This post is a continuation of my first post on how the new tax law affects solo doctors and small medical practices, which discussed the 20% pass through deduction, whether to form separate LLCs for billing and your equipment, loss of the entertainment and (some) meals deductions, S vs C corp taxation under the TJCA, and tax burdens for high earners under the new TJCA brackets compared to 2017 brackets.
My spouse and I have a combined income over the phaseout limit. This is my second year in practice and earning about $140,000 from my practice this year. Can anything be done?
Try filing as married filing separately. In this case, the phaseout is the same for single filers, with the phaseout beginning at $157,000 and ending at $207,000.
Married filing separately each spouse reaches higher tax brackets quicker, so everyone’s situation will be different as it depends on how much you earn and how much your spouse earns. Run the numbers with tax software to see if this is worth it. Married filing separately also loses some tax benefits including IRA deductions, but you can still do a backdoor Roth IRA. Chances are that if you and your spouse are high income you’d be phased out of most of these benefits anyway.
If you’re in a community property state my understanding it that any wage or practice income is considered community property so this strategy wouldn’t work.
Generally speaking, the most benefit you will get is if your income is right under $157,000 so you get the maximum pass through deduction to offset the higher rates your spouse is taxed at. If your practice only earns $20,000 your first year, with the pass through deduction of 20%, $4000 of income is deductible.
At the 12% tax bracket, for $4000, that’s only $480 in tax savings, so if your spouse earns $400,000 a year it’s likely they’ll be pushed into higher tax brackets more quickly, resulting in a overall higher tax burden for the two of you.
What about groups with multiple doctors?
Let’s suppose we are analyzing Acme Internal Medicine, LLC, which is run by three internal medicine partners (Drs. A, B and C) who choose to divide salary equally. The medical practice makes $900,000 and each partner takes home $300,000. Does each partner get the same pass through deduction?
Dr. A is single. Acme is a specified service corporation because it is a medical practice. The phaseout for single filers begins at $157,000 and ends at $207,000. Dr. A is phased out of the pass through deduction.
Dr. B is married with a stay at home husband (no income). They have $15,000 in annual investment income. The total income is $315,000 which is just at the phaseout limit so Dr. B gets the maximum pass through deduction. If Dr. B had $25,000 of investment income, part of the pass through deduction (10% of it to be specific) would be phased out.
Dr. C has a wife that is an ophthalmologist and makes $350,000 a year. Their annual income of $650,000 is well over the phaseout limit so there is no pass through deduction.
The bottom line here is that even within a single pass through LLC taxed as a partnership or with S corp election, some partners may be eligible for the deduction while others are not. This concept is important for my discussion of surgery centers and optical shops below.
Is my surgery center ownership distribution eligible for the pass through tax deduction?
First of all to be eligible your surgery center must be taxed as a pass through (files a 1120S and issues shareholders K1 forms) rather than a corporation (issues 1099-DIV forms). If your surgery center is taxed as a corporation, then it pays tax at the corporate level and then you report the dividend/ distributions and pay capital gains taxes (with favorable rates over ordinary income tax rates). The rates might be more favorable, but your dividend will be less since it’s already been taxed.
If your surgery center is taxed as a pass through, then the income limitations of $157,500 for singles and $315,000 for married filing jointly (MFJ) still apply. So if you earn $290,000 as an employee and have $20,000 in surgery center pass through distributions on a K1, then you would be eligible for the full deduction MFJ assuming your spouse doesn’t work.
This makes a nice little tax break. 20% of $20,000 or $4000 is deducted. At the 24% bracket this is a $960 tax break. It won’t make you rich, but you can certainly pay some bills or go out to dinner a few times with this.
Whether the pass through deduction is phased out depends on whether or not the IRS determines whether surgery centers are specified service corporations. According to this paper by tax attorneys (read the last paragraph of this paper), this a grey area- it depends on whether the surgery center is defined as providing health care vs provision of a surgery facility! I suppose the new tax law gives attorneys something to do….
If a surgery center is deemed to be a specified service corporation, the phaseouts apply. And if you’re over the phaseouts you get ZERO deductions. However, if the center is NOT deemed to be a specified service corporation, you can still take the deduction…. but of course there’s a catch.
It’s called the W2 wages and qualified property limitation. So even if the company ISN’T a specified service company this rule applies, but only over the same phaseout limits.
The deduction is limited to the LESSER of: 20% of qualified business income, or the greater of one of the two: 50% of W2 wages, or 25% of W2 wages plus 2.5% of unadjusted basis of qualified property. This is done on a pro rata ownership basis, so if your surgery center has salaries of $700,000 and you own 1%, you are attributed $7000 in W2 wages and 20% of this will be $350. Similarly, if your center has $1 million of qualified property (equipment), 1% of this amount is $10,000, and 2.5% would be $250. At the 40% marginal bracket this gives you a tax break of a whopping $140 or $100. Your accountant will probably charge $150 to fill out the forms.
What about my optical shop profit distribution?
I’m fairly certain that your optical is in the business of selling products (glasses) and will NOT count as a specified service corporation. So the rules for surgery centers apply: if your total income (practice, other wages, spouse, and investments) falls under the phaseout limits as specified above, you are entitled to the full 20% deduction on any surgery center income.
If your income falls OVER the phaseout limits of $207,000 for singles or $415,000 married filing jointly, the same rules above regarding wages and unadjusted income apply.
Many solo doctors don’t separately incorporate their optical, because incorporating involves a ton of extra paperwork- credentialing for insurances, business licensing and insurance, and a separate tax return. One advantage of separately incorporating your optical is asset protection, if the practice goes bankrupt due to a judgement at least you can liquidate your frames and keep the cash.
Some solo ophthalmologists (or ones that work on a group, for that matter) hire optometrists. Typically the optometrists aren’t owners in the practice, but some ophthalmologist owners elect to let the optometrist own part of the optical. This may be a good way to reward a loyal employee and keep them engaged by making them feel like they have a stake.
If the above situation applies, or if you are in a larger practice where the optical is profitable and the physician owners would benefit from the pass through deduction, it might be worth it to separately incorporate your optical shop. Given the W2 wage and qualified property restrictions it is unlikely that most ophthalmologists would significantly benefit from any deduction, but because employed optometrists in your practice earn less and their income has a better chance of falling under the phaseout limits, it is likely they could benefit from the new tax law pass through deduction.
If you’ve read this far, yes that’s passion fruit terra cotta in the picture above. Tasty!