LLCs, Sole Props, Professional Corporations... 🤯
If you’re a therapist in private practice, and considering establishing a business entity, like an LLC, then this post is for you. We are going to discuss all the ins and outs of business entities for therapists.
I love reading... 😍📚
And yet, I think this video 📹 will be a whole lot easier to understand. 👇
Download the slide deck here.
Why this video doesn't cover S-Corporations
You might be surprised that this video doesn't cover S-Corps. Why? Because an S-Corp is NOT a business entity. Rather, it's a special (and complicated) tax election which LLC's and Corporations can opt into. This video will help you decide if an LLC or Corporation is right for you. A future post will cover the S-Corp election in detail. And that detail is important to understand and think through. I see more people regret having made the S-Corp election too soon rather than regret not having made the election earlier.
Did you miss the video? It's right there 👆
But first an important disclaimer...
Before beginning, one very important note. I am not an attorney. Only properly licensed attorneys are authorized to provide you legal advice. What we’ll cover today are general concepts that will help you better decide whether you’d like to further investigate establishing a business entity. If you need advice for your particular situation, reach out to a qualified corporate attorney in your area.
Why even consider a business entity?
Let’s take a moment to discuss why you would even consider a business entity in the first place.
The first reason is arguably the most important: certain business entities create a legal shield for your personal assets. A classic example is if someone visiting your place of business slips and falls and ultimately you are sued as a result. If your business is conducted through a business entity offering limited liability, the business entity itself is the defendant in the lawsuit. That means only the assets owned by the business entity itself can be used to fund any damages ultimately assessed. In contrast, if you conduct business absent a business entity, you would be personally named as a defendant in the lawsuit. That means if you’re found liable, you could be forced to sell many of your personal assets, such as your house, investments or vehicles.
Income Tax Management
The second reason you might consider a business entity is to offer you some additional options for managing income tax. I’m going to defer a detailed discussion of business entity taxation for a subsequent video, but for now just remember that certain business entities can offer you some flexibility around taxes BUT there is no automatic tax benefit you get as a result of establishing a business entity. Said another way, if you choose not to create a formal business entity, that does NOT mean you're making some big tax mistake and overpaying your taxes.
House Intellectual Property & Brand
A third reason to consider a business entity is that it provides a place to house a unique brand name and assets, such as intellectual property that you develop. Absent a business entity, you operate your business under your own legal name. In contrast, you can name a business entity pretty much anything you feel like. Further, if you choose to sell this branding & intellectual property to a third party at some point in the future, having a business entity to sell might make that transaction easier to complete. There certainly is some validity to this idea, but if branding is your primary concern, completing a Doing Business As (DBA) filing might be an easier option for you to consider. Similarly, housing assets for sale in a business entity is also not required - you can just sell the assets directly - or you could transfer assets into a business entity at some point in the future. That type of transfer would likely require you to use an attorney, but if you’re working on selling your business, you would likely be working with an attorney already anyway.
The bottom line is that providing a place to house assets and a brand name is certainly an advantage of forming a business entity, but if it’s the only advantage that matters to you, it might not justify the work required to form that business entity. If you’re unsure about this, I’d suggest you check in with a local attorney.
What IS a business entity?
Now that we know some of the reasons you might want to form a business entity, let’s discuss what the heck a business entity is, anyway.
As we hinted at on the previous slide, it’s a legal structure you create that owns all the assets of the business and through which you conduct your business activities.
When you form certain business entities, you are in effect creating a distinct legal person. What the heck does that mean.
Well, let’s think about the opposite situation for a moment: if you don’t create a business entity, that means that from a legal point of view there is no distinction between the business and you. You personally are entering into a rental lease, you personally are collecting revenue from clients - all the activities and money are all mixed together with the activities and money of your personal life - there simply is no distinction between the two areas.
In contract, certain business entities create a distinct legal entity, which you can think of as a distinct person in a sense. In this case, as an example - you aren’t personally entering into a rental lease, the business is. If that lease isn’t paid for some reason, the business entity is responsible for the unpaid rent, not you personally.
To continue the rental lease example, when your business entity entered into that lease, you were probably the one who signed the lease agreement. And when you signed that document, you weren’t signing as you the individual. Instead, you were signing the lease as an authorized representative of the business entity. This is an important distinction to keep in mind, you're not signing the document and putting yourself personally on the hook for paying the rent. You’re signing as a representative of your business.
Business entities never protect you from professional liability.
This next point is a really important one. A business entity creates a liability shield for many purposes BUT business entities will never shield you from professional liability. What professional liability means is the actions you take as a licensed professional in your state. So any malpractice claims that might be made against you, the business entity never creates a legal shield for you personally. This situation applies to any licensed professional, including therapists, doctors and attorneys. So it’s super critical that you keep your malpractice insurance up to date, regardless of what business entity you use.
Business Entities are Created under State Law
One final note is that all business entities are created under state law. So that means that there are different rules, regulations and fees in each state and the District of Columbia. So 51 different sets of rules. Yes, this is a headache and makes things even more confusing! AND if you complete an interstate move, be sure to think through the impact that has on your business entity of choice. If you move from California to Oregon for instance, your business entity does not automatically change from a California entity to an Oregon entity. You will have to complete certain filings, or even create a new entity to ensure it remains valid and of benefit to you. An interstate move is another situation where it makes a lot of sense to talk to a good corporate attorney.
Business Entities: Four Primary Options
There are four primary flavors of business entities to consider, so let’s discuss each one in turn.
Option One: Sole Prop
The first option is the Sole Proprietorship. To call this a business entity is a bit misleading, since it really isn’t a separate business entity at all. A sole proprietorship, which you’ll also hear called a sole prop, is how your business is automatically classified if you create no formal business entity at all. So if you just start doing business one day, you are automatically a sole prop. And as we’ve mentioned earlier, that means all of your business and personal assets and activities are intermingled. Any liability that results from the operations of your business is your personal liability.
Option Two: Partnership
The second option is a Partnership. A partnership is analogous to a sole prop, in that if more than one person enters into business together, a partnership is automatically created. No formal action to create a business entity is required, it just - almost magically - comes into existence.
What’s a bit different with a partnership, however, is that you can create formal legal agreements between the partners that stipulate how the partnership is run and governed. These types of agreements are, in fact, a really good idea. Similar to a sole prop, in a partnership, there is no legal liability barrier between you and the business entity: you are personally liable for everything the business does. A further wrinkle of the partnership, however is that you are fully personally liable for not only your actions, but also those of your partners. This is a big disadvantage of the partnership business entity structure.
To address this limitation, many states offer what’s known a Limited Liability Partnership. This is abbreviated as an LLP. The critical thing to keep in mind with an LLP, though is that it only shields you from personal liability for the actions of your partners. You remain fully personally liable for any actions you take yourself - so it’s just like a sole prop in that regard. Taxation of partnerships is also particularly hairy, so be sure and work closely with a qualified tax professional if you’re operating as a partnership.
Looking for more great resources to help you navigate your financial life? Check out my free Guide to Financial Planning for Therapists. Click here to access!
Option Three: Limited Liability Company (LLC)
The third business entity option is the Limited Liability Company, or LLC. This is the one that you’ve probably heard the most about. An LLC - unlike a sole prop or partnership - is a fully distinct legal entity which may shield your from personal liability. To create an LLC you’ll have to draft legal documents and complete the filings required by your state. You’ll also have to pay annual filing fees, and in some states there are fairly low income taxes that are assessed on the LLC itself. An LLC is the simplest business entity to form that offers limited liability, which is why it’s so popular.
Option Four: Corporation
Moving on to the fourth and final option for business entity is the Corporation. Similar to the LLC, this is a distinct legal entity, providing a shield from personal liability. Also like the LLC, it requires the drafting of formal legal documents, and completing state filing requirements. Annual filings and filing fees are also required for the corporation entity. Although in many ways similar to an LLC, Corporations are higher maintenance. They require greater corporate formalities, including creating a board of directors, and that board must hold regular meetings and those meetings must be documented in formal minutes. This requirement applies even if you are the only member of the board for your corporation. One last point on corporations, unlike LLCs, the default tax treatment is that they owe their own income tax. Under current tax law, corporations will pay a flat 21% income tax at the federal level, and often will pay additional state income tax. In addition, you as a shareholder will also pay income tax on any profit distributions from the corporation to you - these distributions are called dividends. This unfortunate tax characteristic is known as double taxation. This doesn’t mean that corporations are always a bad tax choice, but it is something you’ll want to carefully consider.
But wait... do you need a Professional Business Entity?
Ok, so those are the four flavors of business entities, but that isn’t quite complicated enough, so we need to throw in an additional wrinkle. If you are practicing therapy through your business entity, as you know, that is an activity regulated and licensed by your state government. And many states require that licensed professionals conduct business only through certain types of business entities. These are called, fittingly enough, “professional” entities. So, check and see if your state requires you to use not just an LLC but rather a Professional LLC - which you may see abbreviated as PLLC.
In some states, LLC's aren't allowed for professionals at all!
Not every state allows professionals to use LLCs at all - and California is one of them. In California, if you want to form a separate business entity for your private practice, the only option is a Professional Corporation. You could still operate through a sole prop or partnership, but if you want a business entity that offers liability protection you’ll need to form a Professional Corporation, sometimes abbreviated as a PC.
You’ll need to check with your secretary of state’s office to see if your state requires you to use a designated professional entity. You’ll also want to look into naming requirements and business activity restrictions. Many states require that certain language be included in the business name, such as “licensed marriage and family therapist” or something of that nature. Often, professional entities also have restrictions on the types of activities in which they can engage. That may take the form of stipulating that a certain percentage of the business entity’s activities must relate to the licensed activity. For example, if a substantial portion of your business revenue comes from, say, coaching rather than licensed therapy, you may need to house the coaching in a separate business entity. I know… all of this can be a real bummer.
And if you discover your state requires a professional business entity and you’ve been using a non-professional business entity, don’t panic. You can change this, and it usually won’t be that big of a deal, but you do want to get that corrected. This situation would again be an excellent time to work with a qualified corporate attorney in your state. Your secretary of state’s office should also be able to help you navigate correcting your business entity.
Maintain the health of your business entity to stay protected.
We’ve talked a lot about how LLCs and Corporations offer you liability protection. But there are a number of things that you need to do to make sure that liability shield remains in place. There are situations where if you don’t follow good corporate housekeeping procedures, a court may disregard the business entity and hold you personally liable. This is a situation known as “piercing the corporate veil.” We do not want this to happen.
So what do you need to do to make sure your corporate veil isn’t pierced?
Separate Business & Personal Financial Accounts are Critical
First and foremost, your LLC or corporation must have its own bank and financial accounts. This is absolutely 100% critical. Similarly, please don’t intermingle personal and professional purchases. If it’s a personal expense, always use your personal credit or debit card. If it’s for your business, use a corporate credit card or debit card linked to your business checking account. It’s fine on occasion to use your personal bank accounts to purchase something for your business, and then your business can reimburse you. But the opposite is not ok: NEVER use business accounts to purchase something for your personal life. Following this rule will not only protect you from liability, it will also make your bookkeeping so, so much easier.
Frequently communicate that you're organized as an LLC or Corporation
Another really important element is to use the business entity name on all client agreements and contracts. It’s important to make clear to those who do business with you that they are working with your business, not you as an individual.
A related point is to use the LLC or Corporation descriptor when referring to the business entity. You want to make it clear to everyone they are doing business with a business entity which has limited liability. So put the LLC or Corporation descriptor everywhere you can - in marketing collateral, email signatures, etc.
Follow good corporate housekeeping procedures
You’ll also need to perform all requisite corporate housekeeping. These include annual state filings and for corporations holding board of directors meetings and keeping minutes of those meetings.
Maintain adequate insurance coverage
Finally, you should also carry the appropriate amount of liability insurance for your business. The idea here is that you should still be able to compensate others for any actions for which you’re found liable. The courts don’t look kindly on simply hiding reckless behavior behind a corporate shield. Carrying appropriate insurance coverage is one important way to illustrate that you’re being a prudent business owner and not a reckless one.
Dave, what about S-Corps?!
Alright, so some of you may be thinking, “Dave, this is great, but you haven’t mentioned an S-Corp at all! I hear an S-Corp is the way to go, why are you leaving it out?!” Well, I’ve left S-Corps out of this conversation because they are not, in fact, a business entity. What do I mean by that?
Before I answer the S-Corp question, let me explain the reasoning. And that reason is that the legal aspects of your business entity and tax aspects of your business entity are two entirely separate concepts. Your business entity is a legal entity, and legal entities are primarily about liability. The tax treatment of your business entity is a separate matter. I know, this is confusing, but when thinking about your business entity, you want to always first ask yourself, am I navigating a tax matter or legal matter. And then go and find out what applies to your situation. For better or worse, different types of business entities can receive the exact same tax treatment. And, confusingly, one type of business entity can receive different tax treatment depending on the circumstances.
LLCs and Corporations can both make the S-Corp Election... but an S-Corp isn't actually a type of business entity.
Returning to the idea of an S-Corp, that is a tax treatment which certain business entities can elect - or choose - to receive. Specifically, both LLCs and Corporations can elect to be taxed as an S-Corp. And there are some real tax benefits to the S-Corp election, but it is a complicated matter. But don’t fret, we will discuss the wonderful world of S-Corps in the near future.
For now, just remember that if you are interested in the S-Corp election, you’ll need an LLC or Corporation business entity. And be sure and subscribe to my newsletter so you don’t miss my upcoming video on the tax benefits of an S-Corp.
Is a business entity worth it?
The real question is, of course, is a business entity worth it? And like most things, the answer is it really depends.
Setting aside the tax benefits of an S-Corp election for now, it really comes down to a question of liability. And again, remember no business entity will protect you from professional, malpractice liability. So the question then becomes what type of liability is your business likely to expose you to, and what degree of personal assets do you want to protect? If your practice is 100% telehealth, then obviously no one is going to trip and fall in your office, so you have less liability there. If you own a group practice, there are a lot more people and moving parts that might give rise to liability. And if you don’t have many personal assets to protect - perhaps you’ve recently graduated and have a mountain of student loan debt - you might have less reason to worry about a liability shield. But you do want to be careful here, because in certain circumstances liability damages can be collected against your future earnings. That possibility isn’t universal, and once again highlights the value of discussing liability concerns with a licensed attorney.
That's a Wrap 🎬
Alright, I hope you found this post helpful! This was a LOT of information. So, let me know if that avalanche of information was helpful! What made sense, and what points are still confusing? What else would you like to hear about that would be helpful? Give me a shout and lemme know!
And if this all feels a bit much, give me a shout. I work one-on-one with therapists from all over the country helping them address issues just like the ones we talked about today! There are a bunch of different ways to work with me which I describe on my services page.
Turning Point is a registered investment advisor in the state of California. Please visit turningpointhq.com for important information and additional disclosures. This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes financial, legal or tax advice; a recommendation for purchase or sale of any security; or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Read the full Disclaimer here.