The 2017 Tax Cuts and Jobs Act created the Internal Revenue Code (IRC) 199A, which provides for a maximum of 20% deduction of business profits for sole practitioners and pass-through entities and drops the corporate income tax rate to a flat 21%—a dramatic decrease from 35% previously.
For specified service trade or businesses, which includes medical practices, the 20% deduction is phased out when the individual tax return shows taxable income above $315,000 for married filing joint ($157,500 for all other filing statuses) and is completely lost when taxable income is above $415,000 joint ($315,000 for all others).
A question often raised is whether the medical practice should change its tax entity status to a C corporation. This type of entity pays tax at a flat 21%; unlike pass-through entities, no income flows onto the shareholder’s individual tax return.
The general structure of the medical practice is that the shareholders typically leave little to no profit inside the business, opting to bonus it out via compensation. As a result, the 21% tax rate would only apply to the small remaining income left in the practice, with the bulk of the income being taxed to shareholders individually.
The alternative is to leave profit in the company and pay out a dividend taxed at preferential rates. The corporate tax rate of 21%, plus the qualified dividend tax rate of up to 20%, plus the net investment income tax rate of 3.8% which reaches a total of 44.8%, is significantly higher than the individual’s top tax rate of 37%. Depending on the state, near double taxation can result.
Examining the benefit of a C corporation tax structure makes sense under the following common scenarios:
- The practice leaves significant profit in the business. This would be done if the practice wanted to build up reserves for future expansion or other strategic moves requiring cash that the practice may have difficulty raising.
- The practice has offices in many states, and wishes to insulate the doctors from the need to file personal returns in many jurisdictions.
- The practice wants to expand overseas. As technology continues to develop, international telemedicine will become the next hot growth area, as reimbursement for telemedicine is typically easier and more lucrative than it is in the U.S. Expanding overseas with telemedicine is also often easier than expanding across states.
The deadline for an S corporation or LLC to change to a C corporation is 75 days after the close of the tax year. For calendar year practices, the deadline is March 15, 2019 to make the change for the 2019 year. While there are various procedures to get a late election accepted, such acceptance is no guarantee. Thus, if changing entity classification might be of benefit to your practice, now is the time to make that determination.
For further information about the new section 199A deduction and whether a C corporation is right for your practice, please contact Larry Rubin, Aronson’s professional services industry group lead at 301.222.8212.