Update by Howie, December 2018: Unfortunately if you own real estate in a separate LLC/ entity, or create another non specified service business to try to make income eligible for the pass through deduction, there are severe limitations on if it will be eligible for the 20% pass through deduction.
3. Change my practice into a C corporation
Since my professional S corporation has no chance of seeing any pass through deductions, I thought about converting to a C corporation instead. By doing so, I would pay the 21% corporate tax rate on all my earnings, and then just keep everything undistributed in my corporate account. Thus, avoiding the remaining 14.8 to 18.8% in capital gains tax. Then, I would let everything grow in some sort of investment vehicle. Sort of like an unlimited modified 401(k). Then, when I die, all the assets in the corporation would be passed down to my children, where up to $5.6 million dollars per individual (2018) would be tax free.
But alas, the elegance of the tax code strikes once again. Enter the accumulated earnings tax, where the IRS assesses a 20% tax on retained earnings considered beyond what is ordinary and necessary for business. As a personal service corporation, you can accumulate up to $150,000 in excess of any amount that is necessary to run your business. So, as a hedge fund, you can justify sitting on millions in dollars in stocks without incurring the accumulated earnings tax. However, as a medical practice, it’s kind of difficult to justify holding 1,000 shares of Amazon as an ordinary business expense. Hence, converting to a C corp is out as well.
As you can see, if you make over $415,000 as a couple or $207,500 as a single person, you’re pretty much screwed. Of course, no one’s going to feel sorry for you. Is it really worth all this corporate juggling and acrobatics to save $5,000? Probably not. As you can see, in conclusion, there really is no tax strategy for the high earning pass through entity in the Trump era. >:(
Appreciate the post, I’m in a similar scenario trying to figure out the best course of action
So knowing what you know now, if you had to do it all over again, would you consider starting up as a sole proprietor?
This is Howie. My understanding from going to OMIC lectures is sometimes if there is a suit filed due to negligent acts of an employee, the physician and the practice are both named. The physician individually is sometimes dropped but the corporation remains, because the basis of the suit was vicarious liability over the employee. If you do not incorporate this will not be possible.
Settlements against an individual are reportable to the NPDB (National practitioners databank) while settlements for corporations aren’t.
Some states have laws stating that the shareholders of corporations are liable for their employees’ vicarious acts, but this can be negotiated in a settlement if you incorporate.
Great post. Tough to capitalize once you’re above that threshold. Below $315k of taxable income seems to be the sweet spot with this new bill.
That was a great analysis of something made very complex with multiple moving parts. As you said it may not be worth doing any of these strategies.
I considered all these options and as you said it’s not worth it. I decided to buy a lot of Realestate building and do a NNN DEALS and make my wife manage them as a real estate professional and do a coat segregation study to depreciate he building to set of my salary. This year I’ll be able to write $150k off from my salary.
This is Howie. We will have a post on cost segregation analysis. You are correct that this is a tax break now (time value of money)- but don’t forget at sale of the property the depreciation you take now is recaptured at 25% which may or may not be favorable depending on what tax bracket you’re in (it’s usually favorable for docs).
I suppose you could continually do 1031 exchanges, bequeath the property to your heirs, and take advantage of the step up basis at death.
But in my opinion (and I respect that others will differ) is that commercial real estate is most definitely NOT a passive investment- upkeep for the building, finding tenants, etc is work. And when it comes time to sell it depends on how the market is. If you have to sell in a bad market due to cash needs you may not come out ahead as much as you’d like.
In addition to being illiquid, there isn’t much diversification in one single property (or a few) compared to the total stock market index fund.
Yes there are some people who buy the right place at the right time and get rich, but there are others who barely break inflation or take losses. To each their own…
I have struggled with all these same issues. I find that most cpas, even the ones that claim to be experts in medicine, tell me things that won’t make a difference. It is shocking to me how few cpas seem to know about the limit on retained earnings. One thing I have been kicking around: non qualified deferred comp. I would be a C corp and pay the 21% profit. Then I would fund a deferred comp for myself. You do have to pay payroll tax (here would only be the medicare most likely). The money is not deductible to the corp now but it would be when realized years later. I assume that means some year in the future I will start showing losses in the C corp? I am in my early 40s and figure I could ladder income for 10-15 years from now if I retire early and can’t access retirement funds anyway. Thoughts?
1. Are you maximizing your 401k ($56k), Backdoor Roth ($11k married), HSA ($7k family), and 529 plans ($28k for two kids)? That would be $101,000 in tax advantaged accounts.
2. If you are really maxing out all these accounts, and invest properly, you’re probably going to have at least $150,000 of income per year even if you retire super early. Therefore you’re taxed at about 15%. If you are taxed at the corporate level at 21% and then individual at 15% then it’s still a 33% tax (note: I’m not 100% sure if you would pay corporate tax as I’m not expert at this)
3. Based on my limited understanding of non qualified plans, the company still must exist. Do you have partners who will continue the company and do you trust them to run the company the way you did? Will they sell to a larger group that might terminate the non qualified plan?
4. Have you considered a defined benefit plan? If you have relatively few employees that are young compared to you this might work when you can defer $100,000 in the highest tax brackets. Charles Schwab has a proposal form you can fill out. Drawbacks are matching for employees is high, administrative costs are high. But this is asset protected where a non qualified plan isn’t.
yes on maximizing everything else. I am part of a large group practice without walls model partnership that is the main source of income. We have another organization that I do cash pay items through. I am trying to figure out a tax advantaged situation to save even more. I am not eligible for the pass through deduction. The 80/50 rules explicitly rule out the crack and pack. However I don’t think that would apply to a C corp since Uncle Sam will get his corp tax on this. So I could remove money from my partnership (where I have to pay medicare tax on distributions) and send it to another entity. I could keep the entity open even when it doesn’t have cash flow later correct?
The details are beyond my knowledge. My understanding is that you would still pay corporate tax the year the money is earned, but personal tax the year the company gives you the money. As I said my last comment after corporate tax you have 0.79 of every dollar and even if your tax rate is 15% (would imagine its higher if you’re maxing everything else and have post tax income, 0.79 times 0.85 is 0.6715, a 32.8% rate. That’s a tax arbitrage of 3.2% off the highest personal rates. If it’s worth setting up a non qualified plan all the power to you!
This article states usually not best fit for small family businesses:
http://fambizpv.com/articles/money_issues/nonqualified.html
BTW most folks would love to have your problem; they don’t earn enough!😀
Also, there are “financial advisors” who are looking to steer you into these plans for their own benefit, by selling you insurance within a non qualified plan. I’m not saying that you shouldn’t get a non qualified plan, but find conflict free good advice.
These same advisors often steer you into high load investments for 401k and IRA, but a 401k is still a good idea. Just buyer be aware!