We often find that physicians have received little advice or direction from their CPAs in the area of asset protection. As a CPA with more than 20 years of experience and an attorney and lecturer to CPA groups nationwide, we are surprised by how little attention this area of financial planning is given. Ask yourself: Has your CPA helped you shield your assets from unnecessary exposure? The answer is usually “no.”
Unfortunately, even when doctors do get asset protection advice from their accountants, the advice is often wrong. Common mistaken advice ranges from, “You don’t need to worry about asset protection, you have insurance” and “Why create a professional corporation for protection… it’s not worth the expense?” to “Just put the assets in your spouse’s name—it will protect you.”
Let’s take a look at each of these common CPA myths:
“Your Insurance Protects You”
We strongly advocate including property and casualty (P&C) insurance as part of your asset protection plan, but an insurance policy is 50 pages long for a reason. There are a variety of exclusions that most doctors never take the time to read, let alone understand. This is true for personal policies, like homeowner’s, car, and umbrella insurance, as well as business policies and medical malpractice, which is the most important type of policy for physicians.
Even if your policy does cover the risk in question, there are still risks of the claim going beyond coverage limits (malpractice judgments do periodically exceed traditional $1/3 million coverage), strict liability, and bankruptcy of the insurance company. In any of these cases, you could be left with the sole responsibility for the loss. Lastly, even if all your losses are covered within coverage limits, you may see your future premiums skyrocket.
For these reasons, while P&C insurance is undoubtedly part of every client’s comprehensive asset protection plan, it is unwise to rely solely on insurance for your protection, especially when many asset protection techniques can help you reduce taxes and build retirement wealth.
“You Don’t Need a Professional Corporation (PC)”
We have talked to numerous physicians over the years who have followed this advice from their accountants. The main justification seems to be the expense ($1,000 or so to create, a few hundred dollars per year to maintain) and the additional paperwork (tax return, minutes, etc). What is so troubling here is that physicians seem to follow this incorrect advice, while almost no other sophisticated businessperson would. In our experience, no other owner of a significant business (with $100,000 or more in annual revenues, employees, etc.) would allow that business to operate in his or her own name.
When you fail to use a PC or other similar entity (PA, PLLC) to run your practice, you expose all your personal wealth to any claim from the practice. While CPAs are quick to point out that the PC will not protect your assets from malpractice anyway (and they are right), they ignore all liability risks created by employees that you might have nothing to do with. For example, consider car accidents employees might get in when driving for the business (receptionist going to pick up lunch for the office), a slip and fall in the office, or a car accident in the parking lot, among many other possibilities. If implemented correctly, the PC would protect your personal wealth against these potential liabilities and more; but, without one, your personal wealth could be vulnerable.
For this kind of protection, the small cost and paperwork seems to us well worth it. In fact, most CPAs themselves have such an entity in place, and nearly 100 percent of solo attorneys use one. Why is it not good enough then for small medical practices?
“Use a ‘Disregarded Entity’ for Tax Purposes”
Related to the mistaken advice that a physician should avoid using a PC is this more-common misguidance for solo physicians: have a professional entity but choose to have the entity taxed as a “disregarded entity” by the IRS. Essentially, a solely owned LLC can elect not to be treated as a separate entity but instead as a disregarded entity where the profits or losses simply flow to Schedule C of the tax return of the sole owner (physician). CPAs often recommend this as a cost-saving measure—saving the cost of a simple tax return, perhaps $1,000 per year.
Such advice may be detrimental from a tax perspective, because by choosing a disregarded status for a solely owned LLC, the doctor may also pay more taxes on his or her annual income than if a different tax status were chosen; typically the “S” tax status would be superior here.
“Just Put Your Assets in Your Spouse’s Name”
The third common mistaken CPA advice about asset protection is that assets in your spouse’s name cannot be touched. Many physicians have come to us with their assets in the name of the non-physician spouse and assumed those assets were protected from lawsuits against the physician. In many states, this simply will not hold up. To see how this legal interpretation may be inaccurate, ask yourself:
- Was the doctor’s income used to purchase the asset?
- Has the doctor used the asset at any time?
- Does the doctor have any control over the asset?
- Has the doctor benefited from “the spouse’s assets” in any way?
If the answer is “yes” to any of these questions, most courts find that at least half of the asset’s value will be exposed to claims against the doctor. In community property states, 100 percent of the value may be exposed, as a community asset.
Another good litmus test is to ask the CPA what he or she thinks will happen in a divorce if you follow the advice to put all the assets in the spouse’s name. The CPA may say that the court will treat these assets as joint because you are still treating them as joint (living in the house, spending the accounts, paying the taxes). Therefore, the court knows that you haven’t really “given the asset away” to the spouse. This may be the way the court will treat the assets for creditor purposes as well.
In today’s litigious environment, asset protection should be a fundamental part of any physician’s financial plan. It is unfortunate that so many doctors are often misled by inadequate advice from their accountants. Physicians should be wary of such advice and ask an advisor well-versed in asset protection to be part of your team and work with your CPA. The authors welcome your questions.
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