common tax problems in running a physician practice

#AICPA_HEALTH

Common Tax Problems inRunning a Physician Practice

AICPA Healthcare ConferenceNovember 14, 2013

Presented by Greg B. Gates, CPA, JDPrincipal PYA GatesMoore

Atlanta, GA

American Institute of CPAs #AICPA_HEALTH

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 co-founding 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.

[email protected]

mailto:[email protected]


Income Tax Trivia

1. In what year was the first U.S. income tax imposed?

2. What was the tax rate?3. Which constitutional amendment allows

Congress to levy an income tax?4. What was the due date of individual

income tax returns?5. Who was the only U.S. President that

visited “the” IRS office building while in office?


Common Tax Problems

Educating Physicians about “Phantom Income”

Reasonable Compensation/Justification for Dividend Payments

S Corporation Conversions

Automobiles

Owner-Occupied Lease Arrangements


Year End Tax Projection

“Common Scenario”

CashTaxable Income

Projected at Year End $100,000$200,000

Payment of Bonuses <100,000><100,000>

Cash Balance $ 0

Taxable Income$100,000

Doctor’s Question: “How can this happen?”


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.


Operating Expenses

Cash Tax

Collections $10,000

$10,000

Operating Expenses(e.g. office rent, staff

salaries, supplies, etc.) (10,000)

(10,000)

Cash Balance $ 0

Taxable Income

$ 0


Timing Differences (pay cash for fixed assets)

Tax

Cash Tax Years 2-5

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

Tax Timing Differences (borrow for operating expenses) Cash

Tax Years 2-5

Loan Proceeds/Collections $90,000

$ - $90,000

Pay Expenses/Loan Payoff

(90,000) (90,000) -

Cash Balance/Taxable Income $ -

$(90,000) $90,000

(assumes a 5 year loan with equal principal payments)


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.


C Corporations

Deferred Income Tax Liability

Illustration

Net income at October 31$ 900,000

Cash & other Current Assets<1,030,000>

Net Book Value of Fixed Assets < 160,000>

Liabilities 340,000

Current Year “M-1’s” 20,000

NOL Carryforward 0

Deferred Income$ 70,000


Taxable Income to Reflect

Eliminate Deferred Income$107,692

Proof:

Taxable Income$107,692

Federal Income Tax Rate 35%

Tax$ 37,692


Solution

Just pay the tax!

“Three Year” Plan

Annual Payment Thereafter


Agreements


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


S Corporations


S Corporation

Doctors “Remuneration” Paid by• Salary• Dividends

Issue of “Reasonable Compensation”

Justification of Dividends


“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?


Involve clients in the discussion of reasonable compensation:

e.g.• Neurosurgery Group• Cardiology Group


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.”


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.”


IRS GuidelinesNotice 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 re-characterize 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.


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


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.)


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

% 44% 56% 100%

Average $434,800 $550,000 $984,800


“Reasonable Salaries”

Determination of “Technical Profits” = $2,925,000

Dividends 2,750,000

Sullivan Cotter and Associates, Inc.(rounded) Median 75th Percentile 90th Percentile

General Cardiology -National 300,000 375,000 523,000

Invasive-Interventional - Southeastern 433,000 540,000 ID*

Invasive-Noninterventional 397,000 628,000 703,000

Medical Group Management Assoc. (rounded)

General Cardiology 367,000 492,000 613,000

Invasive-Interventional 486,000 665,000 844,000

Invasive-Noninterventional 431,000 537,000 691,000

* ID = insufficient data


Compensation Benchmarks:

Specialty and %

DOL MGMA AMGA Sullivan Cotter

Towers Watson

Internal Medicine:

25%

$137,310 178,146 192,866 170,700 157,800

OBGYN : 25% $165,830 247,815 259,020 220,000 250,000Pediatrician:

50%$154,650

216,112 222,827 191,535 170,000

Surgeon- General: 25%

Not reported (1)

$303,626 317,156 277,126 312,500

Department of Labor Bureau of Labor Statistics Versus Common Industry Benchmarks

• This wage is equal to or greater than $187,199 per year.


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



2013 Imposition Of Additional .9% Medicare FICA On Those “Earning” More Than $250,000

Illustrations of Built In Gains & Losses


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!


Fair Market Total Ist YearBasis Value BIG BIG

Cash 704,825 704,825 - -

Due From Affiliates 187,549 187,549 - - Due From OfficersFurniture, Fixtures & Equipment* 350,023 1,189,021 838,998 -

Accounts Receivables* - 748,948 748,948 748,948 Supplies - 32,086 32,086 32,086 Liabilities (14,811) (14,811) - - Estimated Built In Gains 1,227,586 2,847,618 1,620,032 781,034

Accounts Payable (to include accrured wages, if any) (100,000) (100,000)

Built In Gain (Or Built in Loss needed) $ 1,520,032 $ 681,034

Cash available with suspension of shareholder wages (Jan 1 - Mar 15, 2013) (980,127) (581,034)

Additional Bonus Needed (or "Cushion" in BIG Calculation) $ 539,905 $ 100,000

Round To: $ 540,000 $ 540,000 Gross Wage $ 540,000 $ 540,000 Taxes (at 40%)(Estimate) (216,000) (216,000)Loans Payable to Doctors OR (324,000)Net Checks $ 324,000 $ -

Board Resolution is needed to a) declare the built-in gains bonus, and b) to suspend shareholder wagesuntil the built-in gain bonus is paid.



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)


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


Ultimate Solution(Group Practice)

No corporate cars

Discuss liability issues

Practice can reimburse doctors for business use

percentage of automobile expenses


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


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


Facts/Results

2. Rental Activity Reflects a Loss

Question: Can the loss be used?

Answer: It depends.


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


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.

common tax problems in running a physician practice

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