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How to Join Forces
The legal entity you use can have far-reaching implications. Choose wisely.
, Scott Becker, Emily Balfe
Publish Date: October 10, 2007   |  Tags:   Facility Construction and Design

Once you've decided to start up an ambulatory surgery center, one of your very next steps should be determining what kind of legal entity you will form to own the facility. The decision is very important, as it influences your liability for the debts the center incurs, the share of profits you will pay to Uncle Sam, and the governance of the center. Unfortunately, like many important decisions, it is also quite complex. Much depends on the kind of ASC you plan to build, who the owners will be, and the laws of your state. In this article, we'll briefly explain the rationales for "S," "C" and professional corporations, "limited liability" companies, limited partnerships, and general partnerships.

These entities all have one thing in common: They do an excellent job of shielding investors from legal and financial liability. Unless an investor agrees otherwise, he or she is generally not personally liable for the debts of the corporation.

The kind we are all familiar with-the kind that house behemoths like GE and Microsoft-is the "C" corporation. Although this is how all Fortune 500 companies are formed, they are rarely appropriate for an ASC. The reason is that corporate profits are taxed twice. Let's say a corporation makes a profit of $5 million. The corporation first pays 34 percent taxes on the $5 million in income. Then, the shareholders would pay taxes on amounts that they received as distributions or dividends from the "C" corporation. In this way, the after-tax amount of approximately $3.3 million would net down to around $2 million after the shareholders paid taxes on this income at their personal tax rates (usually 36 to 39 percent for physicians).

More popular for ASCs is the "S" corporation. This type has only one level of taxation. If the corporation generates $500,000 in income and a person owns 10 percent of the "S" corporation, the party is deemed for federal and for most state income tax purposes to have earned $50,000 in taxable income.

Remember that in any given year, the corporation may not actually pay the investor the $50,000; it may choose to pay only enough to the investor to pay taxes, and retain the remainder for future operations.

Note that an "S" corporation can only be held by individuals (limited to 75 individuals) and/or by tax-exempt entities. An "S" corporation is not an option if you intend to invest in the ASC through a for-profit corporation or if a management company will be an investor.

Another variation is the professional corporation. These are generally available for use only to centers that are owned solely by physicians. Because an ASC is not considered to be providing "professional physician services," it is typically not necessary to use a professional corporation. However, in certain situations, a professional corporation may be advisable. For instance, use of a professional corporation might exempt you from applying for a Certificate of Need. In some states which require a CON, surgery centers which are operated as part of a physician's practice are exempted. An added bonus is that a professional corporation can be taxed as a "C" or as an "S" corporation. The downside of selecting a professional corporation is that your ability to have third party partners in the surgery center is very restricted.

Possibly the most popular format today is the limited liability company. This type of entity was developed during the last decade and is now available for use in almost every state.

An LLC has many of the same attributes as an "S" corporation without some of the restrictions on use. Like "S" corporations, LLCs are taxed only at the shareholder level. An LLC itself does not pay federal income taxes. In most states, it's also exempt from paying state income taxes. The physicians or owners pay taxes on their share of income.

Like corporations, LLCs protect investors from liability. Again, unless an investor separately agrees to be liable for debts, investors are not generally personally liable for the debts and liabilities of the LLC. Another reason to choose an LLC is that it does not restrict the type of entity that may own interest in the company. In almost all states, a hospital, a hospital district, a management company, or individuals can all own an interest in an LLC.

Despite all these advantages, in several states there are reasons not to use LLCs. For example, California has traditionally made it very easy for limited partnerships to receive Board of Pharmacy licensure. However, this licensure isn't available for LLCs. In other states, LLCs must pay state income taxes but other legal entities are exempt. In Texas, LLCs remain subject to certain franchise or income taxes to which limited partnerships are not.

Before the development of LLCs, limited partnerships were the most popular entity for ASCs. LPs provide for one level of taxation to their participants. The principal downside is that the partners who are substantially involved in the ASC's management are liable for the debts and liabilities of the partnership.

Each limited partnership also must have a general partner who is exposed generally to the liabilities and the debts of the partnership. There are mechanisms for the general partner to limit exposure. For example, rather than naming a person as general partner, it's possible to form a corporation for that person and then name the corporation general partner. However, a court might view this structure as an means to evade the liability inherent in the LP structure.

Limited partnerships remain the entity of choice in states where there are other obstacles to use of LLCs, such as California and Texas.

Much less popular is the general partnership. Like a limited partnership, this format provides for a single level of taxation at a state and federal level. The key negative is the fact that all partners are liable for all of the debts and liabilities of the partnership. For this reason, an attorney would typically only use this format for an ASC if the parties to the venture were not individuals, but entities that have limited their exposure to liabilities. For example, a hospital or management company may invest through a partnership with the recognition that the liability will stay at the management company or hospital company level, and won't trail back to the individual owners. Even here, most parties hesitate to use such a structure out of concern that the liabilities of the partnership may taint or cause liability to the member entities.

Your choice of legal entity can help protect you from liatility and from excessive taxation and ensure that you can continue to actively be involved in operating the ASC. Take the time to make an informed decision now, and you'll have few regrets later.