The practice of medicine is a profession fraught with liability. It’s not just medical malpractice claims either – employment related issues (wrongful termination, sexual harassment, and discrimination), careless business partners and employees, and contractual obligations (personal guarantees, leases, business agreements, etc.) add to the increased risk assumed by a physician in private practice. Couple these practice-related liabilities with personal liabilities (divorce, vehicular accidents, rental real estate), and it is clear that your physician clients need to protect themselves from more than just professional negligence claims. In this issue you will learn:
- Types of insurance physicians should have in place;
- State exemptions that protect certain types of assets from the claims of creditors; and
- The role of business entities in liability planning for physicians.
Tip #1 – Insurance is the First Line of Defense Against Liability
Liability insurance is the first line of defense physicians should use to protect themselves. Liability insurance provides a source of funds to pay legal fees as well as settlements or judgments. Types of insurance physicians should have in place include (as applicable):
- Homeowner’s insurance
- Property and casualty insurance
- Excess liability insurance (“umbrella” insurance)
- Automobile and other vehicle (motorcycle, boat, airplane) insurance
- General business insurance
- Professional liability insurance
- Directors and officers insurance
Planning Tip #1: Physicians should not rely on insurance as their sole means of liability protection since the cost of a comprehensive policy may be prohibitive, and each type of policy has numerous exceptions to coverage. Instead, insurance should be used as one layer of a multi-layer strategy designed to place a barrier between the physician’s business and personal assets and the claims of a plaintiff. In addition, physicians should work with an insurance professional who can explain the purpose of each type of coverage, make recommendations for liability limits and deductibles, and shop around for the best coverage on an annual basis.
Tip #2 – State Exemptions Protect a Variety of Personal Assets From Lawsuits
Each state has a set of laws and/or constitutional provisions that partially or completely exempt certain types of assets owned by residents from the claims of creditors. While these laws vary widely from state to state, in general physicians may be able to protect the following types of assets from a judgment entered against them under applicable state law:
- Primary residence (referred to as “homestead” protection in some states)
- Qualified retirement plans (401(k)s, profit sharing plans, money purchase plans, IRAs)
- Life insurance (cash value)
- Property co-owned with a spouse as “tenants by the entirety” (only available to married couples; and may only apply to real estate, not personal property, in some states)
- Prepaid college plans
- Section 529 plans
- Disability insurance payments
- Social Security benefits
Planning Tip #2: Physicians should consult with an experienced asset protection attorney in their state of residence to determine which state exemptions are available and how much they can protect. It is also important to understand the pros and cons of each type of exemption. For example, while tenants by the entirety co-ownership between the physician and their spouse may make sense in the short term, in the long run it can become completely useless if the couple divorces or if the non-physician spouse dies first. As with liability insurance, exemption planning is best used as one layer of an overall asset protection strategy.
Tip #3 – Business Entities Protect Business and Personal Assets From Lawsuits
Business entities include partnerships, limited liability companies, and corporations. Physicians who own their own practice need to mitigate the risks and liabilities associated with owning a business (just like any other business owner) through the use of one or more business entities. Physicians should work closely with a business planning attorney to determine the right structure for their practice by not only taking into consideration asset protection, but also income taxes, estate planning, retirement funding, and business succession goals.
Business entities can also be an effective tool for protecting a physician’s personal assets from lawsuits. In many states, assets held within a limited partnership or a limited liability company are protected from the personal creditors of an owner. In addition, the personal creditors of an owner cannot step into the owner’s shoes and take over the business. Instead, the creditor is limited to a “charging order” which only gives the creditor the rights of an assignee. In general this limits the creditor to receiving distributions from the entity if and when they are made.
An added benefit of using a limited partnership or limited liability company to protect a physician’s personal assets is the leverage that can be created for gifting and wealth transfer planning through the use of valuation discounts. With a properly structured limited liability entity, assets held within the entity will be entitled to a discounted valuation for tax purposes because of lack of control, the lack of marketability of the interests in the entity, and the inability of owners to simply to walk away from the business and take their ownership interests with them. Discounts on the value of the entity’s underlying assets can range from 20% to over 50%. Valuation discounts allow the physician to gift entity interests for cents on the dollar and at a reduced use of the lifetime gift tax exemption.
Planning Tip #3: Creating a business entity that protects a physician’s assets from lawsuits involves much more than just filing some forms with the state division of corporations and paying an annual fee. Business formalities must be observed and documented, otherwise a creditor can attack the entity through “veil piercing” or “constructive trust” or “alter ego” arguments. In addition, state laws governing business entities vary widely and are constantly changing due to legislative action and court decisions. Therefore, it is important for physicians to work with a business planning attorney who assists with documenting business formalities and keeps on top of changes in applicable laws. Finally, as with liability insurance and state exemptions, business entities should be used in conjunction with other asset protection strategies.
Final Advice for Helping Physicians Protect Their Assets
Physicians are constant targets for lawsuits both professionally and personally, because they are perceived to have “deep pockets.” You can add value to your relationships with your physician clients by helping them identify ways to protect and preserve their business and personal assets. We are experienced with helping physicians create effective, multi-layered asset protection plans. Please call us if you have any questions about this type of planning and to arrange for liability protection consultations for your physician clients.