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MONTHLY TAX NEWSLETTERJuly 2012
For doctors in practice, making a lot of decisions every day is just part of the deal. While some practice management issues come with only one obvious solution, most require that you spend time researching a variety of options only to learn that there is more than one correct answer. Selecting the best type of entity for your practice is one of those issues with multiple correct answers.
If you are in the process of opening or purchasing a practice, now is the time to determine which type of entity would work best for your practice over the long-term. Or, if you have owned a practice for a number of years, why not take this opportunity to determine if you have selected the best type of entity for your situation. Let’s take a look a pros and cons of the various entities available to healthcare professionals in practice.
Most Popular Entity Selection
Most healthcare professionals operate their practice as a Sole Proprietorship, a Limited Liability Company (LLC), or an S-Corporation. Different rules apply to the different type of entity. The first question, however, is why even bother to create an entity for your practice. Why not just go with a sole proprietorship or a general partnership?
If you are involved with partners in your practice, setting up an entity is a must. While asset protection laws vary by state, running your practice as an S-Corp or LLC should protect your personal assets from your business partner’s mistakes. Without forming an entity, you would be running the practice as a General Partnership which offers no protection to that risk.
For practices with one owner, setting up an entity helps keep your practice separate from your personal finances. Some people who own a practice and also own the real estate where their practice is located actually end up establishing two entities - one to hold the assets of the practice and a second to hold the real estate.
Let’s start by looking at two major characteristics for these three options. While Single Member LLCs and S-Corporations are separate legal entities, only an S-Corp comes with the requirement of filing a separate tax return each year. Sole proprietors and Single Member LLCs report their income and expenses on a Schedule C filed as part of the owner’s individual income tax return.
Benefits of S-Corporations
When your practice is set up as a sole proprietorship or LLC, you pay Social Security and Medicare taxes on 100 percent of the income that you report on your tax return. By setting up your practice as an S-Corp, you have the option of taking a portion of the profits as an “S-Corp Distribution” instead of as salary. By doing so, you avoid paying these two taxes. Currently, the maximum combined tax rate for these two taxes is 13.3%. Take a salary of more than $110,100 (in 2012), and the rate drops to 2.9%.
Keep in mind that the rules require that you pay yourself no less than a “reasonable salary” and then only take the excess income as S-Corp distributions. Have the S-Corp issue you a distribution of $50k instead of a paycheck and you’ll save from between $1,450 and $6,650 in Social Security and Medicare taxes, depending on your total annual salary from the practice and other sources.
Pitfalls of an S-Corporation
There are some pitfalls with S-Corps to consider. For starters, expect to pay higher accounting fees since the S-Corp needs to file its own tax return each year. You should also look into the minimum tax that an S-Corp will need to pay in your home state as well as any other states where you operate your practice.
When it comes to deducting certain types of expenses, staying away from the S-Corp might be prudent. It’s actually easier for people who operate their practice as a Sole Proprietor or LLC to claim the home office deduction or to deduct their automobile expenses.
If there are multiple owners to the practice, maintaining an LLC allows the owners to claim any professional expenses not run through the practice directly against their share of the practice income. For practices set up as an S-Corp, each owner would need to claim these expenses as a miscellaneous itemized deduction, which are only allowable to the extent they exceed 2% of each owner’s income and then are capped for any owner subject to the Alternative Minimum Tax (AMT).
And you need to be careful if you earn a good salary working outside of your practice, and also own a profitable practice. Since an S-Corp is required to pay its owners a reasonable salary, there is a chance that someone earning more than the FICA max might end up paying extra Social Security taxes if your salary from all sources exceeds $110,100. Yes, you will get back the Social Security taxes withheld from your pay, but you don’t get back the Company match of 6.2%. The cost of this tax could be as high as $6,93 ($110,100 * 6.2%).
It’s not uncommon for healthcare professionals to lose money in years that they open a practice from scratch, purchase an existing practice, or expand their current practice. Assuming you borrow money to fund these transactions, the type of entity determines how much of these losses the you can claim each year.
To maximize the upfront losses you can claim, an S-Corp might not be the best choice. If you set up your practice as an S-Corp, you can only claim losses to the extent of the money you invested into the practice. Guaranteeing loans or other liabilities is not sufficient to allow you to claim these losses.
Running your practice as an LLC or a Sole Proprietorship allows you to claim larger losses up front. The only catch is that you need to be personally liable for paying off these loans.
If you borrow money to purchase, open, or expand a practice, the S-Corp tends to be the better option with respect to managing the tax burden while repaying the loans. Since the losses are not allowable up front for the S-Corp, those suspended losses are released as you generate profits to pay down the loans. With an LLC or a Sole Proprietor, you’ll claim the losses in the early years which will not provide you with any tax shelter as you pay down your loans.
Do you have children under the age of 18? If so, going with the Single Member LLC or Sole Proprietor will let you take advantage of a quirky tax break. While you get to deduct “reasonable” wages paid to your child for services provided, neither you nor your child owes Social Security or Medicare taxes on wages paid. Plus, he or she does not owe any federal income taxes on the first $5,800 of wages earned (in 2011). (We wrote about this opportunity in our May 2007 Newsletter.)
This is true arbitrage. You move money from your practice’s bank account to your child’s bank account, and the government gives you a tax break on that money. You can also contribute money into a Roth IRA for your child based on the wages you report. Assuming the Roth rules don't change during your child's lifetime, your child will benefit from decades of compounded growth within these tax-free investment accounts.
Caveat employer. Keep in mind that you are only supposed to pay your child a fair wage for services actually performed. You will also need to complete and file quarterly and annual payroll tax forms, as well as prepare a W-2 form for your child.
Flexibility of an LLC
LLCs are very flexible entities. With an LLC, you can start as a disregarded Entity, and your practice will be treated as a Sole Proprietorship for tax purposes. When the time is right, you can then elect treat your LLC as an S-Corp by filing a Form 8832. The beauty of this strategy is that you can continue to use same EIN and NPI, and don’t need to re-credential with any insurance companies you submit claims to.
Entity Selection Scorecard
Choosing the correct entity for your practice is a tough decision. You should definitely reach out to a lawyer and an accountant who are familiar with your state’s rules and regulations prior to making your final decision.
Even so, here is an Entity Selection Scorecard to help you with your decision:
S.P. = Sole Proprietor, S LLC = Single Member LLC, M LLC - Multiple Member LLC
R-2012-23, Feb. 16, 2012
WASHINGTON –– The Internal Revenue Service today issued its annual “Dirty Dozen” ranking of tax scams, reminding taxpayers to use caution during tax season to protect themselves against a wide range of schemes ranging from identity theft to return preparer fraud.
The Dirty Dozen listing, compiled by the IRS each year, lists a variety of common scams taxpayers can encounter at any point during the year. But many of these schemes peak during filing season as people prepare their tax returns.
“Taxpayers should be careful and avoid falling into a trap with the Dirty Dozen,” said IRS Commissioner Doug Shulman. “Scam artists will tempt people in-person, on-line and by e-mail with misleading promises about lost refunds and free money. Don’t be fooled by these scams.”
Illegal scams can lead to significant penalties and interest and possible criminal prosecution. The IRS Criminal Investigation Division works closely with the Department of Justice to shutdown scams and prosecute the criminals behind them.
The following is the Dirty Dozen tax scams for 2012:
More information on these Tax Scams is available at www.irs.gov/newsroom/article/0,,id=254383,00.html.
At my firm this year, we instituted a Book Club for the first time. We are currently reading The 7 Habits of Highly Effective People by Stephen R Covey. We are scheduled to discuss one habit per month for the remainder of the year. I highly recommend that you read this book if you haven't done so already, or re-read this book if it's been a while since you last read it.
When reading about Habit 2, Begin With The End in Mind, I was struck by this passage from the book:
Management is a bottom line focus: How can I best accomplish certain things? Leadership deals with the top line: What are the things I want to accomplish? In the words of both Peter Drucker and Warren Bennis, 'Management is doing things right; leadership is doing the right things.' Management is efficiency in climbing the ladder of success; leadership determines whether the ladder is leaning against the right wall.
I found these words to be quite meaningful because I read them following a somewhat heated discussion I had with a staff member. She was upset with me because I wasn't able to find time to help her with an client issue that she was trying to resolve. She was looking for me to help her get this issue right. (Ultimately we met later that morning and everything worked out fine for our client.)
After reading this passage, I gave some thought to the roles I need to play at my 12 person CPA firm. My first idea was to define these terms: leader, manager, supervisor, coach, and mentor. According to dictionary.com:
A person or thing that leads. Also, a guiding or directing head, as of an army, movement, or political group.
A person who has control or direction of an institution, business, etc., or of a part, division, or phase of it. Also, a person who controls and manipulates resources and expenditures.
A person who supervises workers or the work done by others. Dictionary.com defines supervises as: oversees a process, work, workers, etc. during execution or performance.
To give instruction or advice to in the capacity of a coach; instruct.
A wise and trusted counselor or teacher. Also, an influential senior sponsor or supporter.
At a professional practice the size of my firm, my brother and I are the primary source of these five positions to most of our ten-person staff. We are not only the leaders and the managers of the firm, but, in most cases, are also the supervisors, coaches, and mentors.
If you are in a position of responsibility, I'm sure you struggle with which of these roles you play with respect to your direct reports and/or to other staff members who you interact with on a regular basis; especially when you factor in how busy you are trying to provide great care to your patients as well as running your practice.
If you have already come up with solutions to this practice management dilemma that you would like to share with other readers of this newsletter, please e-mail me at firstname.lastname@example.org.
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