and responsibilities.

Organizing a psychology practice as an LLC may avoid the limitation in most states that all members of a professional corporation must belong to a single profession. For example, in Maryland, orthopaedic physicians and physical therapists are forming LLCs comprised of members of both professions; Maryland law prohibits two types of professionals from owning stock in a professional corporation, but permits it for LLC ownership. continued

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