Entity Selection: Key Concepts for Protecting your Hard-Earned Assets
From limited liability to corporation and everything in between, learn what will be right for you.
By Grant Engrav
Focusing on operations and marketing is natural in the early days of business formation, but don’t ignore the issues of asset protection.
This is easy to do as you likely have more debt than assets initially. You want to avoid embodying the 2021 version of the myth of Sisyphus, that unfortunate Greek whose punishment by the gods was to perpetually roll a boulder up a hill, only to have it tumble back down upon reaching the summit. Don’t let that be the financial story of your hard work. Review these basic concepts, and work with an attorney who knows your state laws to ensure that the boulder you’ve been rolling since physical therapy school stays with you in retirement.
My law practice focuses on working with physical therapy clients in Oregon and Washington, and this article is a high-level overview of important notes you should consider when picking the right entity for you—it is not legal advice. Every state has different laws, and a local lawyer should be consulted.
WHAT IS LIMITED LIABILITY?
When we talk about limited liability, we are talking about a business owner’s ability to create two separate buckets for the assets the business owner controls. The first bucket holds the assets of the business. The second bucket holds the business owner’s personal assets, for example a house, vehicle, or bank account.
In the worst-case scenario, a catastrophic accident occurs at the business during a gap in insurance resulting in millions of dollars of damages. And the plaintiff (person filing the lawsuit) is awarded damages by the jury of $5,000,000. But all the assets of the business are worth only $1,000,000. In a properly-formed company, where the business owner has correctly set up and managed the company (the “corporate formalities”), the plaintiff will not be able to go after the business owner’s personal assets for the $4,000,000 difference. In other words, the house, vehicles, and other assets in your personal bucket are not being exposed to the everyday risks of running a business.
HOW TO MAINTAIN (OR LOSE) LIMITED LIABILITY
One thing that often is surprising to new clients of mine is that limited liability protection can be lost. This can happen in a couple of different ways. The case Walkovszky v. Carlton is a classic example of this. In this case, Mr. Carlton was the owner of a cab company in New York City in the 1960s. Mr. Carlton had the bright idea to form a different company for each and every vehicle in his company, and when his drivers would negligently hit a pedestrian, he would claim that that particular company had no money and nominal insurance. As each “company” only consisted of the vehicle, his idea was to limit his exposure to lawsuits so that the plaintiff could only collect the value of the car. However, Mr. Carlton did not think of everything. Because he was using the same bank account for all of his companies—a violation of “corporate formalities”—the court didn’t let Mr. Carlton get away with his plan and allowed the plaintiff to “pierce the veil,” which is a very cool legal term that essentially means the plaintiff can go after the owners’ personal assets.
To respect the corporate formalities, business owners should ensure that they are not intermingling their business’s capital and assets with their own. The business owner in the Walkovsky case was using the same bank account for all of his companies. Other proactive steps include signing all agreements in the name of the business, not your own name, and generally ensuring that you are treating your business like a real, and distinct business, and not a fraudulent attempt to evade liability for personal conduct.
THE BIG 4.5: WHICH ENTITY BEST FITS YOUR NEEDS?
A corporation is what we all think of when we think about companies. Many of the iconic companies we can think of end with “Inc.,” signifying their status as a corporation. Corporations generally have limited liability. They are often subject to taxation at the corporate, as well as the individual level (resulting in two layers of taxation), and they generally require significant administrative work because of requirements to keep minutes and to execute certain filings required by the Secretary of State. If you are taking on significant investor money and plan on issuing lots of shares to lots of investors, a corporation may be a good fit; otherwise, as a general rule of thumb for the physical therapist private practice owners, keep reading.
Limited Liability Partnership
Partnerships can result even when you weren’t trying to form one. If you, PT Pamela, shared some funds and started working at the same physical location as PT Pete, you might accidentally have formed a partnership. To make your partnership one of limited liability (an “LLP”), you will generally need to register with your state’s secretary of state. Although LLPs are easy to form, are mostly light on the administrative upkeep, and offer pass-through taxation, these entities are generally disfavored because of some nuances in limited liability law, and because of the prevalence of limited liability companies and case law that provides business owners with greater clarity of their rights.
Limited Liability Company
In my home state of Oregon, the way I approach entity selection conversations is to ask why the client shouldn’t form an LLC, not why they should form one. As a general, national rule, this entity is easy to form (the Oregon Secretary of State requires only an annual $100 payment, and the formation process is so easy that I form one live every year in front of students from a local university). An LLC offers limited liability and pass-through taxation as well. Every client has unique plans and business models, but in my experience, an LLC is the best entity type for most physical therapy private practice owners. But this is good to review with an attorney in your state(s).
Some states, such as Washington State, require anyone practicing medicine through a corporation to practice through an entity indicating its professional services status (typically a PPLC or a PC). Other states like Oregon, require at least a majority of the owners of the entity to be licensed under their respective license type. This general requirement is referred to as the Corporate Practice of Medicine. If a company is practicing medicine (every state I have seen considers physical therapy a legal subset of the practice of medicine) you should carefully review these rules and consult an attorney to determine if your state requires a professional entity registration.
The reason this section is titled the big 4.5, and not the big 5, is because an S-corporation, despite a lot of false information online and near the open bar at physical therapy conventions, is simply a tax election. In other words, you can form an LLC or a Corporation and then by filing IRS form 2553, you can elect to have your entity taxed as an S-Corp. You should speak to a CPA about whether an “S-election” makes sense for your company, as the answer depends on current tax law and your revenue and expected profit. You should know that an S-Corporation cannot have more than 75 owners, and due to an odd, old rule, cannot have foreign owners.
Each of the entities mentioned here is subject to different tax consequences and advantages. Just as a patient is wise to review their insurance coverage when they are consulting their orthopedic surgeon and physical therapist on a pending operation, you are wise to consult your attorney and CPA when you are forming a physical therapy practice. It is common that differences in taxation advantages will help you decide which entity is best for you. You should make a practice of having this conversation with your CPA annually, given the ever-changing tax laws at a national and state level. Additional things to consider as you set up or review your chosen entity:
The rules of the company. Arguably more important than your entity selection is the document that provides the rules between you and your co-owners. An LLC has an operating agreement, a Corporation has bylaws and shareholders agreements, and a Partnership has a partnership agreement. Regardless of the entity and the title, this document is the constitution of your company. Whether you are forming your company now, or whether you are many years into practice, if you are not the only owner of your practice, I highly recommend you invest in a well thought out document that provides you with a clear understanding of your rights and obligations as an owner. To be direct, the clients who pay attorneys the most in litigation fees are the clients who never formed clear rules for their company at the outset.
Limited liability is important, but insurance is crucial. Work with your insurance representative to ensure you have a clear understanding of your general liability policy (for example, slips and falls) as well as your professional liability policy (malpractice). It is a great idea to discuss your policies with an attorney as well. Due to the uptick in patient-to-PT-Board complaints nationally, one trend I’ve been advising clients on is to make sure their professional liability policy includes “license defense” coverage. These policies typically have low premiums and will provide you with legal defense if you ever experience a board complaint.
How hard is it to change my entity? The short answer is not that hard. You will likely need to consider Medicare form 855A and third-party payor contracts, but if there is the potential for material benefit by changing your entity, you shouldn’t let administrative paperwork stand in your way.
Does your state have a liability shield for medical services you perform as a volunteer? Oregon, for example, has ORS 676.340, which permits certain license types to be free from liability for services performed without compensation.
Grant Engrav is a partner with Engrav Law Office LLP, in Portland, Orgon. He is the current Co-Executive Director of Oregon Physical Therapists in Independent Practice (OPTIP) and his practice focuses on small to mid-sized medical clinics. He can be reached at firstname.lastname@example.org and followed via LinkedIn at www.linkedin.com/in/grant-engrav-0b570b13.