Should You Restructure Your Medical Practice After the New Tax Law?

Converting from an S corp to a C corp isn’t a decision to make lightly

Now that the dust has settled from the rollout of the Tax Cuts and Jobs Act (TCJA), medical practices structured as pass-through entities are facing a dilemma: Since the tax reform significantly reduces the tax rates imposed on C corporations’ taxable income, is it beneficial to switch your structure?

The answer depends on several factors.

Since the release of the Internal Revenue Service’s (IRS) “check-in-the-box” regulations in the 1990s, U.S. businesses can choose whether they want to be taxed as C corporations or pass-through entities like S corporations, sole proprietorships, limited liability companies, or partnerships, subject to certain requirements. A wealth of variables may factor into this important decision, including state laws, creditors’ rights laws, securities laws, and, of course, tax laws.

Traditionally, doctors have preferred pass-through entities, with only a quarter of medical practices filing as C corps. That’s largely because of the double taxation that plagues C corps – once at the corporate level and again for any dividends reported on a doctor’s individual or joint return.

But the new tax reforms offer an enormous tax break for C corps – slashing the old maximum tax rate of 35 percent to a flat 21 percent. The TCJA also repealed the corporate alternative minimum tax (AMT) intended to ensure that corporations pay a minimum amount of tax by limiting or eliminating certain deductions, credits, and other tax preference items.

Pass-through entities also received a significant tax break with a 20 percent Qualified Business Income deduction that reduces the top federal tax rate on their income from 37 percent to 29.6 percent. Profits from pass-through entities are taxed according to the owner’s personal tax rate.

But here’s the thing: the QBI deduction is only temporary – it’s on the books through the end of 2025 – while the C corp tax relief is a permanent cut. And, of course, a 21 percent tax rate is better than 29.6 percent.

Also, doctors who own medical practices – as well as other skilled service providers – can only qualify for the pass-through break if they earn no more than $415,000 a year for a married couple filing jointly or $207,500 for a single filer. Skilled services are defined as any trade or business where the principal asset is the reputation or skill of one or more if its employees or owners.

Owners of pass-through entities who don’t fit the new law’s definition of a specified service trade or business aren’t subject to the same income limits to qualify for the tax break.

The challenges of C corps

So, what’s the hesitation about switching from a pass-through entity to a C corp? For one, there’s still that pesky matter of double taxation to consider. At C corp status, income is first taxed at the entity level rate of 21 percent, and then dividends are taxed to the individual at up to 23.8 percent. Once both taxes are paid, the effective tax rate of a C corps can actually be higher than a pass-through entity – especially if the owner can claim the QBI deduction.

It is, however, worth noting that C corp dividends are only taxed in the year they are paid. That means substantial tax savings could await medical practices that convert to C corps if they invest a high percentage of their profits back into the business as equipment or other property as part of a long-term strategy, instead of distributing them as dividends.

C corp structures also tend to make practice sales more problematic – something to consider as more and more doctors increasingly give up their independence to join larger groups or hospital systems. The double taxation generally makes asset sales by corporations less tax-efficient for sellers. If it is likely that your practice will be sold soon, retaining the pass-through structure may be wiser than converting to a C corp.

Another important consideration is that laws are never “permanent.” While the reduction to the maximum corporate tax rate was written for longevity, it could change, for instance, if Democrats win back the Senate and vote through alterations. At that point, converting back to a pass-through entity from a C corp could be quite complex.

Legal loopholes that lower your taxes

Skilled tax advisors may be able to find legal ways to help high-income doctors qualify for the lower pass-through tax rate. For instance, they may consider converting their office building into a real estate investment trust and charging themselves rent, thus reducing their income.

Of course, there also can be workarounds to avoid the double taxation of C corps for doctors and other professional service providers whose income is too high to qualify for the pass-through deduction. One tactic, while complex, is slicing the business into two or three separate entities to take advantage of the reduced corporate rate and other aspects of the new law. For instance, real estate or medical equipment could be owned by a C corps while practice income stays in an S corp to avoid being double taxed.

Practice owners can also extract money from a C corp by taking advantage of an array of tax-free benefits that are not generally available in pass-through entities. In a C corp, benefits such as health insurance and educational assistance are paid with pre-tax dollars; in an S corp, individuals pay taxes on their income before paying for benefits.

In fact, benefits costs are treated as wages for S corp owners, so they don’t interfere with their ability to claim the self-employment deduction on their personal returns.

There’s also a special benefit for owners of small C corps to exclude most – if not all – gains from the sale of corporate stock. Although this perk has existed since 1993, the previously high tax rate of C corps prevented most doctors from choosing this structure and taking advantage of this benefit.

Making the change

Changing from a pass-through entity to a C corps is relatively easy – in fact, if your practice is based in a state that allows for “statutory,” or streamlined, conversions, it can take less than a week if the process goes smoothly. Only about 15 states don’t allow this practice, including Arizona, New York, and Pennsylvania.

In most cases, the transformation is tax-free – but special circumstances could apply that could lead to a taxable event, so it’s wise to consult with a tax advisor before converting. That said, the cost of hiring lawyers and accountants to help with the process can add up; thus, it’s also important to tally your potential savings ahead of time to make sure you won’t wind up spending more money than you save by restructuring.

Also keep in mind note that the tax-free transition door only swings one way, so doctors need to do their homework and make sure restructuring is the proper path before walking through it. Converting back to a pass-through entity if you’re unhappy with the results could come at a hefty tax price. And read this carefully: The IRS only allows one change in your tax election every five years – unless the previous election was for a newly-formed entity or more than half the business’s ownership interests have changed.

So, what’s the right answer?

Switching from a pass-through entity to a C corp is not a decision to make lightly, and ultimately also involves many factors that have nothing to do with taxes. But the major changes enacted by the TCJA can make this option worth exploring under certain circumstances – especially for medical practices that don’t qualify for the 20 percent QBI deduction or want to maintain a long-term re-investment strategy in the business.

Of course, every medical practice will have unique circumstances to consider before contemplating such a significant change. Qualified tax advisors can help you carefully consider the pros and cons of converting, conducting extensive calculations and projections that help you make the best long-term choice for your practice.

Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact on their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning, and to find out how we can help your business exceed your expectations.

Doctors: Pay Off Student Loans Quickly

6 strategies for taking years off medical school debt and saving thousands in the process

Graduating from medical school is a major accomplishment. But for too many doctors, the celebration is dampened by the massive student loan debt that can go hand-in-hand with a medical degree.

In the class of 2018, 75 percent of medical school students graduated with student debt, according to a NerdWallet report. The average amount: $196,520, up from $190,694 in 2017.

To put that in perspective, the monthly payment on a $197,000 student loan balance is $2,212 on the standard 10-year federal repayment plan, assuming a 6.25 percent average interest rate. That’s more than double the average American’s monthly mortgage payment of $1,029.

Many doctors struggle to afford the full amount of their monthly student loan bills during their residencies and wind up putting their loans into forbearance until they complete the program. Unfortunately, the spiraling interest charges can result in a balance that’s thousands of dollars higher than the amount they originally borrowed by the time they become attending physicians.

Such crippling debt at the start of a medical career is a bitter pill to swallow, and repayment times on traditional student loans programs can drag on for 10 to 30 years. Let’s take a look at six ways to manage medical school debt while paying it down faster.

  1. Refinance with a private lender. The high balances and high-interest rates that characterize medical school debt can translate into a big opportunity for savings by refinancing with a private lender. The federal student loan interest rate is 6.6 percent for graduate programs like medical schools for the 2018-19 school year.

    Student Loan Hero points to reputable student loan refinancing lenders that offer rates as low as 1.95 percent – a significant saving over the length of the loan. Doctors are often ideal candidates for refinancing, as qualifying for the lowest rates requires excellent credit and a high-income relative to your debt.

    Consider this: if you took out a $189,000 loan at 7 percent interest, you would pay more than $74,000 in interest payments by the time you paid off your loan. If you refinanced your debt with a 5.5 percent interest rate, you would only pay $57,000 in interest and save $17,000.

    Of course, there’s a tradeoff to consider: refinancing means sacrificing federal loan benefits. That includes student loan forgiveness options, strong deferment protections, and access to federal income-driven repayment (IDR) plans.

  2. Consider an income-driven repayment plan. With an average first-year salary of less than $60,000, the high monthly demands of a standard 10-year student loan repayment plan can be a stretch for doctors during their residencies. But remember, deferring payments until you finish can tack thousands of dollars onto the cost of your loan.

    IDR plans can be a great option for residents who can’t afford to make full payments. There are four federal plans that cap monthly payments at a percentage of your discretionary income, making them easier to afford. That can extend your student loan term to 25 years, but also fights the balance creep of accumulating interest that accompanies forbearance.

    At a $56,000 annual income, you might owe as little as $315 a month. These plans also typically forgive any balance remaining after the repayment period.

    Here’s the downside: your low monthly payment may not cover all the interest that accumulates on your loan, increasing your total balance. To counter this, the government’s Revised Pay As You Earn (REPAYE) program offers a subsidy that waives half of any unpaid interest.

    But there’s a caveat there as well. Since payments grow with your income, your monthly payment could eventually wind up higher than it would have been in a standard 10-year federal repayment plan.

  3. Think carefully about how you file your taxes. For doctors who recently got married and are making payments on federal student loans, tax filing status as a married couple could significantly impact your student loan payments. Several IDR plans the only factor in joint income with your spouse if you file joint tax returns, while REPAYE considers your spouse’s income regardless of how you file.

    Of course, filing taxes as married-filing-separately could lead to higher taxes for the household and negate any associated student loan savings. It’s wise to consult with a qualified certified public accountant about the best way to file taxes while paying student loans.

    CPAs will also help you take advantage of relevant tax credits. For instance, if you made student loan interest payments in 2018, IRS tax law allows you to claim a student loan interest deduction of up to $2,500 on your 2019 tax return, as long as you and your student loans meet certain eligibility criteria. This credit is available to people with federal and private student loan debt, and you don’t even have to itemize your deductions to qualify. It is phased out, however, after a certain income level is reached.

  4. Don’t assume high salaries preclude you from forgiveness programs. If your income is low compared to your medical school debt, student loan forgiveness programs can serve as a lifeline. Public Service Loan Forgiveness (PSLF) offers student loan forgiveness after 10 years for doctors whose work qualifies as “public service.” That might include working for public or nonprofit hospitals, academia, the public health sector, or the military.

    To receive this loan forgiveness, you must make 120 monthly payments on an income-driven payment plan while working for a public service employer. If your income becomes too high to qualify, your payments cap out at the standard 10-year plan’s repayment rate, which still counts toward PSLF.

    Of course, there’s a catch: while public service can be personally rewarding and gives you the chance to help people who really need it, it does often come with lower salaries and less desirable locations. It can also limit your choice of specialties.

  5. Negotiate a physician signing bonus. Medical employers often use physician signing bonuses to attract top talent – and they can offer a great opportunity to pay down a substantial chunk of your medical school debt. In 2017, the average physician signing bonus was $30,000 – but the largest was $200,000.

    If you apply an extra lump-sum payment of $30,000 to the average loan of $197,000 at the beginning of the 10-year repayment schedule, you’ll save you more than $27,000, assuming the 6.6 interest rate. It also enables you to pay off your loans 27 months early.

    And don’t stop with your signing bonus. Continuing to make extra payments once you can afford to can eliminate a big portion of your student debt and help you pay it down faster.

  6. Live like a resident (just a little longer). To make extra payments on medical school debt, you need to make them a financial priority. The simplest way to do this is by mentally preparing yourself to live like a resident for a few more years, even though you may be earning three times as much.

    If you can keep your living expenses and discretionary spending low for the first few years that you earn an attending’s salary, you can pay off your debt aggressively – saving thousands of dollars in the long-term.

    Just be sure these important financial strategies are also in place:

  • An emergency fund that ideally contains enough to cover three to six months of living expenses
  • Investing in a retirement fund to at least get your employer’s 401(k) match
  • Paying down high-interest debt like credit cards

Medical student loan debt can feel daunting, and most doctors are anxious to get out from under the burden as quickly as possible. But practicing medicine leaves physicians little time to address student loan strategies – and most aren’t sure of the best path forward. A skilled CPA can help you discover ideas and tax strategies that may take years off your loans – saving thousands of dollars in the process.

Provident CPA & Business Advisors serves successful professionals, entrepreneurs, and investors who want to get more out of their business and work less, so they can make a positive impact on their lives and communities. Typically, our clients reduce their taxes by 20 percent or more and create tax-free wealth for life. Contact us for expert advice on tax planning, and to find out how we can help your business exceed your expectations.

Many Doctors Moonlight. How Does it Impact Their Taxes?

It’s important to understand what supplementing your income means for your taxes.

Modern medical debt is mounting. The figures run high to enter the medical field: $240,000 to $340,000 for a public or private degree with a median graduating debt of $190,000. It’s no wonder moonlighting is used by many physicians to get ahead. It can provide a valuable income stream at a crucial point in a graduate’s life, though not all who moonlight are fresh out of class.

The reasons aren’t solely financial, either. Moonlighters are part of a huge shift in the American workforce as up to 50 percent of the workforce goes freelance within the next decade. Today, burnout and job dissatisfaction mean upwards of half of all physicians are starting to seek some independence.

Whatever your motivation to moonlight, here’s what you need to know to file your taxable income properly.

Some important cautionary advice on moonlighting

You must first be certain that you’re permitted to moonlight under your current practicing circumstances. Failure to check your employer’s policy could result in severe penalties (consider the University of Colorado School of Medicine’s ban on moonlighting as an example). In other instances, you may find that only a certain number of moonlighting hours are allowed based on your experience or that they are dependent on supervision.

Policies vary between states and institutions and you will likely require a signed agreement from your primary employer to enable you to moonlight. If you’re sure that extra work won’t lead to trouble with your employer or with the law, then you’re free to consider your taxes.

Moonlighting and the 1099

An important distinction here is just how you’re choosing to earn the extra income. Who’s paying and where makes the difference between you being classed as an employee or as self-employed. Moonlighters often work at locations outside of their day job and for employers other than their primary one. This is known as locum tenens.

As such, they’re typically taxed under the 1099-MISC filing category. This makes the recipient responsible for filing fees and taxes on their moonlight income. These expenses won’t be removed from a paycheck as they usually are by a full or part-time employer under the standard W2 form.

The 1099 means you personally account for your owed taxes come April, typically via the 1040-ES filing. On the other hand, 1099 earnings do have the advantage of having certain tax deductions, provided you’re working at a secondary institution. This could be a big help with things like travel costs or supplying a home office and would be filed under Schedule C.

The Tax Cuts and Jobs Act (TCJA) could also be strongly in your favor if your job allows you to work and charge independently for your services. You could be looking at a 20 percent individual income tax deduction if you qualify. That said, working in the health care field is an out-of-favor “specified service trade or business” group when it comes to the new deduction, which means extra requirements to qualify for it; you can read about those here.

You can run your figures through this tax calculator for an idea of how the TCJA might affect you.

Moonlighting and the W2

The same can’t be said if you do all your moonlighting at the same facility as your day practice. The TCJA is less generous to physicians who remain stationary under same employer circumstances. You’ll still be making extra money, but the results would be taxed as usual by your employer and appear on your W2 as per your standard hours. There are financial upsides, however.

Onsite moonlighting at your usual facility removes the need to spend money on travel; a sometimes-hefty expense often incurred in a locum tenens scenario. Physicians who moonlight as their sole working model are also required to have pay for liability coverage insurance. This is another expense you might side step by remaining onsite with your primary employer.

Permission to moonlight and proper insurance should be priorities for every physician. Failure to ascertain either one could lead to financial liabilities that could easily consume any extra income or tax savings.

Managing today’s taxes is a big step toward your future

Choosing to moonlight will help boost your income and offer you expanded experience and independence. But don’t let your hard work be wasted by bad tax decisions. Get in touch with Provident CPA & Business Advisors and we’ll help craft a strong tax plan for your future. Among our strategies is assessing whether doctors can declare themselves as independent contractors rather than employees of a medical group, which could save them big come April. In the meantime, check out our earlier blogs on asset protection and malpractice to get more financial and tax information for medical professionals.