There are two certainties in life: death and taxes. While you can possibly prolong the former, the latter can’t be avoided—but it can be mitigated.
Whether you are just starting your career or considering a strategic move, there are tax implications that you should consider in addition to the many logistic and practice-oriented decisions that are inherent in any career move. Addressing the tax implications of these opportunities before you sign any employment contract or go too far down the path of business planning will protect you financially and may present additional opportunities for you and your practice.
Careful tax planning is imperative to good business practices. Though this article outlines certain potential tax issues for physicians to consider, the authors urge readers to consult an experienced tax advisor to discuss the tax implications of every business opportunity.
When presented with an opportunity to join an existing practice, work for a hospital or start your own practice, there are several tax issues that you should consider.
The job of your dreams might be beyond your commuting radius. As a result, you may need to pack yourself and your family and move to another part of the state—or country—at a significant cost.
Some of the expenses you incur as part of your relocation may be deductible on your personal income tax return. In other instances, your new employer may offer to pay your moving expenses or reimburse you for certain costs incurred. Keep all receipts and invoices associated with your move.
Individuals are often permitted to deduct reasonable expenses of moving household goods and personal effects from their former residence to the new residence. This includes packing and crating charges, connecting or disconnecting utilities, transportation to the new residence from the former residence, and in-transit storage and insurance for the household goods and personal effects owned by the taxpayer. Individuals may also be permitted to deduct reasonable expenses of traveling (including lodging) from their former residence to the new place of residence. Note, this does not include expenses for meals during that transition.
Oftentimes, the employment contract may specify that moving expenses will be paid by your prospective employer. Alternatively, an employer may reimburse certain expenses, or up to a certain limit. These expenses should be excluded from your wages as a non-taxable fringe benefit, so long as the payments constitute qualified moving expense reimbursements for IRS purposes. There are certain items that the IRS does not consider approved moving expenses (e.g. certain storage charges, pre-move house hunting expenses, expenses of obtaining a new driver’s license, expenses of buying or selling a home or entering into or breaking a lease). Accordingly, if your prospective employer agrees to coordinate your relocation or to reimburse you for the costs you incur, you should ask how those costs or reimbursements will be accounted for or reported for tax purposes.
Income guarantee agreements
Income guarantee agreements are a common arrangement used by hospitals to attract you to the hospital’s service area in order to meet community health care needs. In conjunction with a private practice in the hospital’s service area that will offer you an employment agreement, these income guarantee agreements will contain many provisions that may be misunderstood.
Income guarantee agreements differ from one hospital to the next. Generally, the hospital will offer you a guaranteed salary and incremental practice expenses for a defined period of time, which will be offset by any revenue generated by your clinical efforts and include a maximum hospital contribution. In return, you agree to build and maintain your medical practice within the hospital’s service area for a certain period of time. After the guarantee period ends, you will agree to either repay the hospital (plus interest) for the amount you borrowed during the guarantee period, or the hospital may forgive repayment over time if you continue to work full time in the hospital’s service area and fulfill other requirements that may be imposed.
The tax implications of an income guarantee provision are often triggered as amounts are forgiven, although the specific tax consequences will differ based on the specific terms of the agreement.
In most cases, the income guarantee is structured as a loan and the hospital will be required to issue a Form 1099 each calendar year for the forgiven guaranteed amount—plus interest. The hospital will send a copy of the Form 1099 to you and to the IRS. You will be required to include the reported amount as income each year and pay federal and state income taxes thereon. Of course, paying taxes on the loan amount forgiven is preferable to paying back principal and interest to the loaning hospital. It is important that you and your tax advisor, on the one hand, and the hospital and their legal counsel, on the other hand, agree on the tax implications of the income guarantee agreement, the repayment and/or forgiveness of any funds advanced, and how the arrangement will be reported for tax purposes. The hospital will certainly work with experienced counsel to draft its income guarantee agreements; you, too, should have counsel who protects your interests.
Employee or independent contractor
When accepting a position with a hospital or a medical practice, you and your tax advisor and the organization with which you are negotiating a service contract should discuss your status as an employee or an independent contractor—not only for income tax purposes, but also for purposes of benefits, professional liability insurance, and any restrictive covenants. The IRS and each state taxing authority has its own unique rules and regulations that address the classification of workers for income tax purposes.
Based on an examination of cases and rulings, the IRS developed a 20-Factor Test that it often uses to determine whether an employee-employer relationship exists. More recently, those factors have been divided into three categories—behavioral control, financial control and relationship of the parties.
The most important point for physicians to remember is that your status as an independent contractor or employee will depend almost entirely on the specific facts of your business opportunity.
When dealing with physicians, the IRS considers factors such as the degree to which the physician has been integrated into the organization—whether a hospital or a medical practice; the substantial nature, regularity and continuity of the physician’s work for the organization involved; the authority reserved by the organization to require the physician to comply with its general policies; and the degree to which the physician has been afforded the rights and privileges generally established for physicians of the organization. The IRS and state taxing authorities will consider the degree of control that the organization has over a physician’s performance of his medical duties in addition to the physician’s financial investment in the business and the contractual nature of the relationship between the physician and the organization.
If you are treated as an employee of an organization, you will receive a Form W-2 from your employer and have payroll taxes—including wage withholding and FICA—withheld from your paycheck each pay period. If you are treated as an independent contractor, you will not receive a Form W-2 and will not have payroll taxes withheld from your compensation. An independent contractor can expect to receive a Form 1099 from the organization and to pay self-employment tax on compensation. You will have quarterly tax deposit obligations and you must budget cash flow accordingly.
The tax consequences and obligations differ significantly depending on how a physician is classified, and penalties for misclassifying a service provider can be significant.
Choice of entity
The prospect of starting your own medical practice or joining an existing practice can raise multiple issues—whether to affiliate other physicians, the optimal location, branding, funding or loan procurement and selecting the best vendors. Notwithstanding all of these important decisions, arguably the first issue you should address is the organizational form of the medical practice. For instance, if you choose to form a limited liability company, a partnership (if more than one physician is an “owner” of the entity), or a professional corporation, each structure has unique characteristics for federal and state tax purposes that affect the way the business of the practice is conducted and how the “owners” are taxed on earnings.
Owners of a limited liability company are called “members.” Partners form a partnership, and shareholders or stockholders own a professional corporation. Depending upon the state where you practice medicine, there may be restrictions relating to whether a non-physician can be your co-owner in the medical practice.
Most physicians will find it preferable to conduct business using a “pass through” entity that is not itself subject to income tax. Pass-through entities include partnerships and limited liability companies that are treated as partnerships (“LLCs”).
These entities do not pay federal income tax; rather, the income, deductions, gain, losses and credits of these entities “pass through” to the owners who pay any resulting income tax. Conversely, most corporations are subject to income tax. As a result, any income earned by such a corporation is subject to tax at the corporate income tax rates, and any dividend paid by the corporation to its shareholders is subject to tax at the shareholder level. Accordingly, a corporation may not be the optimal choice of entity for a medical practice.
In order to avoid this double taxation and to maximize the profits available for distribution to owner-physicians, a pass-through entity is often preferable. Partnerships and LLCs also offer physicians greater flexibility in terms of practice management, growth, and compensation/profit-sharing options.
For most physicians, the opportunity for a job search will materialize numerous times throughout your career.
Each of the issues discussed has its own complexities and needs to be assessed in light of the specific facts and circumstances. Uncle Sam will always be entitled to his fair tax share, but with careful tax planning and the assistance of experienced advisors, you can help ensure you are not taxed to death and can enjoy the success of your work effort.
Elizabeth A. Mullen (firstname.lastname@example.org) is special counsel in Saul Ewing’s Washington, D.C., office and a member of the firm’s tax practice. Bruce D. Armon (email@example.com) is managing partner of Saul Ewing’s Philadelphia office and co-chair of the firm’s health law practice group.