A Dentist’s Guide to the Law. American Dental Association
types of insurance such as general liability coverage should be considered in these litigious times. However, insurance can be expensive, deductibles and co-pays apply, and potential sources of liability keep expanding. As a dentist starts to accumulate more personal assets outside the practice and the practice itself grows, liability issues become more important and may lead the dentist to conclude that he or she has outgrown the sole proprietorship format. Some other factors that influence the business format decision will be discussed in the subsequent sections.
15. What Are the Pros And Cons of a General Partnership?
A partnership is a business arrangement where two or more dentists own the practice together — for example, if two or more dentists wish to operate a practice together. These dentists should understand the economies of scale achievable by working together and agree upon an arrangement to share costs and profits. The dentists may consider establishing a general partnership, under which the partners share decision-making as well as financial risk. Similar to sole proprietorships, general partnerships retain full, shared liability among the owners. Partners are not only liable for their own actions, but also for the business debts and decisions made by other partners. In addition, the personal assets of all partners can be used to satisfy the partnership’s debt.
Another risk is that the vision and enthusiasm that the partners had when they started the practice can sometimes wane. As in a marriage, disagreements or disgruntlement can arise which can cause an unfortunate split of the practice. For that reason, it is very important that a group practice have a formal written agreement setting forth the parties’ understanding of the relationship — profits, expenses, decisions, what happens upon termination, and so forth. The agreement should be drafted by an attorney, and should reflect the parties’ expectations and understanding of the partnership.
Although the partnership will need to file a separate informational tax return, the partnership does not generally itself pay tax but, rather, income and losses are allocated among the partners based on their agreed percentage, and the partners pay taxes as part of their own personal returns. There is no additional partnership tax (with limited exceptions at the state level in a few jurisdictions).
Next to sole proprietorships, general partnerships are the simplest legal format, requiring less administrative detail and fewer associated costs than the formats to be discussed below. But in a general partnership, liability and decision-making must be shared.
Keep in mind that you must tailor any partnership agreement to meet your needs and to satisfy state law requirements. Your counsel can draft an agreement and help determine what is right for you.
Related References and Resources
• Appendix 1: Checklist of Questions to Ask When Forming a Group Practice
16. Does a Limited Partnership Have Advantages Over a General Partnership?
It depends. A limited partnership differs from a general partnership in that it has two separate classes of membership: a general partner or partners, and limited partners. The general partners hold the management and decision-making authority for the practice. They also are individually charged with liability that might exceed the assets of the practice. The limited partners, on the other hand, do not have decision-making responsibilities, nor are they individually liable for liabilities of the practice (other than their own malpractice) that exceed their own investment in the business. In that sense, limited partners are much like individual stockholders in a public corporation. They have no real say in how the business is operated, but the most they can lose is the money they invested in their limited partnership interest.
At the same time, a limited partnership is similar to a general partnership in many ways. Partners associate together to share profits and expenses, and will have an extensive written agreement setting out the legal and financial elements of operating the practice, dealing with any termination of the business, admitting new partners, and so forth. The limited partnership files an informational tax return but taxes are paid by the individual dentist members, not the partnership itself.
A limited partnership requires more attention to detail and more filings than a general partnership. It can be formed only by making a statutory filing with the Secretary of State or similar governing office in the state of organization. A partnership agreement is essential for that filing and is more elaborate than a general partnership agreement. Annual filings with the state authority also are necessary, as well as federal and state income tax returns.
A limited partnership does have one important advantage over a general partnership, in addition to the fact that limited partners face a finite amount of risk on liabilities of the practice. Although the precise opportunities and limitations are well beyond the scope of this section, generally speaking, a limited partnership can slice and dice profits, losses, tax credits, required investments, and capital gain/loss in any way (proportionate or disproportionate) that the parties choose. To take some simple examples, a limited partner who has more assets to invest in the practice than the others might receive all the profits until that dentist has “recouped” his or her investment, and thereafter profits might be divided according to set percentages. A partner who has substantial other income — such as from a spouse — might negotiate to be allocated more of the anticipated early year losses from the practice. A partner who has substantial net operating loss carryovers from a prior business might want to be allocated more of the taxable income (but not cash flow).
Because of these tax advantages, limited partnerships are attractive formats for specific, one-time investment opportunities. One such example would be a real estate purchase, where certain investors are willing to invest money for profit but have no expertise or interest in managing the property, much less any desire to take on liability risk. The format is much less attractive for an operating business like a dental practice because a dentist who invests money in the practice will usually want to have a vote in how it is run. The new dentist who is associating with an established practice usually has little money to invest and is often taken on as an associate until such time as sufficient mutual trust is developed to allow that dentist to become a “full partner” and participant. At a point in a practice’s evolution when employees are being hired, income is increasing, perhaps a lengthy lease is contemplated, and substantial equipment purchases are being made, a corporation or limited liability company as the legal format may become increasingly attractive.
17. What Is There About a Corporation That Would Make Me Want To Incorporate My Practice?
At least theoretically, incorporation is a way to reduce certain legal exposures. A corporation offers the owners of the practice (its shareholders) the ability to separate themselves legally from its operation. These shareholders invest the required start-up capital to get the business running, and the board of directors they elect, who in turn appoint the officers, who in turn are responsible for the day-to-day operations as well as important strategic decisions for this new legal entity, the corporation. As a practical matter, the shareholders, directors, and the officers will be by and large the same persons, at least in all but very large associations. Nonetheless, flexibility is possible with this arrangement. The new dentist who starts as an associate may “buy in” and become a shareholder after some years as a valuable contributor to the practice, but might not be quite ready to assume the same management responsibilities as the founding dentist. So perhaps the associate might become an officer, but not a director.
Because a corporation is a separate legal entity distinct from its shareholder(s), an important advantage of a corporation over the other formats discussed above is that all shareholders have limited liability. In other words, the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts the business incurs, except in the case of fraud or malfeasance. This limited liability can be comforting to a group of dentists entering a fifteen-year lease, or purchasing $1 million of new equipment. (Note, however, that a bank from which