What Legal Structures Work Best for My Medical Business?
Daniel McNeff, Business Owner and CEO at Legally Mine,
Les Sliger, Senior Advisor
J.L. Hillery, J.D.
When looking at legal structures for any business, the first question asked by most people is, “how will it make a difference for me?”
The right legal entities can accomplish two things for you and your business: first is asset protection and second is tax reduction. There is simply not enough space allotted for this article to be in-depth about individualized needs, but we will attempt to give you a broad overview of how these tools work, hoping this may open your eyes to the fact that there are attainable ways to start making your financial life much safer and more rewarding.
Asset Protection
If you would like to protect your assets from lawsuit losses there are two simple rules to remember.
Rule # 1. All lawsuits are about money! If there is no money to take in a lawsuit no lawsuit will be filed.
Rule # 2. Any Asset you own in your own name or in your spouse’s name will be vulnerable to a lawsuit and is often times an invitation to an aggressive trial attorney to sue you. This includes personal assets such as your home, savings, brokerage accounts, rental properties, vacation home, jewelry and other personal properties.
Even if you have created a corporation for your medical business, if you are the owner of all the stock, or even more than 10% of this stock, it will be considered a closely held corporation and you will be considered an officer of this corporation. As such, you can and will be held responsible for the actions of this corporation which leaves all of your personal assets vulnerable to a lawsuit. The use of an LLC can in fact, give your practice better asset protection, but it like any other asset protection entity, it will only protect your practice if a lawsuit is created outside the practice.
A few years ago a physician in California sent his secretary out to pick up sandwiches for his office staff. She hit another car and killed a couple of people in an accident. Since she was on an errand for the practice, a wrongful death lawsuit was filed naming both the practice and the physician. The 30 million dollar jury award took everything the practice owned and also everything the physician owned as well. The physician was set up as an LLC being taxed as a C corporation, but since the practice caused the lawsuit and all of his personal assets were in his own name, he lost everything he had worked for over 30 years.
Any entity creating a lawsuit can be sued and everything owned inside of this entity will be vulnerable to the lawsuit. Although, there are certain entities available that afford better overall protection than others – and if used correctly can eliminate the threat of a lawsuit. The only way to truly protect your personal assets is to make sure that they are in asset protective entities and to make sure that you have a strategy in place together with those entities.
A Brief Example of How This Works
In the early 1960’s, Family Limited Partnerships (FLP) began to be used successfully as asset protection entities. Since limited partners could not be held liable for losses in a lawsuit, the idea was to create an FLP with a “C” Corporation as the general partner, owning just 1%, and individuals owning 99% as limited partners. If a company were sued, the asset owners could only lose the 1% owned through the “C” Corp. An attorney wanting to sue would have to determine if it was worth it to sue the defendant for only the 1% they owned. Most often it was not. Though tested many times in courts in the 60s, in 1974 the U.S. Supreme Court upheld the asset protection status of the FLP, and its use as an asset protection tool became much more popular.
In an attempt to capture some sort of compensation from the FLP’s, trial lawyers lobbied for, and passed, legislation in all 50 states that allowed lawyers to go after distributions, or profits, from the FLP that were due to the defendant. This law is called The Charging Order, and despite the fact that it was an attempt to obtain assets from a defendant, in the end, if the FLP is set-up properly, the charging order actually kills all hope of ever getting any money at all. To begin with, the Charging Order concedes that the assets held in the entity cannot be seized through a suit. However, it does entitle the plaintiff the defendant’s share of any income from the FLP when a distribution is made. If left alone, this made the FLP an ineffective tool for income-producing assets.
However, asset protection attorneys discovered that if set-up properly, the only person who could make a distribution would be the general partner. Since the general partner is more than likely also the defendant in the case, he or she would never distribute the funds in a way that would allow it to be handed over to the plaintiff.
The key to success here is having the entity set-up properly. Many attorneys in the U.S. use a very old FLP that was designed for estate planning, not asset protection. It distributes assets on a pro-rata basis. This actually allows a judge to order a distribution. The judge can also order the defendant’s share of the FLP to be given to the plaintiff until the judgment is satisfied. However, if set-up properly on a non-pro-rata basis, giving sole distribution rights to the general partner, the Charging Order can actually make it so the plaintiff will never get a dime. What’s more, the general partner can take out interest-free loans or take a salary for management of the FLP, neither of which would be considered distributions, and would not be subject to the lawsuit.
In 1977, the IRS made the picture much more difficult for trial attorneys with ruling # 77-137. It states that the plaintiff will have to pay any taxes on judgments pursued through the CO, even if they never receive a distribution. This stopped most attorneys from even thinking about pursuing a lawsuit against a properly drafted FLP.
If set-up properly, you can protect both income and non-income producing assets by placing them in FLP’s. This will leave no assets available for a plaintiff to take. Furthermore, if a party should pursue a lawsuit against you anyway, they will not only not get any assets or income, they will also have to pay taxes on the judgment despite the fact that they will never get any of the money.
In the 1980’s a new tool called the Limited Liability Company (LLC) was introduced in the state of Wyoming. It works as an asset protection tool because it, too, uses The Charging Order as the sole remedy for getting assets out of the LLC. The need to set the LLC up on a proper basis is just as important as it is with the FLP. The problem is that most LLC’s are set up with the wrong wording. It is believed that many of todays existing LLC’s offer no asset protection for income-producing assets because most have the distributions set up on a pro-rata basis.
Many medical practitioners and business owners have underestimated the importance of lawsuit prevention for their practices and as a result have lost everything they have spent years working for. As our financial times get more desperate, people are willing to take more desperate actions to survive. These actions may very well include the fabrication of a lawsuit that can ruin everything you have worked for.
If your attorney does not know the how and why of these legal details, then caution should be exercised before asking them to set up your structures for you. And you would be better off finding an attorney who does know these details in an out.
Many of the tools we use for lawsuit prevention can also be used for income tax reduction, which is nice since in most cases it will more than pay for the establishment of asset protection in your life.
Tax Reduction
In their landmark book, “The Millionaire Next Door”, authors Stanley and Danko clearly point out that financial independence is often achieved by those who seek ways of reducing their taxes. One often overlooked method of reducing your income taxes is by taking advantage of deductions made available through corporate resolutions.
One example is the medical benefits resolution which will allow you to deduct expenses related to health care. These tax-deductions for personal expenses are not available to you if you are taxed as a sole proprietor or even an LLC being taxed as a general partnership. Only the “C” or “S” Corp will give you complete access to all of these deductions. There are dozens of these corporate resolutions that will help you pay for regular expenses that would be paid for with after-tax dollars in any other situation.
Income shifting is another way to defray income taxes. This is done by using the FLP as a means of giving financial help to children or elderly parents with untaxed dollars. A child needing financial help through his or her college years could take income from the FLP and pay taxes on that income at their tax rate, making it so you will not pay taxes on the monies at all.
Again these are just a few of the many strategies and techniques available through your legal entities that can help you lower your income taxes. Others exist that can help you reduce your capital gains and estate taxes, too.
Conclusion
Very few people in medical professions enter their chosen fields because they wanted to become expert business men and women. As physicians you do what you do because you love helping people in their time of need and not because taking time to understand business law sounds like fun. But taking the time to understand the legal entities available to you is a worthwhile investment, and can improve your ability to serve your clients better by keeping your focus on serving them and not on protecting yourself against frivolous lawsuits. Also it can have a positive impact on your bottom line, which can then pass through to your clients in the form of lower prices and costs.
If you would like more information on these and other legal entity strategies, contact Legally Mine, LLC at 800-375-2453 or info@legallymineusa.com. We are also available for presentations at your local and state association meetings.
