On Dec. 22, 2017, President Trump signed the massively complex Tax Cuts and Jobs Act into law. The vast majority of tax provisions are effective after 2017, but there is one particular provision to know regarding the ability to more rapidly write off new and used depreciable property purchased after Sept. 27, 2017. Much tax planning should come from this new tax law.
Most physicians will see reduced income taxes in 2018 due to reduced tax rates across the board with the highest tax rate dropping from 39.6 percent to 37 percent. The long-term capital gain tax rates stay at the highest rate of 20 percent, plus 3.8 percent should the capital gain be of an investment, passive nature. So the game plan stays the same with regard to characterization of taxable income — try to convert ordinary income taxed at 37 percent to the lower long-term capital gain rates of either 20 percent or 23.8 percent. This conversion requires special planning and particular circumstances but should always be considered.
Choice of taxable entity for medical practices is always an important part of any tax reduction planning. For married physicians with taxable income below $315,000, they should avoid the C corporation because of the ability to exclude some of their taxable income under the new Qualified Business Income exclusion for pass-through businesses, such as limited liability companies and partnerships. For married physicians with taxable income in excess of $415,000, the 20 percent reduction of Qualified Business Income is fully phased out and is therefore of no benefit to the physician. This leaves us with the question of what should married physicians who have taxable income in excess of $415,000 choose or change to in terms of the choice of taxable entity for their medical practice.
Physician C corporations after 2017 will enjoy a maximum tax rate of 21 percent versus the maximum tax rate for individuals of 37 percent. C corporations who intend to leave funds inside the corporation can be a good choice of entity to operate under. However, physicians should not leave substantial funds inside their business entity, nor invest in appreciating assets through their business entity. In addition, there is the double tax situation of the C corporation paying taxes on the retained income and then the physician paying taxes on the cash dividend distributions from the C corporation. Tax calculations for the most part show the combined double tax to be higher than the single tax paid by physicians on flow-through business entities where income is reported directly on the physicians’ personal tax return.
S corporations are still the better choice for most physician practices. A twist to this discussion is to consider having medical practices with several physicians use a limited liability company (LLC), taxed as a partnership, to bill patients and pay office expenses. Each physician would be a partner in the LLC through independent individually owned PA entities that have elected to be taxed as S corporations. This would allow for some planning opportunities to reduce Social Security and Medicare taxes on the income allocable to each physician while also providing each physician some flexibility to deduct certain expenses that as a whole the physician group would have difficulty collectively approving. Of course, all tax planning comes with some caveats that need to be fully understood.
With regard to rental properties owned by physician groups, the LLC entity taxed as a partnership is still the preferable choice to hold and operate the properties. If the property’s market value is of a substantial amount, then a limited partnership entity is likely preferable to assist in avoiding the Texas Franchise tax upon the sale of the property. LLC and partnership entities under the new Qualified Business Income law may get a reduction in the taxable income of the rental property.
Also, the new tax law increased tax-free transfers of your estate during your lifetime or at death to $11.2 million per person. This amount is inflation adjusted and will continue to increase over time but sunset on Dec. 31, 2025. With this increased exemption, it is even more important to review assets/investments within your estate that produce income and/or are appreciating. Gifting those investments to family members would reduce your taxable estate and transfer future income to be taxed at the family member’s tax rate, which might be a lower rate. However, the step up in basis rules were retained for estates passing assets to heirs, so any gifting should be weighed against retaining the asset in the estate, as gifting does not provide for a step up in basis of the gifted asset to its market value at the date of the gift.
Under the new tax law starting in 2018, there is no deduction allowed for any type of entertainment, amusement or recreational activity. I mention this only for keeping this in mind as decisions are made to incur entertainment expenses for the benefit of your practice.
There is so much in the Tax Cuts and Jobs Act bill. I have just touched the surface. Tax advisors are studying the new law now. Be sure to get with your tax advisor soon.
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.