Common Tax Problems in Running a Physician Practice

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Medical practices face unique challenges when it comes to taxes. For this reason, PYA Principal Greg Gates has compiled guidance to educate physicians on practical income tax issues. He recently presented “Common Tax Problems in Running a Physician Practice” at the 2013 AICPA Healthcare Industry Conference.

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Common Tax Problems in Running a Physician Practice

  1. 1. Common Tax Problems in Running a Physician Practice AICPA Healthcare Conference November 14, 2013 Presented by Greg B. Gates, CPA, JD Principal PYA GatesMoore Atlanta, GA #AICPA_HEALTH
  2. 2. Greg holds a BS in Business Administration from Colorado State University and a Juris Doctorate from the Marshall-Wythe School of Law, College of William and Mary. Prior to cofounding GatesMoore in 1982, Greg worked as a tax specialist with a Big 4 accounting firm and was Vice President of a national practice management consulting firm. As a Certified Public Accountant, he specializes in tax law and in the area of physician "buy-ins," compensation arrangements, practice mergers, practice valuations, strategic planning, and retirement plan design and compliance. Greg is a frequent speaker for various medical societies. He is a member of the Georgia Bar Association, the Georgia Society of Certified Public Accountants, and the American Institute of CPAs. Greg served as an adjunct faculty member of The Kennesaw State University Physician’s MBA program while teaching a course in medical practice valuation. Greg was named by Atlanta Magazine (for the sixth consecutive year) as one of Atlanta's 2013 FIVE STAR Wealth Managers, in the category of Taxation. GatesMoore merged with Pershing, Yoakley & Associates on January 1, 2012. ggates@pyagatesmoore.com American Institute of CPAs #AICPA_HEALTH
  3. 3. Income Tax Trivia 1. 2. 3. 4. 5. In what year was the first U.S. income tax imposed? What was the tax rate? Which constitutional amendment allows Congress to levy an income tax? What was the due date of individual income tax returns? Who was the only U.S. President that visited “the” IRS office building while in office? American Institute of CPAs #AICPA_HEALTH
  4. 4. Common Tax Problems Educating Physicians about “Phantom Income” Reasonable Compensation/Justification for Dividend Payments S Corporation Conversions Automobiles Owner-Occupied Lease Arrangements American Institute of CPAs #AICPA_HEALTH
  5. 5. Year End Tax Projection “Common Scenario” Projected at Year End Payment of Bonuses Cash Balance Taxable Income Cash $100,000 <100,000> $ 0 Taxable Income $200,000 <100,000> $100,000 Doctor’s Question: “How can this happen?” American Institute of CPAs #AICPA_HEALTH
  6. 6. Explanation Three Types of Expenses Operating Expenses Timing Differences Permanent Differences • • • • • 50% of meals & entertainment Officers life insurance premiums Treasury stock purchases Federal income taxes paid (C Corporation) Etc. American Institute of CPAs #AICPA_HEALTH
  7. 7. Operating Expenses Cash Tax $10,000 $10,000 salaries, supplies, etc.) (10,000) (10,000) Cash Balance $ Collections Operating Expenses (e.g. office rent, staff Taxable Income American Institute of CPAs 0 $ 0 #AICPA_HEALTH
  8. 8. Timing Differences (pay cash for fixed assets) Tax Years 2-5 Cash Tax Collections $50,000 $50,000 Equipment Purchase/Depreciation* (50,000) (10,000) (40,000) Cash Balance/Taxable Income $ $40,000 $(40,000) - $ - *Computed on a straight line basis without regard to Section 179 for illustration Timing Differences (borrow for operating expenses) Cash Loan Proceeds/Collections $90,000 Pay Expenses/Loan Payoff (90,000) (90,000) Cash Balance/Taxable Income $ $(90,000) - Tax Tax Years 2-5 $ - (assumes a 5 year loan with equal principal payments) American Institute of CPAs #AICPA_HEALTH $90,000 $90,000
  9. 9. Permanent Differences Cash Tax Permanent Differences* Collections $10,000 $10,000 Meals & Entertainment (50%) (10,000) (5,000) Cash Balance/Taxable Income $ 0 $ 5,000 *Permanent differences include such expenses as penalties, 50% of meals and entertainment, officers life insurance, federal income taxes, gifts in excess of $25 per donee, club dues, Treasury Stock, etc. American Institute of CPAs #AICPA_HEALTH
  10. 10. American Institute of CPAs #AICPA_HEALTH
  11. 11. C Corporations Deferred Income Tax Liability Illustration Net income at October 31 Cash & other Current Assets Net Book Value of Fixed Assets Liabilities Current Year “M-1’s” NOL Carryforward Deferred Income American Institute of CPAs $ 900,000 <1,030,000> < 160,000> 340,000 20,000 0 $ 70,000 #AICPA_HEALTH
  12. 12. Taxable Income to Reflect Eliminate Deferred Income $107,692 Proof: Taxable Income Federal Income Tax Rate Tax $107,692 35% $ 37,692 American Institute of CPAs #AICPA_HEALTH
  13. 13. Solution Just pay the tax! “Three Year” Plan Annual Payment Thereafter American Institute of CPAs #AICPA_HEALTH
  14. 14. Agreements American Institute of CPAs #AICPA_HEALTH
  15. 15. Shareholder Agreements Practice Valuation formula should include deferred income tax liability* as an “offset to value” Buy In Be aware of a deferred income tax liability* if a doctor is buying into a practice *Or Deferred income in a flow through entity American Institute of CPAs #AICPA_HEALTH
  16. 16. S Corporations American Institute of CPAs #AICPA_HEALTH
  17. 17. S Corporation Doctors “Remuneration” Paid by • Salary • Dividends Issue of “Reasonable Compensation” Justification of Dividends American Institute of CPAs #AICPA_HEALTH
  18. 18. “Chicken or the Egg” Does the IRS concern itself with the amount of dividends if they deem compensation to be reasonable? OR If you can justify the dividends paid, does the level of compensation matter? American Institute of CPAs #AICPA_HEALTH
  19. 19. Involve clients in the discussion of reasonable compensation: e.g. • • Neurosurgery Group Cardiology Group American Institute of CPAs #AICPA_HEALTH
  20. 20. Distribution V. Wages/Salary IRS REQUIREMENT: “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.” American Institute of CPAs #AICPA_HEALTH
  21. 21. IRS Guidelines IRS Definition of Reasonable Compensation: “Reasonable compensation is the value that would ordinarily be paid for like services by like enterprises under like circumstances.” American Institute of CPAs #AICPA_HEALTH
  22. 22. IRS Guidelines Notice of Acceptance as an S Corporation We would also like to take this opportunity to inform you of your tax obligations related to the payment of compensation to shareholder-employees of S Corporations. When a shareholder-employee of an S Corporation provides services to the S Corporation, reasonable compensation generally needs to be paid. This compensation is subject to employment taxes. Tax practitioners and subchapter S shareholders need to be aware that Revenue Ruling 74-44 states that the Internal Revenue Service (IRS) will recharacterize small business corporation dividends paid to shareholders as salary when such dividends are paid to the shareholders in lieu of reasonable compensation for services. This position has been supported in several recent court decisions. American Institute of CPAs #AICPA_HEALTH
  23. 23. Services of Shareholder 9 Factors (Fact Sheet 2008-25, August 2008) 1. Training and experience 2. Duties and responsibilities 3. Time and effort devoted to the business 4. What comparable businesses pay for similar service (US Bureau of Labor Statistics) 5. The use of a formula to determine compensation 6. Payments to non-shareholder employees 7. Dividend history 8. Timing and manner of paying bonuses to key people 9. Compensation agreements American Institute of CPAs #AICPA_HEALTH
  24. 24. Dividends are distributions of Practice profit from: Return on Capital Investment Profit from employment of non-shareholder physicians and mid-level providers Profit from Ancillary Services (e.g. “nuclear” services, labs, x-ray, CT, MRI, etc.) American Institute of CPAs #AICPA_HEALTH
  25. 25. Illustration of Cardiology Practice Salary Dividends Total Doctor A $587,000 $550,000 $1,137,000 B 372,000 550,000 922,000 C 374,000 550,000 924,000 D 490,000 550,000 1,040,000 E 351,000 550,000 901,000 Total $2,174,000 $2,750,000 $4,924,000 % Average American Institute of CPAs 44% $434,800 56% 100% $550,000 #AICPA_HEALTH $984,800
  26. 26. “Reasonable Salaries” 75th Percentile 90th Percentile Sullivan Cotter and Associates, Inc.(rounded) Median General Cardiology -National 300,000 375,000 Invasive-Interventional - Southeastern 433,000 540,000 Invasive-Noninterventional 397,000 628,000 703,000 General Cardiology 367,000 492,000 613,000 Invasive-Interventional 486,000 665,000 844,000 Invasive-Noninterventional 431,000 537,000 691,000 523,000 ID* Medical Group Management Assoc. (rounded) * ID = insufficient data Determination of “Technical Profits” = $2,925,000 Dividends 2,750,000 American Institute of CPAs #AICPA_HEALTH
  27. 27. Compensation Benchmarks: Department of Labor Bureau of Labor Statistics Versus Common Industry Benchmarks Specialty and % DOL $137,310 Internal Medicine: 25% OBGYN : 25% $165,830 $154,650 Pediatrician: 50% Not SurgeonGeneral: 25% reported (1) MGMA AMGA Sullivan Towers Cotter Watson 178,146 192,866 170,700 157,800 247,815 259,020 220,000 250,000 216,112 222,827 191,535 170,000 $303,626 317,156 277,126 312,500 •This wage is equal to or greater than $187,199 per year. American Institute of CPAs #AICPA_HEALTH
  28. 28. Conclusions How to support your Reasonable Compensation Figure Develop a consistent year-to-year Reasonable Compensation Determine your Reasonable Compensation figure using the IRS guidelines and the 9 factors handed down by the courts Add to your Reasonable Compensation documentation, reasoning, and notes to your corporate minutes American Institute of CPAs #AICPA_HEALTH
  29. 29. S Corporation Conversions 2013 Imposition Of Additional .9% Medicare FICA On Those “Earning” More Than $250,000 Illustrations of Built In Gains & Losses American Institute of CPAs #AICPA_HEALTH
  30. 30. S Corporation Client Conversations One group did not convert due to C Corporation disability insurance premiums One group did not convert due to C Corporation long term care insurance premiums But, both groups were very appreciative of the analysis! American Institute of CPAs #AICPA_HEALTH
  31. 31. S Corporation Conversions Basis 704,825 Cash Due From Affiliates Due From Officers Furniture, Fixtures & Equipment* Accounts Receivables* Supplies Liabilities Estimated Built In Gains Fair Market Value 704,825 Total BIG - Ist Year BIG - - - 187,549 187,549 350,023 1,189,021 838,998 (14,811) 1,227,586 748,948 32,086 (14,811) 2,847,618 748,948 32,086 1,620,032 748,948 32,086 781,034 (100,000) (100,000) Accounts Payable (to include accrured wages, if any) Built In Gain (Or Built in Loss needed) - $ 1,520,032 Cash available with suspension of shareholder wages (Jan 1 - Mar 15, 2013) Additional Bonus Needed (or "Cushion" in BIG Calculation) $ (980,127) 681,034 (581,034) $ 539,905 $ 100,000 Round To: $ 540,000 $ 540,000 Gross Wage Taxes (at 40%)(Estimate) Loans Payable to Doctors Net Checks $ 540,000 (216,000) $ $ 324,000 540,000 (216,000) (324,000) - OR $ Board Resolution is needed to a) declare the built-in gains bonus, and b) to suspend shareholder wages until the built-in gain bonus is paid. American Institute of CPAs #AICPA_HEALTH
  32. 32. Automobiles Holy Grail = Corporate Car Typical Problems  Purchase made in or lease executed in the doctor’s personal name, yet the note or lease payment is paid through the practice  Documentation of Business Use %  Definition/Understanding Business Use  Failure to add personal use % to W-2  Disallowance of expenses on audit (Payback Provision) American Institute of CPAs #AICPA_HEALTH
  33. 33. Solutions As always, the solutions are education and communication Assign the lease to the corporation (with lessor’s consent) Forward worksheet/correspondence for completion of W-2 addition American Institute of CPAs #AICPA_HEALTH
  34. 34. Ultimate Solution (Group Practice) No corporate cars Discuss liability issues Practice can reimburse doctors for business use percentage of automobile expenses American Institute of CPAs #AICPA_HEALTH
  35. 35. Owner Occupied Lease Arrangements Typical Scenario – Doctor (or a group of doctors) owns his medical office building as a single member LLC and leases to his practice Practice is structured as: • LLC • S Corporation • C Corporation • Sole Proprietorship American Institute of CPAs #AICPA_HEALTH
  36. 36. Facts/Results 1. Rental Activity Reflects a Profit • • • General Rule: all “real estate” is passive Under NOPA rules this profit cannot be used to offset losses from other passive activities Worst of both worlds American Institute of CPAs #AICPA_HEALTH
  37. 37. Facts/Results 2. Rental Activity Reflects a Loss Question: Answer: Can the loss be used? It depends. American Institute of CPAs #AICPA_HEALTH
  38. 38. Facts/Results If, a) the real estate activity is owned in the same %s as the medical practice, and b) the practice is a C Corporation Then NO, the loss may not be used (suspended and used consistent with suspended losses). Bad result = NOPA rules American Institute of CPAs #AICPA_HEALTH
  39. 39. Facts/Results If, a) the practice is a flow through entity, and b) if, an election is made (for the first year of the activities) to aggregate the activities, Then YES, the loss may be used as an offset against practice income. Particularly helped if the real estate entity had a cost segregation study performed. American Institute of CPAs #AICPA_HEALTH

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