If you’re serious about finding different tax strategies, the good news is there are a few strategies you can start implementing right now. Here are some of the ways you can approach your medical practice’s taxes going forward.
Proper Entity Selection
One of the most basic but most important choices you can make for your medical practice is the choice of entity. Your entity selection will be determined by who the owners of the business will be and how the profit will be taxed in your practice.
The right entity choice for you depends on a few factors.
· How much revenue are you generating?
· Do you have employees?
· Do you need to protect any assets or yourself?
· What state is your practice located in?
· What are your costs and managerial responsibilities?
· Are you looking for more permanence or transferability?
Here are the options available to medical practices, as well as their major benefits and drawbacks. Remember, depending on the state your practice operates in, some of these options won’t be available to you.
A sole proprietorship is one of the common entity types chosen by medical professionals because it’s simple and inexpensive to set-up and maintain.
As a sole proprietor, you pay income tax at your ordinary rate and self employment tax on 100% of the profit from your business. Self employment tax is when you are responsible for all 15.3% of your Social Security and Medicare taxes with an additional 0.9% Medicare Tax if your income is over $200,000 filing as a single or $250,000 if filing jointly. You do not take a W-2 salary.
While sole proprietorships are easy to administer, they create unlimited individual risk for you, the owner and they tend to be audited more frequently then Partnerships, S-corps, or C-corps by the IRS. Even if you create a single member limited liability company (SMLLC), as a physician, you will not be able to avoid personal liability.
Partnerships are pass-through entities. The partnership’s tax return acts as an information return and the income and losses both pass through the entity and into the owners’ personal tax returns.
Similar to sole proprietorships, 100% of partnership profits will be passed to the owner and taxed at your ordinary rate and subject to self employment. You do not take a W-2 salary. You would be forced to choose the partnership option if you have more than one owner, which in some states can include your spouse.
Again, you still have liability issues with a partnership unless you choose to be a limited liability company (LLC) but, again, as physicians the LLC protections do not apply to you.
Like partnerships, S-Corporations are also pass-through entities where any income or losses are generally taxed at the entity level. It is important to note some states will impose an entity level tax.
Where S-corporations differ from partnerships and sole proprietorships is in the way they are taxed. You are required to take a reasonable salary in your S-corp which will be subject to social security and medicare taxes. However, any profit above your salary is considered a distribution and not subject to social security and medicare taxes. This can be a significant tax savings depending on your circumstances.
Although there are tax saving attributes of the S-corporation, they are more expensive and time consuming to administer. They also require you to be on payroll and limit the types of ownership.
A C-Corporation is a stand alone entity that protects against most business risks, excepting malpractice, for which you would still require insurance. However, it can protect you from general business liabilities. C-corps are easy to transfer via corporate stock and well understood governance laws. If you plan to have outside investors in your medical practice, this form of entity would be ideal.
C-corporation profits are taxed at the entity level. You receive a W-2 salary from the business and if you take any profits from the business they are treated as dividends and taxed at dividend tax rates. This causes the same profit to be double taxed. C-corporations are also more expensive and time consuming to administer.
Contributing to a retirement plan is the easiest and most direct way to lower your taxes. By contributing to a pre-tax retirement plan, you receive a deduction for the contribution. As a result, you pay less on taxes because the retirement contribution lowers your taxable income. It’s important to note that there are limits to how much you can contribute to your retirement depending on the type of retirement plan and whether you are the employee or the employer.
Another advantage of contributing to a retirement plan is that you may pay a lower rate at retirement than when you put the money into the retirement account. Your retirement savings are tax-deferred which means you do not pay tax when you contribute to your retirement but it will grow tax free. When you are required to take it out, you will have to pay tax on it at the time of withdrawal.
For many physicians who tend to retire before they have to take required distributions from their retirement account at age 72, they can take advantage of lower tax rates and start taking the retirement contributions earlier so their distributions are spread out over more years. After age 59 ½, there is no penalty for taking your retirement out before age 72.
They can also convert their pre-tax retirement to a post-tax retirement account, known as a Roth account, by paying tax at lower rates between retirement and age 72. This can be a significant strategy to save money and legacy planning.
Despite the direct tax benefits of retirement plans, there are a few things you need to think about when choosing the type of retirement plan for your practice:
· How aggressive do you want to be with retirement savings?
· Do you have employees?
· What sort of investments do you want in your retirement plan?
If you think a retirement plan makes sense for you, it’s time to choose the retirement best plan with the assistance of a tax or financial advisor.
Hiring family members in your practice allows you to shift income from your higher tax bracket to their lower tax bracket and create a deduction of their wages through your business. This gives you the opportunity to teach your children about handling money or to save for their retirement or education. Or, if you have parents that you regularly support, you can hire them in your practice and write off their support as wages.
If you have a sole proprietorship or partnership, you can hire your children and you do not have to pay social security or medicare taxes on their payroll. However, if you have an S-Corp or C-Corp, you will have to pay payroll taxes. In addition, when hiring a spouse, you can contribute more to their retirement based on the compensation they earn in your business. This can equate to more tax savings.
This is a fairly easy tax strategy, but you must follow a few rules. Any family member you hire must have a legitimate job in your practice and be paid a reasonable wage. It is important to document their job responsibilities and duties as well as open a separate bank account in their name.
Many medical practices build a large collection of medical equipment. This creates an opportunity to use the equipment in a gift-leaseback which effectively replaces the current salary of a family member. Typically, you would use this strategy for the support of a parent or child. You need to determine the fair market value of the equipment and the fair rental value of the equipment. A gift of the equipment is transferred to your family member and then the family member leases the equipment back to your business. This creates a rental deduction for the business, the family member receives income/support and you avoid payroll taxes on the family member’s salary. Family members can also continue to depreciate the equipment to help lower their taxable income.
It’s important to note that you need to do a proper appraisal of the equipment and have a rental agreement in place with your family member.
Hidden Business Deductions
Lastly, there are several deductions available to your medical practice that you might not know about.
The Augusta Rule is otherwise known as the 14-Day Rental Rule. The rule allows you to rent your primary residence (not a rental property) for up to 14 days per year without paying any tax on the rental income on your individual tax return regardless of how much you make. You do not receive any deductions for the time your home is rented. This can be done if you have a home near major sporting events or even rent your home to your business. You need to document the business purpose of the rental, such as corporate meetings, and charge a reasonable rental rate (similar to hotels or other similar venues).
The Home Office deduction is a broad topic that we can’t fully delve into here but what you need to know is if your home is your primary work place or the primary place where you perform administrative duties for your business, you can partially deduct many of your home’s expenses. This is done by dividing the total square footage of your office space by the total square footage of your home. The calculated percentage is then applied to the expenses associated with maintaining your home, such as mortgage interest, real estate taxes, utilities, repairs, and even the deprecation of your home.
If you have a home office, but also travel to another location for your practice such as a hospital or clinic, you can deduct the mileage from your home to your other work location. This also
applies to mileage between hospitals or going to business meetings or meals. It is recommended to use apps, such as MileIQ, that track your mileage using GPS and produce reports at the end of the year for tax preparation purposes.
A Health Savings Account (HSA) is one of the ultimate tax efficient ways to save. They allow for contributions to be contributed tax-free, grow tax free, and be distributed tax free if used for qualified medical expenses. In order to qualify for an HSA, you must meet the qualifying limits.
It is important to point out that you can pay for your medical expenses out of pocket and hold onto the receipts until you are ready to take the money out of the HSA. This could be later in retirement years allowing your HSA funds to grow more quickly and when you would like some extra tax-free income.
Bonus – Own Your Building? Cost Segregation Studies
Do you own the building your medical practice is in? Then as a bonus, you can consider a cost segregation study.
Cost segregation studies are used to break down a structure into various depreciable components that have shorter depreciable lives. This allows the owner to accelerate depreciation instead of the whole building being depreciated over a 40 year period.
Depreciation of property value is one of the more complex deductions. But having a cost segregation study done can uncover new tax-savings opportunities. These studies normally cover things you can’t calculate on your own such as:
· Structural elements
· Land improvements on the structure’s exterior
· Construction expenses
In general, these studies need to be completed by experienced firms. You can refer to the American Society of Cost Segregation Professionals for more in-depth information on how they can help you.
These are some of the strategies that you can probably implement right away but – as we all know – different diagnoses require different approaches and every business has a unique financial situation. Therefore, depending on the characteristics of your business and on the plans that you have for your future, it is always wise to consult with a qualified tax or financial advisor before moving forward with the implementation of any of these strategies.
Alexis E. Gallati, EA, MBA, MS Tax, CTP, is the founder and Lead Tax Specialist at Cerebral Tax Advisors, and the author of the book “Advanced Tax Planning for Medical Professionals”. Not only does she have extensive experience in high-level tax planning strategies and multi-state tax preparation, but she also holds two master degrees, and serves as an Enrolled Agent, NTPI Fellow, and Certified Tax Planner. Alexis grew up in a family of physicians and is married to a private practice physician. Physicians and healthcare professionals all over the country work with Cerebral Tax Advisors to lower their personal and business taxes through court-tested and IRS approved tax strategies.