How Trump's Tax Plan Could Affect Doctors

Karen Riccio

Disclosures

November 10, 2017

In This Article

House Bill: Change to the Amount of Income Taxed

Pass-through Income Taxed No More Than 25%

As explained by the CBPP, this is "income from businesses such as partnerships, S corporations, and sole proprietorships claimed on individual tax returns—that is, it "passes through" to the business owners and is taxed at the owners' individual tax rates (the same rates that apply to wages and salaries). If you only work for yourself, this applies to you.

Currently, pass-through income is taxed at the top individual rate of 39.6%. Under the most recent GOP plan, however, pass-through income would be taxed at no more than 25%, with about 80% of the resulting tax cuts going to households with incomes over $1 million. This would put about $50,000 each into those wallets and boost after-tax incomes by more than 2%, according to the CBPP.

"This is what most self-employed doctors are: sole proprietorships, partnerships, LLCs taxed as sole proprietors or partnerships, and corporations that have taken the S election. They're all pass-through businesses," explained Dr Dahle. "And if they're paying 28%-39.6%, then having that cut to 25% is a huge boon for them. Again, this will drive docs to be more likely to be self-employed."

Whether most physicians will ultimately be able to take advantage of the lower pass-through rate has yet to be seen. It's possible that many will be excluded from this tax break, but, Dr Dahle said, "We'll see in the final law whether there is some wiggle room there—for example, whether part of a practice's income may qualify."

Although the GOP claims that the tax reform bill benefits the working middle class, this particular change does not appear to. That's because the highest-income filers in the top income tax rate would receive the largest rate reduction for pass-through income. Those in the brackets below would receive less of a rate cut, and filers in the 25% bracket or below would get nothing from the special rate.

So, a couple with income of $1 million would get a $1000 tax cut on each $10,000 of pass-through income that would otherwise be in the top tax bracket, compared with $0 for a couple with income below $75,000.

Corporate Tax Rate Reduced From 35% to 20%

While lowering the pass-through tax rate is not necessarily likely to encourage some doctors to become self-employed, this substantial cut to corporate taxes may result in others forming traditional personal service corporations (PSCs)—something Johanna Fox Turner, CPA, CFP, RLP, of Fox Wealth Management, referred to as "relics of the 1980s and earlier when personal tax rates were higher than corporate rates."

"When I started out as a CPA in 1980, all of our doctor clients were PSCs. Today, I would be hard-pressed to find a PSC used by a doctor or group that has been in business for less than 20 years."

Fox Turner said that a corporation qualifies as a PSC if it is owned and run by a licensed professional(s) who practices medicine (or other professions defined by the IRS) and hasn't filed an "S" election. In other words, it is a "C"-corporation that pays a flat tax rate of 35% on all net profits of the business. That high rate, in a nutshell, is why PSCs are no longer popular for physicians. But that could all change if this tax cut sticks.

"If C-corporations for professionals are allowed to qualify for this lower rate and/or the committee reduces or eliminates double taxation of corporate earnings, we'll see PSCs come back into vogue," she said.

There are other benefits to operating as a PSC.

"Physicians operating as a PSC are able to utilize employee benefits not available to doctors operating as S-corporations. Owners can establish a Voluntary Employees' Beneficiary Association (VEBA) and receive tax-free fringe benefits such as health and life insurance, disability insurance, dependent care, and other fringe benefits provided to employees," Fox Turner explained. "In most cases, these benefits are tax-deductible for the PSC and are not considered taxable income for the employees. A 20% corporate rate combined with lower personal tax rates would make the choice of a PSC very attractive."

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