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Many dermatologists in private practice inadvertently lose up to tens of thousands of dollars each year by less-than-optimal management of taxes. The good news is that it possible to improve your post-tax bottom line in a number of ways.
Most dermatologists strive to achieve two goals in their practice: first, to “do good,” by being a quality practitioner and helping patients; and second, to “do well” in terms of financial rewards. The bad news, as to the second goal, is that many dermatologists in private practice do not operate their practices with optimal after-tax efficiency, sometimes leaving up to tens of thousands of dollars “on the table” each year, which can equate to nearly $1 million of lost wealth over a career. The good news is it possible to improve your post-tax bottom line in a number of ways.
There is truly no better time, in the past 30 years, than now to focus on post-tax efficiency. When the Taxpayer Relief Act of 2012 was signed in early January 2013, taxes increased on high-income taxpayers like most of you-in some cases, dramatically. Now, in 2015, the following realities have set in:
1. Many dermatologists face a 50%+ marginal income tax regime, when all of the new tax increases are accounted for. Depending on the city/state where you live, tax rates are now between 45-55%. Income tax planning is more important now than at any time in the last 30 years.
2. These higher rates will apply to more income, with the reinstatement of the itemized deduction limitations and the personal exemption phase-out.
3. Total taxes on long term capital gains and dividends can now reach 23-33% when the new federal tax, healthcare reform tax and state and local taxes are assessed.
While the causes of dollars left on the table in a medical practice can range from billing errors to unproductive employees, this article focuses on three strategies for recapturing some of the funds left on the table:
1. Using the ideal corporate structure
2. Maximizing tax-deductible benefits for the physician-owner
3. Utilizing a captive insurance arrangement
The most important thing you can do is keep an open mind. Just because you have operated your practice a certain way for 5, 10 or 20 years, you don’t have to keep doing the same thing. Changing just a few areas of your practice could recover $10,000 to $100,000 of lost dollars annually.
Choosing the form and structure of your medical practice is an important decision and one that can have a direct impact on your financial efficiency and the state and federal taxes you will owe every April 15. Here are a four critical considerations about corporate structures for medical practices:
1. Avoid using a partnership, proprietorship, or disregarded entity: These entities are asset protection nightmares and can be tax traps for physicians. On the brighter side, doctors who run their practices as a partnership, proprietorship, or disregarded entity have a tremendous opportunity to find dollars on the table through lower taxes-especially on the 3.8% Medicare tax on income. This can be a $10,000 to $30,000 annual recovery.
2. If you use an “S” corporation, don’t treat it like a “C” corporation: Between 60% to 70% of all medical practices are “S” corporations. Unfortunately, many physicians do not take advantage of their “S” corporation status. They use inefficient compensation structures that completely erase the tax benefits of having the “S” in the first place. If your practice is an “S” corporation, consider talking with your financial advisor about maximize your Medicare tax savings through your compensation system in a reasonable way. This can be a $10,000 to $30,000 annual recovery for practices not properly structured.
3. Consider implementing a “C” corporation: Once upon a time, “C” corporations were the most popular entity for U.S. medical practices. Today, fewer than 15% of medical practices operate as “C” corporations. Why? It may be because most physicians, bookkeepers and accountants focus on avoiding the corporate and individual “double tax” problem. However, that focus can cause physicians to overlook the tax-deductible benefit plans that are only available to “C” corporations and that can create a $10,000 to $30,000 annual improvement.
4. Get the Best of Both Worlds – Use Multiple Entities: Very few medical practices use more than one entity for the operation of the practice; if they do, it is simply to own the practice real estate.
Successful practices can often benefit from a superior practice structure that includes both an “S” and a “C” corporation. This can create both tax reduction and asset protection advantages and create a $10,000 $40,000 annual improvement.
If you are serious about capturing dollars left on the table, tax-efficient benefit planning must be a focus. Benefit planning can definitely help you reduce taxes, but that is not enough. Benefits plans that deliver a disproportionate amount of the benefits to employees can be deductible to the practice, but are often too costly for the practice owners. These plans can be considered inefficient. To create an efficient benefit plan, physicians need to combine qualified retirement plans (QRPs) and non-qualified plans.
Nearly 95% of the physicians who have contacted us over the years have some type of QRP in place. These include 401(k)’s, profit-sharing plans, money purchase plans, defined benefit plans, 403(b)’s, SEP or SIMPLE IRAs, and other variations. This is positive, as contributions to these plans are typically 100% tax deductible and the funds in these plans are afforded excellent asset protection. However, there are two problems with this approach: 1) many QRPs are outdated; and 2) QRPs are only one piece of puzzle.
If you have a QRP but have not examined their QRPs in the last few years, you might not know that the Pension Protection Act improved some QRP options, so you may be using an outdated plan and forgoing further contributions and deductions allowed under the most recent rule changes. By maximizing your QRP under the new rules, you could increase your deductions for 2013 by tens of thousands of dollars annually, depending on your current plan.
Many dermatologists begin and end their retirement planning with QRPs, and may have not considered any other type of benefit plan. Have you explored non-qualified plans recently? The unfortunate truth for many physicians is that they are unaware of plans that enjoy favorable short-term and long-term tax treatment. These can have annual tax advantages that vary widely ($0 to $50,000) and also have varying degrees of long term tax value as well.
For practices with gross revenues over $3 million, a small captive insurance arrangement might be significant way to recapture dollars left on the table. Physicians often have uninsured risks in their practices-excess malpractice, economic risks, employee risks, and litigation defense risks from any number of audit or fraud claims. A common strategy is to save funds personally and hope that these risks don’t come to fruition. Reliance on this de facto self-insurance means that those physicians are not taking advantage of the risk management, profit enhancing and tax reduction benefits that are available with a captive insurance arrangement.
By creating your own captive insurance company (CIC), you can essentially create a pre-tax war chest to manage such risks. If structured properly, the CIC enjoys tremendous risk management, tax and asset protection benefits. The potential tax efficiency, in fact, can be in the hundreds of thousands of dollars annually. While an experienced law firm, captive management firm, and asset management firm are crucial, you, as the captive owner, can maintain control of the CIC throughout its life. It can then become a powerful wealth creation tool for your retirement.
Nearly every one of you reading this article would like to be more tax efficient, especially with a higher tax regime in place for 2015 and beyond. We hope these new tax rules motivate you to make tax and efficiency planning a priority, so you too can recapture the dollars left on the table.
OJM Group, LLC. (“OJM”) is an SEC registered investment adviser with its principal place of business in the State of Ohio. This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.