Since the passing of the Tax Cuts and Jobs Act (“TCJA”) in December, many healthcare providers started to wonder if there might be a tax advantage to changing their choice of entity. With the new 21 percent corporate flat tax, would C Corporations be a better option? Or would the benefit of the 20 percent pass-through deduction be more beneficial?
I noted in a previous blog, that most high-earning healthcare entities won’t benefit from the new pass-through deduction. As a result, many physicians can reasonably take that piece out of the equation. So, that means that every medical practice that’s currently a partnership or S Corporation should convert to a C Corporation, right? Not so fast. It’s not that simple.
The tax rate change isn’t the only thing that healthcare entities need to consider. Here are a few questions to ask before you consider any restructuring:
- Do you take cash distributions from your medical practice? Partners and S corp shareholders are taxed at the personal level on income from the pass-through entity; however, individuals are generally not taxed on distributions of income. It’s a different story for C Corporations. In addition to being taxed at the entity level (at a rate of 21 percent under TCJA), when that income is distributed to shareholders via a dividend, those payments are taxed at the individual level as well. This “double taxation” also affects your after-tax income if you sell your shares in the C Corporation. Practices that plow profits back into the business and aren’t planning on ownership changes in the near term definitely can benefit from C corporation status. But if your annual compensation includes distributions or you’re planning to sell in the near future, it’s important to account for double taxation when calculating after-tax numbers.
- Are you looking to bring a new partner into your practice? If you expect ownership changes, staying a partnership is the probably the way to go. First off, it’s a fairly easy process to admit new partners. On top of that, many times a new partner will qualify for a step-up in the basis of the partnership. This allows higher deductions for depreciation and amortization. Step-up treatment is not available for C Corporation owners.
- Does your business operate at a loss? Flow-through entity losses can be used to offset other flow-through income at the individual level. C Corporation losses are typically locked inside the business.
Beyond the benefits or drawbacks under current law, there’s always the possibility that the C Corporation flat tax rate can easily be repealed or replaced in the future. If you convert to a C Corporation now because the 21 percent rate gives you a better after-tax result, there’s no guarantee that the rate will remain stable in the years ahead. Once you convert a pass-through entity to a C Corporation, reversal of the conversion can be very costly – both in time and in your tax bill. So, you should be rather certain that any conversion will stick in the long run.
There are quite a few things to consider when reviewing your choice of entity and the analysis can be quite complex. If you’re looking to make a change in the entity structure of your practice, please consult with your HORNE LLP tax advisor for a careful look at the specifics of your situation and an exploration of both the personal and business tax implications.
This blog is the third in a series that addresses the impact of TCJA provisions on the healthcare sector. You can read our previous blogs here.
In our final blog in the series, we will explore how the TCJA altered deductions for meals, parking and entertainment. We will also watch for any additional IRS clarifications concerning areas of interest for healthcare entities and will issue additional Tax Reform blogs as needed. Consult with your HORNE LLP tax advisor for how these proposed regulations will specifically affect you and be on the lookout for our next blog in this series.