Protecting Your Practice’s Accounts Receivable
Since a medical practice’s Accounts Receivable (AR) is typically its largest and most vulnerable asset, one would think that most Doctors would focus on protecting it (Fortress) from the many lawsuit risks that Doctors, medical practices, and any operating business with employees and customers face. Unfortunately, this isn’t the case. Also, since the Doctor earns the right to be paid weeks and often months before the AR is ultimately collected, one might think that most Doctors would try to apply the concept of Leverage to this unproductive asset (Engine) to get more out of the asset. Again, you would be wrong.
In this Chapter, we will explain the exposure of a practice’s AR to claims against the Doctors and employees of the practice. Then we will compare and contrast two options for protecting the AR and leveraging this asset for further wealth creation.
How Doctors Lose Their Accounts Receivable
A medical practice’s accounts receivable (AR) is the Doctor’s most vulnerable asset when it comes to losing wealth in any claim against the practice. These claims can be medical malpractice claims, employment claims, healthcare related suits, or any number of financial risks to the practice. This financial risk exists because every case against a physician or the practice will include the medical practice as one of the defendants in the lawsuit. When there is a successful lawsuit against the practice, attorneys will look to corporate assets to satisfy the corporate debt. What is the biggest (and possibly only) liquid asset that a practice has? The Accounts Receivable (AR).
The accounts receivable has already been earned by your practice. You are only awaiting payment. Most medical practices “turn over” their AR every 60-90 days or so. This means the creditor only needs to wait 2 or 3 months, at most, to get access to your AR. It doesn’t matter that the AR is used to pay salaries and expenses. Once there is a lien against the AR, it becomes the property of the creditor and you have to find other ways to pay salaries and expenses. More
Using Multiple Entities For Asset Protection
In the last chapter, you learned how a C corporation can make more financial sense for a medical practice than a S corporation. You also learned that, if you have an S corporation now, you can easily convert to a C corporation—or use both an S and C corporation in a multi-entity structure. The strategy of using multiple entities goes beyond the tax and financial benefits of S and C corporations, as you will see here. In this chapter, we will explain additional multiple entity asset protection concepts that can help you better shield practice assets from lawsuits (Fortress) and earn more without seeing more patients (Engine).
Protecting Practice Assets By Using Multiple Entities
We understand that it is a tremendous risk to put all of a practice’s “eggs” into one basket, but what’s the solution? For your practice, it may be as simple as using multiple baskets. In fact, using multiple entities to run a practice is quite common in many types of business outside of medicine. Consider:
· Most restaurant businesses use different entities if they expand beyond one location.
· Most real estate developers or investors use multiple entities for different pieces of property.
· Many owners of taxicabs use one entity to own each taxicab.
Why do these business owners use multiple entities in this way? They do so primarily because they want their businesses to be Fortresses—shielding different business units or assets from claims against other businesses or assets. If one restaurant location performs poorly or there is a lawsuit at one property, the restaurateur does not want the other locations to be held responsible. If one taxicab is in a terrible accident, the owner of the taxicab business does not want the income from the other taxicabs to be exposed to the lawsuit creditor. Doctors can use the same tactic for the exact same reason.
How should a Doctor use multiple entities to protect a medical practice? The most common way is to separate the practice’s assets into various entities. Typically, the practice’s accounts receivable (AR) is its greatest asset. We will deal with this asset in its own chapter later in this Lesson. After AR, many practices own the real estate where the practice operates, as well as some valuable equipment.
There are three asset protection goals of separating the ownership of the real estate and equipment (RE) from the operating practice.
1. First, the RE is a valuable asset that should be isolated from any liability created by the practice. By isolating the practice from the real estate, you may have isolated malpractice or employment liability created by the practice from the valuable RE.
2. Second, the RE itself may cause liability, such as slip-and-fall claims from those coming and going on the premises or by damages resulting from the equipment (or improper use of it by an employee) injuring a patient or employee. If the RE and the practice are operated by the same legal entity, all the “eggs” are in the same “basket.” This means that the claim will be against an entity that has something to lose—all of those valuable assets. By separating the RE from the practice, you have also insulated the practice from these risks.
3. If there is a claim against the Doctors personally, the LLC can provide (+2) protection from such claims—though not in California—due to the charging order protections that you can read about in Lesson #6 on personal asset protection.
Separation Involves LLCs And Lease-Backs
The actual tactic of separating ownership simply involves creating a new Limited Liability Company (LLC) and transferring ownership of the real estate or equipment to the new LLC. Because the RE is no longer owned by the operating practice, claimants suing the practice have no claim against the LLC that owns the RE. For this arrangement to be respected and to ultimately protect the assets, Doctors must:
1. Properly create the LLC, with the right language in its operating agreement and all formalities being followed by the owners.
2. Respect all entity formalities.
3. Transfer title of the RE to the LLC.
4. Create fair market value leases or license documentation between the practice and the LLC(s) and make actual rental payments.
5. Ensure proper tax treatment for all parts of the transaction.
6. Transfer all insurance policies for the RE to, and premiums paid by, the LLC.
7. Comply with all other formalities that evidence the ownership of the RE by the LLC.
8. Note California gross receipts tax issue.
Your Financial Incentive
As we noted at the outset of the chapter, there is also a way the LLC lease-back tactic can be part of your “practice as Engine” strategy as well. In other words, the LLC lease-back can actually allow you to create more wealth while also protecting the RE. In fact, it can help you build wealth without requiring you to work additional hours or see more patients.
For simplicity’s sake, we will assume that you have a one-Doctor medical practice (although these techniques work equally as well for group practices). Let’s assume today that you own the practice’s office building in the same practice entity (PC). Tomorrow, you follow our advice and use the LLC lease-back technique for the practice office and follow all the proper formalities.
We would use an LLC that is initially owned by you and your spouse. Over time, you can gift ownership interests to children while maintaining 100% control of the LLC and the RE the LLC owns. Once the children are over the age of 18 (or age 24 if they are full-time students), their percentage of the LLC income will be taxed at their (likely) lower income tax rates. If you can take full advantage of this opportunity for tax bracket sharing (see Chapter 7-3), you can save tens of thousands of dollars in income taxes each year. Stretched out over a career, the savings (and growth on saved dollars) More