BSM Connection elearning Course

Table of Contents OVERVIEW... 1 FORMS OF DOING BUSINESS... 1 BUSINESS FORMATS AT A GLANCE... 2 COMMON LEGAL DOCUMENTS... 2 WORKER CLASSIFICATION STATUS: EMPLOYEE VS. INDEPENDENT CONTRACTOR... 3 COMMON CHARACTERISTICS OF EMPLOYEE VS. INDEPENDENT CONTRACTOR... 6 CONCLUSION... 6 COURSE EXAMINATION... 7 2009, BSM Consulting

OVERVIEW In today s health care environment, physicians and administrative staff will, by necessity, have to be in a much better position to manipulate and manage the financial aspects of the medical practice. Lower levels of fee-for-service reimbursement, as well as increasing overhead costs, place a great deal of pressure on medical practitioners to manage their financial resources more efficiently. The two Basics of Medical Practice Finance courses are designed to provide practice management the essential knowledge to be able to focus on the important financial issues facing the medical practice and to have a clear understanding of the relationship between different financial reporting tools. This course includes the following topics: forms of doing business, common legal documents, and worker classification status (employee vs. independent contractor). The next finance course focuses on the following topics: practice performance ratios, the concept of leverage, and equipment financing options. Sample financial management and production analysis reports are included to illustrate organization and presentation of information necessary to effectively manage practice financial matters. FORMS OF DOING BUSINESS The legal structure of medical practices varies depending on ownership and tax and liability issues. A description of the various forms of business is provided below. Sole Proprietorship: As a general rule, the sole proprietorship is the simplest form of doing business for a professional practicing alone, both from tax and non-tax standpoints. All income and expenses of the practice are simply reflected in the individual s income tax returns. Any assets used in the practice are owned or leased in the professional s own name. Partnerships: A professional partnership can be as simple an operation as a sole proprietorship or extraordinarily complex, depending upon the number of partners involved and the complexity of the practice. A partnership is usually comprised of individuals; they may also include professional corporations as partners. A partnership normally involves the joint contribution of property or services from the partners in a joint sharing in profits and losses. Although it is a separate legal entity for some purposes, a partnership is not deemed a separate tax paying entity. Income and expenses of the partners are allocated to them according to their proportional value of partnership interest. Corporations: A professional corporation, in contrast with a partnership or sole proprietorship, is ordinarily respected for both tax and legal purposes as an entity separate from its shareholders. A PC, as it is called, may be formed by one or more professionals and must conform to applicable state corporation laws, including all filing, name registration, and other reporting requirements imposed on ordinary business corporations. Regular or C Corporations: A regular corporation is subject to tax on its income and its shareholders are subject to a second tax with respect to any dividends distributed. S Corporation: An S Corporation provides the same limited liability for its shareholders as a regular corporation, while maintaining many of the tax characteristics of a partnership. S Corporations are not subject to taxation; rather, all net income or loss is passed through to their shareholders in much the same way as a partnership. There are, however, certain requirements that must be met in order to qualify as an S Corporation. For example, the stock in an S Corporation must be held by individuals, i.e., stock may not be held by a professional corporation or partnership. 2009, BSM Consulting 1

Limited Liability Company (LLC): A limited liability company is treated in much the same way as a corporation with respect to the limited liability of its members or owners for the debts and obligations of the entity. However, for tax purposes, an LLC is treated like a partnership. Unlike an S Corporation, there is no limit on the type of person or entity that may hold an ownership interest. The LLC is a relatively new company structure; some states have not yet enacted laws to allow for their creation. An illustration and summary of the various forms of business referred to above is provided below. BUSINESS FORMATS AT A GLANCE Here is how major tax and liability rules affect the primary types of business: Business Structure Number of Owners Method of Formation Legal Liability Tax Liability Tax Rate Transfer of Part Ownership Sole Proprietorship One No special steps are required. Owner has unlimited liability. Owner is liable. Owner is taxed at individual rates. Fully transferable through sale or transfer of company assets. Partnership Two or More Verbal contract is sufficient, but a written agreement is advisable. General partners have unlimited liability. Limited partners are liable to the extent of their investments. Partners are liable, whether or not profits are distributed. Partners are taxed at individual rates. May require consent of all partners. C Corporation Any Number Must meet formal requirements set by state law. Shareholders are protected from personal liability. Corporation is liable. Corporation is taxed at corporate rates. Shares are freely transferable. S Corporation Maximum of 100, with restrictions on who or what they may be. Follow state rules for C Corporation, then make S election with the IRS. Shareholders are protected from personal liability. Shareholders are liable, whether or not profits are distributed. Shareholders are taxed at individual rates. Transfer of shares may affect S status. Limited Liability Company One or More Must meet formal requirements set by state law. Members (owners) are protected from personal liability. Members (owners) are liable, whether or not profits are distributed. Members (owners) are taxed at individual rates. Generally requires consent of all members (owners). COMMON LEGAL DOCUMENTS Employment Contracts Employment contracts or employment agreements will generally set forth the responsibilities a physician employee has towards his employer and vice versa. Salary issues, fringe benefit provisions, and issues concerning termination of employment are normally found in the body of these contracts. 2009, BSM Consulting 2

Buy/Sell Agreements Buy/Sell or Shareholder s Agreements normally deal with the most common events that would trigger the purchase and sale of a shareholder s interest in a medical practice; namely death, disability, retirement, and voluntary termination. A buy/sell agreement would typically make a distinction between termination of employment and will normally set forth the price to be paid to the withdrawing shareholder and, as well, the terms upon which this price will be paid. Partnership Agreements If a practice operates as a partnership (and not as a professional corporation), the partnership agreement would normally deal with all of the issues found in an employment contract and buy/sell agreement of a professional corporation. Operating Agreements If a practice operates as a limited liability company, the operating agreement would address the issues found in the employment contract and buy/sell agreement of a professional corporation. WORKER CLASSIFICATION STATUS: EMPLOYEE VS. INDEPENDENT CONTRACTOR Many physicians work for group practices and other organizations as either an independent contractor or an employee. What does this really mean? For federal tax purposes proper classification of the worker affects how you pay your federal income tax, Social Security, and Medicare taxes, and how one files their tax return. Further, classification affects one s eligibility for employer and Social Security and Medicare benefits, as well as one s tax responsibilities. As an employee subject to withholding, a physician will receive a paycheck net of the necessary withholding taxes. The W-4 form completed at the start of employment provides instruction to the employer as to the amount to be withheld. At the end of each calendar year, one receives a W-2 form showing gross wages and a breakdown of withholding. As an independent contractor, one would receive essentially a gross check without taxes withheld. It becomes the taxpayer s responsibility to deposit taxes with the federal and state taxing authorities on a quarterly basis through what s called estimated tax payment vouchers. An independent contractor must pay self-employment or Social Security tax in addition to regular federal and state taxes. In the case of independent contractors, a 1099 form is issued by the payer at the end of each calendar year evidencing the total fees paid. A duplicate is sent to the Internal Revenue Service (IRS) to ensure proper reporting by the taxpayer. The determination of whether one should be an independent contractor or employee is a critical threshold issue. The right classification can only be determined with an assessment of the relevant federal income tax regulations. In addition, in making the right determination, the parties need to consider the possible implication of the Federal Anti-Kickback Statutes. Federal Income Tax Considerations The tax courts consider many facts in deciding whether a worker is an independent contractor or employee. These relevant factors fall into three main categories: behavioral 2009, BSM Consulting 3

control; financial control; and the relationship of the parties. The IRS will carefully analyze the fact pattern if it suspects the taxpayer(s) are engaged in activity with the intent of avoiding federal tax liability. In each case, it is very important to consider all the facts no single fact provides the answer. Consider the following definitions: Behavioral Control These facts show whether there is a right to direct or control how the worker does the work. For example, if the practice has the right to set the doctor s schedule and control how he or she sees patients, the doctor is most likely acting like an employee. Further if one receives instructions on how the work is to be performed this suggests that one is an employee. According to IRS Publication 15.A, instructions can cover a wide range of topics. For example: How, when, or where to do the work. What tools or equipment to use. What assistants to hire to help with the work. Where to purchase supplies and services. If one receives less extensive instructions about what should be done, but not how it should be done, one may be an independent contractor. In the case of medical practices it is fairly common to provide limited instruction to contract physicians. The key factor in determining behavioral control is whether the practice retains the right to control the details of the physician s performance or instead has given up this right. Financial Control These facts show whether there is a right to direct or control the business part of the work. For example: Significant Investment If one has a significant investment in the work performed, independent contractor status may be suggested. A worker that invests in and uses his own equipment when working in the practice would tend to look more like an independent contractor. There is no dollar test; however, the investment must be substantive. Expenses If the individual is not reimbursed for some or all business expenses, independent contractor status is more likely, especially if the business expenses are significant. Opportunity for Profit or Loss If the individual can realize a profit or incur a loss from the services rendered, this suggests one is more in business for themselves and acting like an independent contractor. An independent contractor is generally free to seek out other business opportunities. The fact that they may do their own advertising, have their own office location, and do other work in the market will support independent contractor status. How the practice pays the physician is another factor given consideration. Employees are generally guaranteed an hourly wage for an hourly, weekly, or monthly period of time. For medical practices this can be a perplexing issue since many independent contractors are in fact paid an hourly rate (although many are paid on a percentage of their collected fees). Relationship of the Parties These are facts that illustrate how the business and the worker perceive their relationship. For example: Employee Benefits: If one receives benefits, insurance, retirement contribution or other benefits, this is a clear indication one is acting like an employee. Not receiving these benefits is not a guarantee one is an independent contractor; however, this would be a very significant issue in the overall determination. 2009, BSM Consulting 4

Written Contracts: A written contract provides a good indication of the party s intent. If other factors make it difficult to determine a worker s status, the presence of a written contract can be a more important factor. If one engages a worker with the expectation that the relationship will continue indefinitely rather than for a specific time frame, this is generally considered evidence that the intent was to create an employeremployee relationship. If a practice classifies an employee as an independent contractor and assuming one had no reasonable basis for doing so, the practice may be held liable for employment taxes for that worker. If there is a reasonable basis for not treating the worker as an employee, the practice may be relieved from having to pay all employment taxes for the worker. To get this relief, the practice must file all required federal information returns on a basis consistent with treatment of the worker. There are a number of relief provisions that exist that can reduce or potentially eliminate tax liability possibly arising from an IRS reclassification audit. Whether or not the employer is entitled to relief under one of the applicable provisions of the Internal Revenue Code, an employer can reduce or eliminate any of its liability for federal income tax withholding to the extent it can show the tax has in fact been paid. Generally, the employer provides such proof by submitting IRS Form 4669, whereby the worker certifies, that he or she reported the amounts at issue on his or her tax return and that any taxes due on the return have been paid. Given the complexity of this issue, experienced tax counsel should be consulted in this regard. Other Regulatory Concerns The Federal Anti-Kickback Statute prohibits the knowing or willful offer, solicitation, payment, or receipt of anything of value that is intended to induce the referral of a patient for an item or service that is reimbursable by most federal programs, including Medicare, Medicaid and other programs covering Veteran s benefits. The Office of Inspector General (OIG) of the Department of Health and Human Services (HHS) takes the view that the Anti-Kickback Statute has been violated if one purpose of an arrangement is to induce referrals, notwithstanding the fact there may be other legitimate purposes for which the payment is made. As a result, virtually any financial relationship between a health care provider and a referral source has potential anti-kickback implications. Although an arrangement is prohibited under the Statute only if there is intent to induce referrals, the government could infer such intent from circumstantial evidence that suggests one of the reasons for the business arrangement was to induce referrals. Because of the breadth of the Statute, the OIG has published final rules, referred to as safe harbors, defining payment practices that would not be subject to sanction or enforcement under the Statute. Failure to comply or fit within a safe harbor does not make the activity per se illegal. Rather, the safe harbors set forth specific payment practices that, if fully met, will assure the entities involved of not being prosecuted criminally or civilly for the arrangement under the Anti-Kickback Statute. Most relevant to the assessment of worker classification status are the safe harbors for equipment rental and space rental, as well as employee status. The first two have nearly identical requirements and apply in those cases where one is functioning as an independent contractor. 1. The lease agreement must be set out in writing and signed by the parties. 2. The lease must cover all of the equipment or space leased between the parties. 3. A part-time lease must specify exactly when and for how long the space or equipment will be leased. 4. The lease term must be at least one year. 5. The aggregate rental charge must be set in advance, consistent with fair market value in an arms-length transaction, and not determined in a manner that takes into account the volume or value of referrals or other business generated between the parties. 2009, BSM Consulting 5

In the case of the employee safe harbor, assuming the worker otherwise meets the tests as a bona fide employee the payment arrangement between the parties is protected. As such, there is far greater flexibility to structure the compensation terms when this type of relationship exists. Many practices engage independent contractors and pay them on a percentage of collections. There is no safe harbor for this type of payment arrangement. This does not imply the payment arrangement is illegal. It does, however, suggest that these types of arrangements will face greater scrutiny and must otherwise meet a fair market value test to insure that no portion of the payments made or received represent payments to induce referrals. There are many factors that affect determination of the proper status between a worker and a practice. It is critically important for the practice to set forth all relevant facts surrounding the proposed business transaction and to submit these facts to experienced tax and legal counsel for an opinion on the best structure. Given the consequences of an improper or incorrect classification, this investment of time and resources to properly evaluate and document the transaction will go a long way in providing protection for the parties. COMMON CHARACTERISTICS OF EMPLOYEE VS. INDEPENDENT CONTRACTOR Employee Independent Contractor Control over all aspects of work. Little control over methods and means of work. Employee is paid a salary plus benefits. Work performed is normally within the scope of employer s usual line of business. Tools of trade are provided by employer, i.e., uniforms, supplies, and work space. An employee generally works regular hours according to a set schedule. Patient billings are handled by employer. Contractor is paid a fee with no benefits. Work performed is outside the scope of usual lines of business. Contractor normally provides tools of trade. A contractor will generally have more flexible hours. Contractor would normally bill under his/her provider number. Note: In addition to these factors, the IRS will look at other factors in order to determine the nature of the relationship. They will also consider the totality of the circumstances and not any single factor. CONCLUSION Numerous challenges confront physicians and practice managers as the health care market changes, including the ability to ensure financial stability. Many vital decisions that must be made by practice leadership require physicians and management to have a certain level of financial understanding. These decisions also require the ability to review essential financial information, presented in a concise manner and delivered to management on a timely basis. The second part of this course, Basics of Medical Practice Finance - Part 2, provides practical tools and information to assist in making better business decisions. 2009, BSM Consulting 6

COURSE EXAMINATION 1. Which of the following is an attribute of a limited liability company (LLC)? a. Members are protected from personal liability. b. The entity is taxed like a C Corporation. c. Members do not pay tax on any pass through income. d. Must only meet the requirements of federal law. 2. Net income of a C Corporation is taxed at corporate rates. a. True b. False 3. In the case of an S Corporation shareholders are not liable for personal taxes if the profit is retained by the corporation at the end of the fiscal year. a. True b. False 4. An S Corporation maintains many of the tax characteristics of a partnership. a. True b. False 5. One advantage of a LLC is that members or owners have limited liability for the debts and obligations of the entity. a. True b. False 6. Which of the following are common documents found with a professional corporation? a. Partnership agreement. b. Operating agreement. c. Shareholder s agreement. d. Employment contracts. e. C and d. f. All of the above. g. None of the above. 7. Salary and fringe benefit issues for a shareholder employee are customarily found in the buy/sell agreement. a. True b. False 8. Which of the following is true with respect to an independent contractor? a. Employment taxes are remitted by the employer. b. Employee benefits are normally only provided if the contractor works more than 30 hours per week. c. The contractor normally works a regular number of hours each week. d. The employer provides all the tools of the trade necessary for the contractor to perform his or her work. e. None of the above. 2009, BSM Consulting 7

9. Which of the following is true with respect to an employee physician? a. Wages are subject to withholding. b. Benefits are not typically provided to physician employees. c. The employee receives a gross check and in turn must pay his or her taxes through estimated payments. d. The employee would receive a W-2 at year end. e. A, c, and d. f. A and d. g. None of the above. 10. Proper determination of employee vs. independent contractor status would be based on which of the following? a. Who supplies the tools of the trade? b. Who controls and directs the duties of the job. c. Whether benefits are provided. d. Regularity of hours worked. e. All of the above. 2009, BSM Consulting 8