IT’S NOT JUST WHAT YOU MAKE; IT’S ALSO WHAT YOU KEEP.
With the economic impact of the new healthcare laws and the President’s final 2011 budget uncertain, practice owners and managers would be well served to focus their attention at this time on profit retention strategies. The thousands of doctors we serve are facing challenges including:
- Current Depressed Economic Conditions
- Decreasing Compensation and Insurance Reimbursement Rates
- Increasingly Hostile Litigation System that Targets YOUR wealth
- Stalled or Negative Investment Momentum
- Increasing Overhead and Liability Insurance Costs
- Increasing burdens of Income and Estate Taxes; the estimated “death tax” will be 55% of everything over $1MM in 2011 as of the time of publication
A properly constructed profit retention plan is generally easy to implement and is one of the only ways owners can take more dollars home without earning extra dollars.
Some ideas to help you keep a larger portion of every dollar you make:
Increasing Business Tax Structure efficiency. You walk around turning off lights to save money but is your business tax structure maximized to pay as little as legally possible? One of my Associates, attorney Trisha Lotzer, of Lotzer Law Group in Scottsdale, Arizona examines this issue below. Trisha’s practice, like mine, includes a heavy emphasis on working with medical practices and their owners and she has successfully negotiated over $200 million dollars in transactions including successful medical and dental practice formations, affiliations, purchases and sales
The purpose of profit preservation is to preserve or even increase a practice’s profitability regardless of changes in healthcare policy or expiring tax cuts. Profit preservation plans should be tailored in the context of governmental policies, business operations and customized to maximize the profit preservation potential consistent with personal and professional goals, such as estate and transition or succession planning. Important strategies that owners should consider at this time include changing from an S-corporation or C-corporation status, energy studies, cost segregation studies, insurance and investment audits.
Currently, your practice’s tax status is either working for or against you in terms of profit preservation. With this fact in mind, how do you know which is the right election for your practice and how do you make sure that you are not passing up any dollars that you rightfully earn?
Most healthcare practices and small businesses are organized as S-corporations, or as LLCs with an S-election. This election is generally advantageous for tax purposes because it allows practice owners to avoid the “double taxation” that necessarily accompanies C-corp status and allows owners to benefit from earnings that “pass through” to their individual returns. Whether you are a C-Corp or an S-Corp, it is especially important to consider the negative consequences of a C-Corp, such as double taxation, and reassess your corporate tax status.
Following are two (simplified) examples and clarify what is meant by “double taxation” and “pass through” income. Let’s compare an S-Corp and a C-Corp that each earn $1,000,000 of taxable income after qualifying deductions and expenses:
The C-corporation that earns $1,000,000 is taxed at the highest corporate tax rate of 35%. That leaves $650,000 after taxes are paid. If you, the practice owner, take that $650,000 as a dividend that dividend will be taxed at 20% (the anticipated dividend tax rate). The result of the tax on the dividend results in another $130,000 in taxes, for a grand total of $480,000 in taxes and you, the practice owner, nets $520,000.
With the S-Corp. that earns $1,000,000 the practice owner would net $600,000 and pay just $400,000 in taxes. This is because the $1,000,000 “passes through” to the owner’s individual tax return. And, even in the highest bracket, the most the owner would be taxed is 40% because there would be no “double tax” on a dividend.
(Note from Ike: This is one of many formulas that competent tax counsel must advise you on. Other common formulas often include the physician taking a commercially reasonable salary, let’s say $250K, and taking the balance as dividends from the corporation they own. This moves a larger portion of practice income to the capital gains rate, using the hypothetical numbers above, 20% for capital gains vs. 40% as personal income.)
This merely represents the most basic “double tax” scenario. There are other taxes, including state taxes and self-employment taxes, and other factors that must be considered and weighed for your particular practice scenario. Tax policy must also be taken into consideration when electing tax status as a strategy for profit preservation.
For example, in 2011, some S-Corp practice owners may find themselves pushed into higher personal tax brackets. Based on current reports from congress and the White House, the President’s proposed budget will likely include a tax cut for middle-class taxpayers and the previously enacted tax cuts on upper-income taxpayers would be allowed to expire. If that occurs, individuals currently taxed at 33% would be taxed at 36% and those taxed now at 35% would be taxed at 39.6%. Therefore, we can reasonably anticipate that a number of practice owners will have a higher income tax for certain individuals and for that reason it is reasonable to consider a change to C-Corp status.
While there are a few exceptions, there is a rule that states that if you lose your S-election you can’t re-elect S-Corp. status for five years. For this reason, current S-Corp owners and those contemplating a change from S-Corp to C-Corp status should be especially cautious. Change to or from a C-Corp should be considered by ever practice owner but it should only be executed with the guidance of qualified tax and wealth preservation specialists.
Trisha’s examination of this issue above is a great start, here are some other profit retention strategies I encourage my clients to examine:
Cost Segregation Studies. These studies allow meaningful tax deductions now when you need them most as opposed to spread over 30 years at about 3% per year the way they are typically taken. Most commercial property, even leased, qualifies for the study and the deductions and we can even arrange for a free feasibility study for commercial property with an aggregate value of at least $1MM, an easily attainable entry level. As a bonus, you can even re-capture lost depreciation for as much as the last 20 years!
Energy Studies. Again, owners of commercial properties are seeing energy tax credits of up to $1.80 per square foot when the study is completed and simple low cost changes are made. Would that kind of recurring savings be valuable enough to you to, for instance, change the kinds of light bulbs you use and add a skylight? In most cases it is.
The financial “Audit”. Give your insurance and investment planning a physical and make sure it is working as hard for you as you did to earn it. We have seen that at the worst, some clients lost as much as 60% of their investment portfolios due to the market and their investment allocations while others were down only a fraction of what the market lost and are relatively free of anxiety. Why the huge disparity in results between advisors? What we see is that it is relatively easy to make money in good times by using a simple allocation table that at first glance seems well diversified between different types of investments such as technology, energy and etc. What those plans, such as the cookie cutter ones we see from certain commercial brokerage firms are typically lacking in is a good down-market strategy that values principal protection as highly as it does growth. There are ways to get all or most of the market growth available with guaranteed rates of return or principal guarantees. These types of strategies, when properly allocated, are part of the backbone of what saved the second, more fortunate group of investors described above. These clients are not only whole or close to it, but are now poised and financially equipped to take advantage of emerging opportunities.
Similarly, we find that many practice owners are paying more than necessary for various types of insurance coverage they have in place while they are at the same time lacking in many types of coverage I now describe as essential or are underinsured in areas like their disability insurance. To put it simply, the cost of life insurance, as just one example is now cheaper for the consumer than it was a few years ago. This means that any policy that is more than a few years old should be audited to see if it can be converted or replaced at a lower cost. How dramatic can the changes be? In one case, a doctor’s children will receive 500% more from one of her life policies because of some simple changes we made and issues we spotted without her paying any increase in premium.
Again, as the economy and income and profit slow, never taking a step back, or at least taking as few as possible, becomes more important than ever before. Remember, a portfolio that is down 50% will need to DOUBLE to get back to where it was. How long did it take you to double your money the last time? Do you have that kind of time left? If you don’t like the way you answered those questions for yourself, perhaps it’s time to take a good look at how you are structured and what kind of stop-loss measures you have in place. In many cases it is not too late to make some positive changes and “buy and wait” is not the right answer for every investor or every investment.
Increasing your personal tax efficiency. We deal with high net worth clients every day and are continually surprised by the amount of money that they leave on the table for the government by not maximizing their legal options. For most physicians “just” an IRA or 401K is not adequate tax planning. Even if the money you save is “long term” or retirement money that cannot be used now, you still get to keep it. Many of the most sophisticated programs provide multiple benefits like estate planning and Asset Protection.
A few examples of planning to consider include section 79, post retirement medical reimbursement, defined benefit programs and captive insurance plans. Don’t know where to start? Don’t worry, we can help direct you to experts to show you which plans apply to your unique situation and which have features like guarantee of principle, low market risk, tax deductibility and Asset Protection.
Examining your current practice tax status and the other measures suggested above are all highly effective profit preservation strategies. Each strategy should be examined with caution and undertaken only after a careful analysis of the overall economic factors of the practice and the long term effects or plans of the practice and its owner.
Most strategies can be implemented rather quickly and effectively at any time during the fiscal year. Some mid-year changes may require additional income tax reporting work by shareholders and advisors. However, in many cases this small amount of paperwork can yield great rewards and is a powerful way to preserve practice profits in uncertain times. As always contact us for more info or to discuss these issues and how they apply to your practice.
RELATED ARTICLE: BUSINESS SURVIVAL PLAN
ABOUT OUR GUEST CONTRIBUTOR:
Lotzer Law Group, P.C. – Phoenix, AZ: http://lotzerlaw.com/
Attorney Trisha Lotzer Specializes in business law for corporations, small businesses, medical groups and medical and dental practices. She has successfully negotiated over $200 million dollars in transactions including over $95 million dollars of successful medical and dental practice formations, affiliations, purchases and sales. She can be reached at 866-570-4449 or at: Trisha@LotzerLaw.Com
CIRCULAR 230 NOTICE: To comply with U.S. Treasury Department and IRS regulations, we are required to advise you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used, by any person for the purpose of (1) avoiding penalties under the U.S. Internal Revenue Code or (2) promoting, marketing, or recommending to another party any transaction or matter addressed in this article.