The recently-enacted tax legislation has many provisions of interest to medical practices and their employed professionals. One of particular interest is that providing a new tax deduction for the individual owners of certain “pass through” entities, including partnerships, LLPs, LLCs, and “S-Corporations.” These are entities where federal income tax is generally not imposed at the entity level, but rather on the individual returns of the entity’s partners/owners. A significant number of medical group practices are structured in this fashion, although the percentage is likely declining due to the growth in hospital employed physicians.
Advocates in the corporate world argued successfully to tax-writers on Capitol Hill that, if the corporate tax rate was being lowered for those corporations taxed at the entity level (the “corporate tax cut” which was the driving force behind the tax bill), owners who conduct their businesses through pass-through entities should get a similar tax cut on their individual returns. Legislators struggled mightily with how and to what extent this might work, and whether it was appropriate at all for owners of professional service businesses (e.g. doctors and lawyers) where the owner’s return is very similar to wages for services rendered and less driven by the deployment of investment capital.
The House and Senate took different approaches, and the final Conference Agreement was more closely aligned with the Senate’s approach. Under the final bill, now signed into law:
PLEASE NOTE THAT AAPM&R DOES NOT PROVIDE LEGAL OR TAX ADVICE TO INDIVIDUAL PRACTICES OR THEIR OWNERS. OWNERS OF PASS-THROUGH PRACTICE ENTITIES SHOULD CONSULT THEIR INDIVIDUAL TAX ADVISERS TO DETERMINE HOW THIS PROVISION IS LIKELY TO AFFECT THEIR TAX LIABILITIES IN 2018 AND BEYOND.
- Owners of “specified service” trades or businesses, including medical practices, structured as pass-through entities are eligible for the new deduction, but with limitations not applicable to non-service businesses;
- The deduction percentage is set at 20% of “qualified business income” received by the individual from the entity and taxable on the taxpayer’s individual return. The “qualified amount” will generally be less than the total amount of income passed-through from the entity to the owner, but there are a number of moving parts in the calculation, and physicians will need to consult their tax advisers for assistance in determining the amount of “qualified business income” eligible for the 20% deduction.
- For medical practices and other “specified service” businesses, the deduction phases down when the taxpayer’s taxable income exceeds a threshold amount.
- That amount is $157, 500 for a single taxpayer and $315,000 on a joint return. (These amounts were more generous in the Senate bill at $250,000/500,000.)
- When the taxable income exceeds the threshold by $50,000 in the case of an individual return and $100,000 for a joint return, the new deduction is entirely eliminated, and the taxpayer’s entire pass through income is taxed at ordinary personal income tax rates. In other words, a physician having taxable income above $207, 500 on an individual return derives no benefit from this new “break” for pass through entities.
- The new provision is effective for tax years beginning on or after January 1, 2018.
- Physician employees of pass-through entities, who are not also owners, generally get their compensation directly from the entity on a W-2 basis, and not on a pass through basis. They would not be affected at all by this provision.