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CHOOSING A PROFESSIONAL
LEGAL ENTITY FOR YOUR PRACTICE

PART II Dec 2000 - By Eden Rose Brown J.D. Attorney and Counsellor at Law

The superiority of the Limited Liability Company.

In last months column we reviewed the evolution of professional entities from the popularity of sole proprietorships in the 1970s to the Subchapter S and Subchapter C corporations in the 1990s. Now we enter the new millennium with a new type of legal entity: the Limited Liability Company.

At the outset last month, we stated that the ideal entity for a legal practice would limit liability, be nontaxable and be flexible with regard to co-ownership arrangements, formation and administration. As recently as a few years ago, the state enacted legislation permitting the formation of two new legal entities, the limited liability company (LLC) and the limited liability partnership (LLP) after almost all other state had already passed similar legislation. The entities are fairly similar in that they both offer liability protection and can be treated as partnerships for income tax purposes. There are difference, however, which relate primarily to the type of liability protection afforded.

The limited liability company affords its owners or members the same insulation from personal liability as a professional corporation. That is, the members of a LLC will be personally liable for their own professional malpractice; they will not, however, be personally liable for the debts or liabilities of the company or for the acts or omissions of other members, agents or employees of the company. In somewhat contrasting fashion, the LLP limits the personal liability of partners for the negligence and misconduct committed by other partners and representatives of the partnership, provided that the LLP maintains liability insurance for the negligent or wrongful acts or misconduct of the partners. This insurance is in addition to the malpractice insurance which the partners are required to maintain. Unlike the LLC and the professional corporation, however, the LLP does not shield a partner from the general debts and obligations of the partnership (such as leases and operating lines of credit). This is a distinct advantage of the LLC.

On the flip side, some states have CAT Funds that are not required to, and do not, cover the LLC for malpractice liability. They do, however, cover the LLP. The distinction itself is a mystery to us, as to many insurance brokers (many of whom are unaware in the gap in coverage). Some private insurers will extend coverage to the LLC to bridge the gap. Others will not. The question therefore arises: What is at stake if the practice entity is not adequately insured? The answer is, basically, its accounts receivable. If a practice can obtain sufficient coverage through private insurance, this many not be a significant issue. In any event, the issue figures to be fairly short-lived if state CAT Funds are phased out of existence, as many predict.

An advantage that both the LLP and LLC have over the professional corporation (both Subchapter S and Subchapter C) is that the professional corporation entails a number of formalities and greater administrative expense than do non-corporate forms. State corporation laws distinguish among boards of directors, shareholders and officers, and set forth requirements and responsibilities of each with respect to each other and the corporation. In contrast, non-corporate forms, in essence, are governed by their internal governing agreements. Thus, in general, non-corporate forms are governed in whatever manner their agreements provide, with minimal restrictions imposed by law.

One noteworthy disadvantage of the LLC and LLP as compared to the professional corporation is continuity of life from a tax perspective. Under the partnership tax laws which govern LLCs and LLPs, an entity is deemed terminated from a tax standpoint when there is a 50% or more change in ownership. Thus, for example, the departure of one owner in a two-owner practice can trigger tax consequences of a deemed liquidation, the ramifications of which are potentially significant. This figures to be les of an issue over time as the number of smaller medical practices decreases.

So, considering all of the foregoing, which entity is preferable? The LLC. It’s preferred over the Subchapter C professional corporation because of its “flow-through” tax feature. It’s preferred to another of the flow-through entities, the Sub S professional corporation, given its greater degree of flexibility. (Particularly onerous are the rules prohibiting S corporations from having more than one class of stock). It’s preferred over the LLP because it offers a greater degree of personal liability protection.

In addition, the liability protection featured by the LLC is unqualified, whereas the LLP’s liability protection can be lost in the blink of an eye upon the unwitting lapse of an insurance policy.

In sum, to achieve the goals of liability insulation, favorable tax treatment and ease and convenience of formation and administration, of all the plentiful choices, more often than not, the LLC is the winner.

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Attorney Eden Rose Brown is dedicated to providing comprehensive, highly personalized estate planning counsel to couples, families, individuals and businesses. She holds the highest standard of scholarship, client service and lawyer accessibility. The Law Office of Eden Rose Brown is located downtown in the Pioneer Trust Building, 117 Commercial St. NE, Salem, OR 97301. 503-581-1800. Eden@EdenRoseBrown.com