Choosing the best legal structure for your practice

Choosing the right legal structure is a foundational decision for any private practice, whether you’re just starting out or ready to grow. Common options are a sole proprietorship, partnership, corporation, or limited liability company (LLC). Each one affects your personal liability, taxes, paperwork, and the ability to add partners or raise money. Psychology is a licensed, regulated profession, so your state may limit which legal structure you can use and who is legally permitted to hold an ownership stake.

It explains which risks—like business debts or a partner's malpractice—each structure shields your personal assets from. And it shows which liabilities, such as claims arising directly from your own clinical work, remain your personal responsibility.

If you have a business plan, start by reviewing your goals for the practice, such as how large you expect to grow, whether you plan to add partners or staff, and how much money you will need to borrow or invest. Those goals point to the structure that fits, because each structure handles liability, taxes, and ownership changes differently. After reviewing your business plan, consult with a tax professional and a licensed attorney in your state about which legal structure fits your goals and risk level. As you weigh your options, consider:

• The services you provide
• The size of your practice (now and in the next few years)
• How much control you want over day-to-day operations
• How much formal structure and paperwork you are comfortable with
• Your exposure to lawsuits (often tied to the services you provide)
• Your expected profits or losses
• Whether you need to raise money (for example, loans or investors)
• Tax differences across structures
• Your state’s rules for professional practices, including permitted entity types and ownership limits
• Whether you will hire employees, supervise trainees, or contract with other clinicians
• Your long-term plans (such as adding partners, selling the practice, or succession planning)

Practical tip: Bring your answers to your first meetings with an attorney or tax professional. A clear picture of your goals makes those conversations faster and less expensive. 

Below is an overview of four common legal structures, along with their typical advantages and disadvantages.

A sole proprietorship is the simplest and least expensive legal structure. You own the practice yourself, and the law generally does not distinguish you from the business. You make all decisions and keep all profits—but you are also personally responsible for the practice’s debts, legal claims, and, if you have employees, their actions. Because there is no liability shield, your personal assets are not protected from business debts.

Advantages

• Low setup costs
• Easy to form and run
• You make decisions independently
• You keep all profits
• Business income is typically reported on your personal tax return

Disadvantages

• Unlimited personal liability (your personal assets are at risk)
• Fewer ways to raise money
• May be less attractive to collaborators or future partners
• Some employee benefit costs may not be deductible
• You generally pay self-employment tax (Social Security and Medicare taxes) on all of your net earnings from the practice
• You cannot choose S Corporation tax treatment. (Some owners of LLCs and corporations use the election to lower self-employment taxes by splitting income between a salary and distributions). See below for more information.

A general partnership is similar to a sole proprietorship, except two or more people own the practice together. The partnership and the owners are not legally separate, so partners can be personally responsible for the partnership’s debts and legal claims. In many cases, each partner can also be responsible for actions taken by the other partners in the course of business. Because the stakes can be high, it is important to have an attorney prepare a written partnership agreement that covers decision-making, roles, and how profits and losses are shared.

Advantages

• Low setup costs
• Relatively easy to form and operate
• May be able to raise more money than a sole proprietorship
• Partners can share management responsibilities
• Partners can bring different skills and resources
• Each partner generally reports their share of income on their personal tax return

Disadvantages

• Unlimited personal liability
• You may be legally responsible for your own actions and, in some situations, your partners’ actions
• Profits (and control) are shared
• Shared decision-making can lead to disagreements
• Some employee benefit costs may not be deductible
• Each partner generally pays self-employment tax on their share of partnership earnings. 

A related option is the limited liability partnership (LLP)—sometimes referred to as a PLLP for licensed professionals. While similar to a general partnership, an LLP provides an important liability shield: it generally protects you from personal responsibility for general partnership debts and the malpractice of your partners. You still stay liable for your own professional work. Because rules regarding LLPs vary significantly by state, check with your state’s secretary of state and psychology licensing board to confirm availability and eligibility requirements.

A corporation is usually the most complex and expensive structure to set up and maintain. The state creates (or “charters”) the corporation as a separate legal entity, meaning the business can own property, enter contracts, and owe debts in its own name. Owners, called shareholders, generally have limited personal liability: they typically risk only the money they invested in the corporation. While corporations usually require more formal governance—such as maintaining a board of directors, holding regular meetings, maintaining corporate records, and requiring certain filings—such entities offer robust asset protection and operational scalability. A corporation also files its own tax return. By default, corporate income can be taxed at both the corporate and personal level (often called “double taxation”), but qualifying corporations can elect an option known as S Corporation status to achieve “pass-through” taxation (where profits pass directly to personal tax returns) while retaining full corporate liability shields. 

C corporation vs. S corporation: What’s the difference?

 “C corporation” and “S corporation” describe how the IRS taxes a business. Neither is a different type of business under state law. 

• C corporation: This is the default tax treatment for a corporation. The corporation pays federal income tax on its profits. You then pay personal income tax on any profits the corporation distributes to you as dividends. This two-layer tax is called “double taxation.” 

• S corporation: An eligible corporation or LLC can file an election with the IRS (Form 2553) to be taxed as an S corporation. The business then generally pays no federal income tax. Profits pass through to the owners, who report them on their personal returns, much like a partnership.¹ S corporations must meet IRS eligibility tests, including limits on the number and type of owners. An S corporation election also changes how you pay yourself, through a salary versus distributions. 

Note: Because psychology requires a professional license, your state may require your practice to form as a professional corporation (PC) or professional LLC (PLLC) instead of a standard corporation or LLC. State law may also limit ownership to licensed psychologists and, in some states, other licensed professionals. If your state requires a PC or PLLC, that entity is the one that makes the S corporation election.

Advantages

• Limited personal liability for business debts and many legal claims (but not your own malpractice)
• Can centralize management (for example, through officers and a board of directors)
• Can raise money by issuing shares (stock)
• Some employee benefits may be deductible
• If you qualify, an S Corporation election (a federal tax election) may allow “pass-through” taxation while keeping corporate liability protections. (See LLC for section for “pass through” definition.)

Disadvantages

• More expensive and complicated to set up
• More paperwork, ongoing reporting, and regulatory requirements
• Possible “double taxation” (the corporation pays taxes, and shareholders may also pay taxes on dividends)
• Decision-making power is often tied to stock ownership
• An S Corporation election has specific tax benefits and tax tradeoffs—for example, around how you split income between salary and distributions

An LLC is often described as a hybrid between a corporation and a partnership in an effort to combine some of the advantages of both. It can provide a liability shield similar to a corporation while allowing flexible management. 

Tax flexibility

 By default, the IRS treats a single-member LLC as a sole proprietorship (known as a "disregarded entity") and a multi-member LLC as a partnership by default. Under these default rules, the LLC itself pays no federal income tax. Profits and losses pass through to the owners, who report their shares on their personal returns. An LLC does, however, offer flexible tax adaptability: either type of LLC can elect to be taxed as a traditional or, if eligible, as an S Corporation (see ‘C Corporation vs. S Corporation’ above). Because choosing the right tax classification can significantly impact your self-employment and income taxes, be sure to consult with a CPA or business tax advisor to determine which treatment best fits your practice's revenue. 

All states and the District of Columbia allow single-member LLCs.  However, at least one state, California, does not allow psychologists to practice through any type of LLC, including a PLLC.² Check with your state licensing board and secretary of state before forming an LLC or PLLC. As with a partnership, it is wise to have an attorney prepare an operating agreement that explains how the LLC will be managed, how money will be distributed, and a succession plan. In many states, a practice providing licensed mental health services may need to form a Professional Limited Liability Company (PLLC) instead of a standard LLC since the service to be provided requires professional licensure.

Advantages

• Limited personal liability for the company’s debts and legal judgments against the practice in most cases (but not your own malpractice)
• Management responsibility may be centralized or shared
• Members may be involved in decision-making regardless of their financial investment in the company
• Ability to access capital may be increased
• Pass-through taxation by default, with the option to elect corporate taxation 

Disadvantages

• More complicated to set up than a sole proprietorship or partnership
• May involve state-specific rules for professional practices (for example, PLLC requirements)
• Ownership interests can be harder to transfer than corporate stock

Choosing a structure can have important legal and financial consequences. Before you decide, talk with an attorney and a tax advisor about what fits your situation.

What no structure will do: Protect you from your own malpractice

Many psychologists form a PC, PLLC, or LLP expecting complete immunity from lawsuits. Generally, it does not work that way. While these professional entities protect your personal assets from general business debts and commercial liabilities, the law draws a hard line at professional services:

• Your own work: In most states, if not all, the owner of a professional entity remains fully and personally liable for their own professional negligence or malpractice.
• Your colleagues: You are generally not personally liable for the individual malpractice of your co-owners or independent colleagues (a primary benefit of using a professional entity).
• Your supervisees: Many state professional statutes also extend your personal liability to the clinical work of trainees, unlicensed staff, or junior clinicians under your direct supervision and control.

Even so, a professional entity still protects you in many situations. If the practice defaults on a lease or loan it signed, faces a claim based on a co-owner’s or employee’s conduct, or is sued over an injury at the office, the entity, not you personally, is generally responsible, unless you personally guaranteed the debt or were personally at fault.

Choosing a structure comes down to a few key questions: what kind of protection you need, how do you want to be taxed, and what does your state allow. With those answers in hand, an attorney and a tax advisor can help you set up a structure that fits your practice today and adapts as it grows.

Legal issues are complex and highly fact-specific and state-specific. They require legal expertise that cannot be provided in this article. Moreover, APA and APA Services, Inc. attorneys do not, and cannot, provide legal advice to our membership or state associations. The information in this article does not constitute and should not be relied upon as legal advice and should not be used as a substitute for obtaining personal legal advice and consultation prior to making decisions.

¹ Internal Revenue Service. (2020, December). Instructions for Form 2553: Election by a small business corporation. U.S. Department of the Treasuryopens in new window. 

² California’s LLC statute does not permit a domestic or foreign LLC to render professional services, which include services that require a state license, such as psychology. See Cal. Corp. Code § 17701.04(e)opens in new window. Psychologists in California who want to practice through a business entity must form a psychological corporation under the Moscone-Knox Professional Corporation Act. See Cal. Bus. & Prof. Code § 2995opens in new window. As a result, a professional corporation is the only business entity a California psychologist can use to make an S Corporation election for a practice. Licensed psychologists must own a majority of the corporation’s shares, and certain other licensed health professionals may own minority interests. See Cal. Corp. Code § 13401.5(c); Cal. Code Regs. tit. 16, § 1397.35.