Improving Your After-Tax Financial Efficiency
Two strategies for recapturing dollars left on the table.
Most physicians strive to achieve two goals in their practice—to “do good,” by being a quality practitioner and helping patients; and to “do well” in terms of financial rewards. Unfortunately, as to the second goal, many physicians in private practice do not operate their practices with optimal after-tax efficiency. We often see doctors leaving tens of thousands of dollars “on the table” each year, which can equate to nearly $1 million of lost wealth over a career. The good news is that many physicians can likely improve their post-tax bottom line.
Over the past three decades, there has been no better time to focus on post-tax efficiency due to several factors:
1. Proposals from President Trump and the GOP are on the table to reduce the top individual tax rates and corporate tax rates. Taxes that came into being due to the Affordable Care Act may also go away. But, unless these cuts are revenue neutral, they will sunset in 10 years, making it important to take full advantage of these changes right away.
2. The potential for reduced corporate tax rates and reduced rates on pass-through business income will make corporate structure planning vital.
3. More taxpayers could be subject to the 20 percent capital gains rate as the proposals call for that rate to be effective for married taxpayers with taxable income above $225,000 (as opposed to the current $466,950).
Causes of Dollars “Left on the Table”
While the causes of “dollars left on the table” in a medical practice can range from billing errors to unproductive employees, our expertise and focus is corporate structure, tax reduction, and benefit planning. Ahead, we will focus on two strategies for recapturing some of the funds left on the table:
1. Using the ideal corporate structure
2. Maximizing tax-deductible and non-qualified benefits for the physician-owner(s)
Keep an open mind. Changing just a few areas of your practice could recover $10,000-100,000 of “lost dollars” annually.
1. Using the Ideal Corporate Structure
Choosing the form and structure of one’s medical practice is an important decision that can have a direct impact on your financial efficiency and the state and federal taxes you will owe every April. Yet, from our experiences in examining over 1,000 medical practices, most physicians get it wrong. Here are a few ideas to consider about corporate structure:
A. You likely want to avoid using a general partnership, proprietorship, or “disregarded entity”: These entities are asset protection nightmares and can be tax traps for physicians. Nonetheless, we have seen very successful doctors operating their practices as such. Doctors who run their practices as partnerships, proprietorships, or disregarded entities have a tremendous opportunity to find “dollars on the table” through lower taxes—especially through the Medicare tax on income. This can be a $10,000-30,000 annual recovery.
B. If you use an S corporation, don’t treat it like a C corporation. We estimate that 60 to 70 percent of all medical practices are S corporations. Unfortunately, many physicians do not take advantage of their S corporation status—using inefficient compensation structures that completely erase the tax benefits of having the S in the first place. If your practice is an S corporation, you should maximize your Medicare tax savings through your compensation system in a reasonable way. This can be a $10,000 plus annual recovery for practices not properly structured. Should pass-through income be subject to lower tax rates under new tax laws, this will become even more important as it will lower not only Medicare taxes but also income taxes.
C. Implement a C corporation. Once upon a time, C corporations were the most popular entity for US medical practices. Today, fewer than 15 percent of medical practices operate as C corporations. We believe it is because most physicians, bookkeepers, and accountants focus on avoiding the corporate and individual “double tax” problem. But this is only one of several considerations a physician must make when choosing the proper entity. If you have not recently examined potential tax benefits you would receive by converting your practice to a C corporation, we recommend that you do so. A reduced tax rate on C corporations will make this evaluation especially pertinent.
D. Get the Best of Both Worlds—Use Multiple Entities. Very few medical practices use more than one entity for the operation of the practice. If they do, it is simply to own the practice real estate. While this tactic is also wise from an asset-protection perspective, its tax benefits are typically non-existent. Some practices may benefit from a superior practice structure that includes both an S and a C corporation. This can create both tax reduction and asset protection advantages. If you have not explored the benefits of using both an S and C corporation to get the best of both worlds, now is the time to do so.
2. Maximizing Tax-Favored Benefits
If you are serious about capturing “dollars left on the table,” tax efficient benefit planning must be a focus. Benefit planning can help you reduce taxes, but that is not enough. Benefit plans that deliver a disproportionate amount of benefits to employees can be deductible to the practice, but too costly for practice owners. These plans can be inefficient. To create an efficient benefit plan, physicians need to combine qualified retirement plans (QRPs) with non-qualified plans.
Nearly 95 percent of physicians who have contacted us over the years have a QRP in place, such as 401(k)s, profit-sharing plans, money purchase plans, defined benefit plans, 403(b)s, SEP or SIMPLE IRAs, and other variations. Contributions to these plans are typically 100 percent tax deductible and the funds in these plans are afforded excellent asset protection. However, there are two problems with this approach.
First, most physicians have not examined their QRPs in the last few years. The Pension Protection Act improved the QRP options for many doctors—many of you may be using an “outdated” plan and forgoing further contributions and deductions allowed under the most recent rule changes. By maximizing your QRP under the new rules, you could increase your deductions for 2017 by tens of thousands of dollars annually, depending on your current plan.
Second, the vast majority of physicians begin and end their retirement planning with QRPs. Have you explored non-qualified plans recently? The unfortunate truth for many physicians is that they are unaware of plans that enjoy favorable long-term tax treatment. If income tax marginal rates come down as the administration has promised (and such rates will come back up because of sunset provisions described above), the next few years may become an ideal time to fund non-qualified plans—perhaps the most advantageous time to fund such plans since the 1980s. If you have not yet analyzed all options for your practice, we highly encourage you to do so.
Nearly everyone reading this article would like to be more tax efficient, especially with anticipated tax changes for 2017 and beyond. We hope these new tax rules motivate you to make tax and efficiency planning a priority, so you too can recapture the “dollars left on the table.” The authors welcome your questions.
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David B. Mandell, JD, MBA, is a former attorney and author of more than a dozen books for doctors, including Wealth Protection Planning for Dermatologists. He is a principal of the financial consulting firm OJM Group www.ojmgroup.com, where Carole C. Foos, CPA is a principal and lead tax consultant. They can be reached at 877-656-4362 or firstname.lastname@example.org
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This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.