As my firm continues to prepare income tax returns for our physician clients and their medical practices, many of our physician clients are seeing a nice reduction in their projected income tax liability for the 2018 year and if there are no major changes to the tax laws just passed, they will continue to see a nice reduction through the year 2025.
With that in mind, 2018 quarterly estimated payments and income tax withholding on salaries should be calculated with the reduced tax rates in mind. There is no need to give the IRS extra money that must be returned with no interest earned.
One of the major components of the new tax law, other than the reduced tax rates across the board, is the Qualified Business Income (QBI) deduction. This deduction essentially reduces a taxpayer’s certain specifically defined and qualified taxable income by a straight 20 percent, thus making the highest tax rate for this taxable income go from 37 percent to 29.6 percent. If it sounds too good to be true, then I am proud of you. For physicians operating under a regular “C” corporation, their salary is excluded from this deduction. Additionally, the QBI deduction comes with a very complicated set of rules that needs more clarification and guidance from the IRS. However, for physicians operating as sole proprietors, “S” corporations, PLLCs or partnerships, there is the potential to take advantage of the QBI deduction.
In most of the tax articles that hit the media about the QBI deduction, the concept that physicians cannot take advantage of this deduction is repeated. However, if a married physician’s taxable income is below $415,000, then there is the possibility of taking all or a portion of the QBI deduction. The main step for these married physicians whose taxable income is below $415,000 is to make sure they run their medical practice as a pass-through business (sole proprietor, PLLC, S corporation or partnership).
If the majority of a physician’s income comes from his/her medical practice and the physician’s taxable income exceeds $415,000, then the QBI deduction is severely limited or all together disallowed. It may be more beneficial to separate nonmedical income from the medical practice so that there is more of an opportunity for that income to qualify for the QBI. Some initial ideas to try to qualify for the QBI deduction include:
- Have that medical building and expensive medical equipment separated into a rental entity to try to have that rental income qualify for the QBI. This idea, like all the others here, must be further addressed with clarification of the new tax law.
- Have any income generated from the management of other medical practices, such as debt collection or office support, separated from the medical practice into its own entity for the same possible benefit.
- Have any employee leasing work/revenue separated into a separate entity and use an industry standard markup of the revenue/profit for this service.
- Increase deductions of the medical practice to get below the $415,000 threshold. With that in mind, reconsider more aggressive medical practice retirement plans, or use of a health savings account or even more traditional deductions like increasing charitable donations. With the ability to immediately write off all medical equipment purchased, this would be something to consider as well.
As we learn more about the new tax law, there will be more ideas that will come for our physicians to consider to try to take advantage of the QBI deduction. We will try to keep everyone posted.
As briefly mentioned before, physicians operating under a regular “C” corporation do not get any opportunity to take advantage of the QBI deduction. The “C” corporation choice of entity is usually not a good tax choice for physicians to operate under. Conversion from a “C” corporation does take planning and analysis but can be a good tax saving move. There is some talk that with the new flat tax rate of 21 percent for “C” corporations, physicians should either change their medical practice choice of entity to this type of corporation or just keep the current “C” corporation status. Many studies have been done on this idea of the “C” corporation. It is usually not a good idea for medical practices to operate as a “C” corporation as medical practices should retain as little cash as possible and not invest in appreciating investment-type assets. Additionally, the double taxation from a “C” corporation (the corporation pays taxes on the retained income and then the shareholders pay tax on the corporate dividends as the corporation releases cash to the shareholders) negates the benefit of the lower tax rate at the corporate level.
The discussion here is mainly food for thought as the new tax law needs technical corrections and much clarification as to the intent of the law. The details are likely not to come for many months. Still, it is always advisable to regularly meet with your tax advisor to reduce your tax burden.
Jim Rice, CPA, is a shareholder at Sol Schwartz & Associates PC. He has 39 years of experience in public accounting. In addition to providing business consultation, financial planning and various other accounting services, Rice specializes in income tax planning and consultation. He works with a high concentration of physician practices and high net worth individuals. Contact Rice at 210-384-8000, ext. 112, or firstname.lastname@example.org.