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The Legal Department articles are not intended to serve as legal advice and are offered for educational purposes only. The information provided should not be used as a substitute for independent legal advice and it is not intended to address every situation that could potentially arise. Please be aware that laws, regulations and technical standards change over time. As a result, it is important to verify and update any reference or information that is provided in the article.
This article will address some of the financial aspects of sustaining your burgeoning private practice.
Mary Riemersma, Former Executive Director
The September-October issue of The Therapist carried Part I of this series, and the November-December issue carried Part II. This article is the third in the series on Building a Private Practice. This article assumes you have evaluated the pros and cons of going into a Private Practice, have made the decision that Private Practice is right for you, and have begun the process of turning that Private Practice into a reality.
Budgeting, Financial Planning and Financial Record-keeping
First and foremost, keep good records. Whether you use an accountant, bookkeeper, secretary, a service, or you do the financial record-keeping yourself, there are certain key concepts you should understand. Even if you do not physically do the record-keeping yourself, you need to know the basics. You need to know how to read a financial report, and you need to understand budgeting. You may think you need to do all record-keeping yourself in order to conserve costs, however, that may not be the most cost-effective approach. Consider, you need to do what you do best, and you need to use your time most effectively. Doing what you do best may mean that you are seeing clients at whatever fee you charge, and paying someone else, either at a lower fee than your hourly fee, or who is more efficient than you would be, at doing financial record-keeping.
Establish your accounting period-initially you must determine whether you will operate your business on a fiscal year or a calendar year basis. Operating on a calendar year basis means that you will need to conclude your year at a time when life is fairly hectic, the holidays have just concluded, and you are hopefully working hard at seeing a full client load. It may be that you prefer to operate on a fiscal year basis, and for tax reporting purposes, it is easier to end the year and deal with tax returns during the summer months, when possibly, life in general seems less hectic. Whatever you decide, calendar or fiscal year, the decision must be made when you initially file with the IRS. Once in business, and anytime you change your basis from calendar to fiscal or fiscal to calendar year, you must report the change to the IRS. Regardless of whether you establish your business on a fiscal year basis, you are required, if you have employees, to address employee withholdings and taxes on a calendar year basis. In essence, from this point forward, you become an agent of the IRS.
Generally accepted accounting principles- whatever method of accounting you decide to employ and whomever you select to perform the accounting on your behalf, you should follow generally accepted accounting principles, in keeping with the practices of the profession. Generally accepted accounting principles dictate a double-entry system of accounting. The purpose of a double entry system is that it provides a means to "check and balance" the accounts. When every transaction is recorded twice, it creates a system to balance to "zero," as a "check and balance" that entries have been made correctly. If you can imagine each account as a "T" with a left and right side, when each entry is made to the left hand side of an account, it is called a "debit," and likewise when made to the right-hand side of an account, it is called a "credit." Therefore, because there has been double-entries, when you add up all of the left hand amounts or debits and the right hand amounts or credits, your accounts will "balance."
Cash or accrual-accounting can be either on a cash basis or an accrual basis. Cash accounting recognizes income when cash is received and recognizes expenses when cash is paid out. Accrual accounting recognizes income when earned, even though not received, and expenses when incurred, even though not paid, regardless of the time cash is actually received or disbursed. For example, if you operate according to a cash method of accounting, you would not record monies owed to you, but not yet paid. You would record it only upon receipt from the client. If you operate according to an accrual method of accounting, the patient who has used your services, but who has not yet paid you, would be carried as an accounts receivable. The accrual method of accounting is more difficult and time consuming, but does give a more accurate financial picture. Cash accounting is easy, but can result in a distorted financial picture, since it does not reflect those things owing but not yet paid nor does it reflect what is owed to you that has not yet been received. And, even though accrual is more accurate, it can distort or not reveal cash flow problems. Even though your practice may be profitable, you may not have enough available cash to pay current expenses because you have receivables outstanding. This limited cash flow problem is difficult to identify with the financial report based upon an accrual method of accounting. Cash accounting, on the other hand, may paint a rosy picture, because much of what is outstanding has not yet been accounted for. It is also possible to marry cash and accrual methods of accounting to have a "modified accrual accounting system," which is easier to maneuver than full accrual, and provides more reliable information than straight cash accounting. Regardless of the system you select, should you change from cash to accrual or from accrual to cash, you are obligated to notify the IRS.
Budgeting and breakeven analysis-as you begin practice, you should establish an annual budget detailing your anticipated income and expenses. You will likely need a budget to arrange for a loan, to secure a long-term lease, as well as for your own planning and preparation. You should be realistic as to the income that you project, how you will market yourself to achieve the income that you project, how that income will grow over time, and what steps you will take should your income not materialize as you build your practice. You should also be realistic as to your anticipated expenses-the ongoing costs of sustaining your practice. Expenses include such costs as rent, telephone, marketing and advertising costs, membership dues, licensing fees, continuing education, depreciation on your capital expenditures for office furnishings and equipment, amongst other costs. As you create your budget, keep in mind the income that will be minimally necessary to pay your monthly expenses- when put to paper, this analysis becomes your "breakeven analysis." Keep in mind that, generally speaking, businesses are not lucrative from the first day of operation. In fact, it may take two to three years to turn a profit.
Treat your practice like it is truly a business. Set up a separate checking account and write "draws" or paychecks to yourself. Maintain a petty cash account, which you account for and restore on a regular basis, to cover incidental business expenses. Log all capital expenditures and depreciate them as an expense, even those things that you pick up here and there to decorate your office. Get in the habit of getting receipts, recording the expenditures, and filing them in a manner where they can be accounted for and retrieved. Even if you plan to use a bookkeeper or an accountant to take care of your financial accounting, you will still need to maintain the records in an organized manner that is understandable to the accountant or bookkeeper. If you plan to do the accounting yourself, you may wish to invest in simple and understandable accounting software such as Quicken's Quick Books, or many of the software companies that make software specifically for therapists that have an accounting component. However, if you do put your records on your computer-back up your system regularly-at least weekly. Keep the back up at your home or at another location away from your computer, in case you, like many others, suffer a computer crash or some other unfortunate event. Remember, spend your time doing what you do best-which may mean that you hire out the accounting component of your practice. And, if you hire out the accounting function, hire carefully, review the work of the contractor/ employee, and ask questions until you are confident and satisfied with the answers.
Accounts receivable-initially it may be wise to not carry accounts receivable if you can avoid it. The simplest collection system is to be paid for the services you provide at the commencement of therapy. However, such a system may not be possible, especially if you take insurance or are a managed care provider. If you do have accounts receivable, either because you permit patients to not pay at the time of treatment or because you bill third party payers, become diligent in regular and consistent billings. In other words, bill monthly, carrying forward any unpaid balances onto any subsequent billings. Keep good records and follow up by telephone and/or in writing when unpaid balances begin to age to 60 or 90 days. Document your records with regard to all contacts made with the intent to collect. And, don't allow a balance to grow too large without working out some alternative arrangement with the patient. It may be time to refer to a lower cost provider. It may be time to delay further treatment until the balance is brought current. It may be time to work out an alternative payment schedule. However, keep in mind that balances that grow too large may be considered the equivalent of malpractice and leave you vulnerable to a lawsuit.
Financial Reports-a key financial report is a "statement of financial position" or otherwise known as a "balance sheet." The balance sheet provides the statement of the financial position of the business on a given date. It is comprised of assets, liabilities, and net worth. The assets are your economic resources, accounts receivables, property, supplies, intangibles, cash, and those things that are convertible to cash. The liabilities are your obligations as a result of your past transactions. For example, you took out a loan to pay for the furniture and equipment to open your practice or you have signed a long-term lease. Net worth is your net ownership. Remember the double-entry system discussed above and that both sides of the equation balance. Thus, your assets equal your liabilities plus your net worth. Or, when stated another way, assets minus liabilities equals net worth.
Another key financial report is the "statement of revenues, expenses and net assets," otherwise known as an income and expense statement, or an income statement, or an expense statement. This statement reflects current operations at the close of operations at the end of each accounting period. The typical accounting period is one month. It shows the income received for the period to the current date, money or assets expended for the period to the current date, and the net income or expenses which exceed income, which is added to or subtracted from net worth.
The third financial report is the "statement of cash flows." This report is not always created or necessary, but can be useful when accounting on an accrual basis. It is a resource to show that you will or will not have sufficient "cash flow" to cover current expenses.
Self-Employment and Other Taxes
As a self-employed person, you will be obligated to pay self-employment tax. Self employment tax is the social security and Medicare tax for individuals who work for themselves. Your payments of self-employment tax contribute to your coverage under the social security system. Social security coverage provides you with retirement benefits, disability benefits, survivor benefits, and Medicare. Generally, you are required to pay self-employment tax if your net income is greater than $400 for the year. In addition, you will likely be liable for income tax, and to periodically pay estimated tax. If you have employees, you will additionally be liable for social security, Medicare, federal and state income tax withholding, federal and state unemployment tax, and depositing all of these taxes timely. Information supplied by the Internal Revenue Service, State Franchise Tax Board, and State Board of Equalization can be very helpful in understanding your obligations, or your bookkeeper or accountant should be able to appropriately inform you as to your obligations. Acquire a "Business Tax Kit" from the IRS. It will, among other things include, IRS Publication 583, called "Starting a Business and Keeping Records," which can provide a wealth of information. It also contains an SS-4 form-Application for an Employer Identification Number (EIN), Form 1040-ES for reporting estimated taxes, and Publication 910-Guide to Free Tax Services. The Small Business Start-up Kit for California also includes the SS-4 form and 19 other forms.
How Long Should These Records Be Maintained?
To meet the rigors of the IRS, supporting files or documents for a tax return should be maintained for three years after the return is filed. However, some records should be kept indefinitely, such as your schedule of depreciation. Your capital expenditures will be depreciated over a period of time depending upon the recognized useful life of the objects. Some items, like computers, may be depreciated in two or three years, furnishings in seven or seven and a-half years, build-out for office space may be the life of the lease agreement, etc. If you plan to have employees, keep up to date with all payroll records. Keep in mind that such records are subject to inspection by the IRS and the State of California.
Becoming an Employer
If, when you go into practice, you hire an employee or employees, such as clerical assistance, bookkeeper, licensees, or registered interns, you will find that you become an agent of the government, charged with collecting taxes from your employees and turning it over to the government. You will be required to withhold from the employees' payroll tax for FICA, Medicare, and federal and state income taxes, as well as pay the employer's portion of FICA, amongst others, and pay these promptly to the IRS and State Franchise Tax Board.
When a new employee is hired, you must furnish the employee with a Form W-4, which he or she is to complete and return to you. Form W-4, when completed, will give you the employee's social security number and the number of withholding exemptions the employee is claiming, which is used to determine how much income tax you must withhold from his or her wages. Form W-4 is to be retained by you, and is generally not filed with the IRS, unless the employee claims ten or more withholding exemptions, or who claims he/she is exempt from income tax withholding. Further, by January 31st of each year, you must furnish each employee with copies of Form W-2, Annual Wage and Tax Statement, showing the taxable wages paid to the employee during the preceding calendar year and the taxes withheld. By the last day of February, the original of each W- 2 and a summary form, W-3, is to be filed with the IRS. Of course, if you hire out the accounting/bookkeeping responsibilities, these critical functions will be addressed by the person/entity with whom you employ or contract. Remember, you will be liable for the accuracy of the records, whether or not you prepare them.
Not all individuals who perform services for your business will be employees. In many cases it is possible to structure your legal relationships with persons who provide services for you so that they are considered independent contractors for tax and other legal purposes. From your standpoint as an employer, it is preferable to be able to treat such hired persons as independent contractors, since you do not have to pay taxes or do withholdings. The reason is the independent contractor is considered to be self-employed and would have the same responsibilities you have for reporting and paying tax on his/her income. However, you must file a Form 1099-Misc for each independent contractor (with certain exceptions) to whom you make payments of $600 or more during a calendar year. Because of the obvious advantages to employers who treat their employees as independent contractors, the IRS has been aggressive in attempting to re-classify socalled independent contractors as employees where they perform functions more typical of an employee. Form SS-8 can be used to make a determination as to whether or not the hired person may be an independent contractor or should be classified as an employee. Additionally, keep in mind that an intern may not, under any circumstances, be an independent contractor.
With relatively few exceptions, all businesses with employees must pay unemployment taxes, both federal and state. These taxes are imposed entirely upon the employer. In addition to all other taxes, as well as California payroll withholding tax, you must also pay State Disability Insurance (SDI).
While not a tax, even though it looks like one, if you have employees, or even persons that volunteer in your practice, you are required by state law to obtain Workers' Compensation Insurance. Such insurance provides benefits to employees who suffer job related injuries or becomes ill from a disease caused by the job. It covers not only the costs of health care for the employee, but also provides compensation for the employee rendered unable to work. The consequences for not providing workers compensation coverage can be stiff-don't overlook this coverage if you have even one part-time employee or volunteer. Typically this coverage can be obtained most readily and cost effectively from the State Compensation Insurance Fund.
Note that you do not need workers' compensation coverage for yourself if you are in a sole proprietorship or the sole stockholder in a professional corporation.
Keep in mind that if you have a Keogh, you may need to make Keogh contributions for employees. Whether or not contributions for employees will be required depends upon the structure of the Keogh. Further, depending upon the structure, part-time workers may be treated the same as full-time employees. Be sure to check on the structure of your Keogh prior to hiring employees.
Other Employer Obligations
Employers are required to post notices and notify new employees in writing, by the end of their first pay period, of their right to workers compensation in case they incur a job-related injury or illness. Post a notice to employees giving the insurance carrier's name that advises employees of their rights to compensation if injured on the job and the right to select their own physicians.
Have a written safety plan
Post a notice on employee benefits/hours/ fair employment/equal employment opportunities; such forms can be obtained from a multitude of sources such as office supply houses or from the Federal Employment and Housing Authority. This posting is generally only required of employers with five or more employees.
Post a notice regarding wage-hour laws and working conditions that can be obtained from supply houses or the Industrial Welfare Commission, Division of Labor Standards Enforcement.
You must verify that each new employee is legally eligible to work in the United States. Both you and the employee must complete the Immigration and Naturalization Service (INS) Form I-9, Employment Eligibility Verification. You can get the form from the INS, Department of Justice or the INS website.
Report of New Employees-Federal law requires all employers to report to the Employment Development Department (EDD) within 20 days of start of work, employees who are newly hired or rehired. This information is to assist state and county agencies in locating parents who are delinquent in their child support obligations. The form is a DE 34.
The information contained in this article is intended to provide guidelines for addressing difficult business and legal dilemmas. It is not intended to address every situation that could possibly arise, nor is it intended to be a substitute for independent advice or consultation. When using such information as a guide, be aware that laws, regulations, and technical standards change over time, and thus one should verify and update any references or information contained herein.
This article appeared in the January/February 2004 issue of The Therapist, the publication of the California Association of Marriage and Family Therapists, headquartered in San Diego, California. This article is intended to provide guidelines for addressing difficult legal dilemmas. It is not intended to address every situation that could potentially arise, nor is it intended to be a substitute for independent legal advice or consultation. When using such information as a guide, be aware that laws, regulations and technical standards change over time, and thus one should verify and update any references or information contained herein.