Smart Ways to Save

For most of corporate America, the path toward long-term growth is fairly straightforward: companies plow profits back into the firm to save for a rainy day, and to build capital for making acquisitions that will further growth.

But traditionally, physicians haven't tended to think that way when it comes to their practices -- their businesses. Instead, say financial experts, many spend all extra profits at the end of the year, paying them out in tax-deductible bonuses. That way, there are no assets left on which to pay hefty capital gains taxes.

Yet some financial advisors say that's woefully shortsighted.
"Most physicians are concerned about year-to-year tax savings rather than building a war chest to take advantage of business opportunities," says Keith Borglum, vice president of Professional Management and Marketing, a Santa Rosa, Calif.-based healthcare consulting firm.

That's unfortunate, says Borglum, because without sufficient savings, it becomes more difficult for practices to, say, acquire a piece of equipment that can be used to expand services, hire a new clinician, or invest in staff education or retirement funds.

So while it may be easier said than done, setting aside a nest egg from year to year is a strategy worth considering.

Corporate structure counts

Most physician practices are structured as a C-corporation, a federal tax designation that determines the amount of taxes paid each year, explains Mark Kropiewnicki, a partner with The Health Care Group, a consulting firm in Plymouth Meeting, Pa. Some C-corps enjoy a graduated tax rate that can be as low as 15 percent on capital gains, depending on the worth of the assets the business has accumulated at year end.

But physician practices fall under the C-corp heading of "personal service corporation," which requires that all capital gains be taxed at a flat rate of 35 percent. That means that if a practice has $100,000 remaining at the end of the year, $35,000 off the top goes to Uncle Sam -- and that doesn't include state taxes, which vary from state to state. 

One way around that heavy tax burden, says James Pearman Jr., president of Roanoke, Va.-based Fee-Only Financial Planning, is to structure the practice as an S-corporation or similar entity. S-corps, partnerships, and limited liability corporations are "pass-through" entities, in which all income is distributed to the partners, who pay personal income taxes on it.

The upside to this, says Pearman, is that taxes are not paid twice, which can happen in a C-corp if some of the nest egg is paid out to physicians. "First, 35 percent comes off the top, then the physician must pay income tax, likely at a very high rate," says Pearman.

Under an S-corp, physicians can build the practice's profit into savings by investing in tax-sheltered stocks or bonds. Then, when they want to make an acquisition or buy a piece of pricey equipment, physicians can pull the money out of the investment, only paying taxes on it at that time, says Pearman.

Choosing a corporate structure that will maximize savings is "a matter of weighing the pros and cons," says Daniel Mefford, CPA, and president of Columbus, Ohio-based Practice Resource Management Group.

Mefford explains that, while there is state-by-state variation, in most pass-through entities, the business partners are prohibited from deducting many expenses that are tax-deductible in a C-corp. For instance, there's a limit to how much health insurance expense you can write off through an S-corp. Most larger practices choose a C-corp structure to take advantage of the deductions while solo or two-doctor practices may find it more beneficial to go with the S-corp.

Strategies that work

Still, some advisers continue to recommend spending down all the extra cash at the end of the year or before -- but doing so in clever, growth-stimulating ways. Kropiewnicki recommends using savings to bring on a new partner, or new employees, since those types of expenses are tax-deductible.

Family physician Kevin Kelleher plans to do exactly that. Kelleher, who has been practicing for 18 years, says he spent down his nest egg when he opened his own practice in October 2001, but he's building it back up by doing things like mowing his own grass and upholstering his own exam tables.

"I was able to obtain exam tables for all nine exam rooms for $2,500. My AO binocular microscope was $180 on E-Bay. You simply must look for bargains and prepare in advance," says Kelleher.

When he has a nice lump sum ready to go, Kelleher plans to spend down again by adding a partner. And he doesn't doubt he will attain that goal.

Kelleher says since opening the practice, he has "not borrowed a penny since our sixth week; we will be debt-free by 18 months, [and we] have paid ourselves generous salaries."

Down the road, Kelleher is looking to put future savings "into equipment that will pay for itself, like in-house office labs. They provide quick results for the patient, and they earn nice income."

Other options for reinvesting for growth include adding elective services like bone density screening, sclerotherapy, or anything related to the physician's area of practice that is generally a noncovered service.

"The baby boom is coming into its longest medical service-consuming years," says Borglum, "and many of them are willing to pay for a host of elective services."

But accountants say there's a caveat when it comes to that kind of spending. Practices can only write off up to $25,000 in equipment per year, according to Kropiewnicki. So if Kelleher's practice is a C-corp and he buys a $50,000 piece of equipment during 2003, he'd be able to deduct half of it; the other $25,000 would be taxed at 35 percent.

In that case, Kropiewnicki recommends buying half of the equipment on or before Dec. 31, and half after Jan. 1. That way, you can write off $25,000 in each of the years and avoid paying taxes on the money.

Keep in mind that technology advances so quickly that often, as soon as a practice has paid off a large piece of equipment, it's already outdated. So it may make more sense to lease the newest technologies, collect income from having them in-house, and then opt for an upgraded version when the lease is up.

If a physician has his or her heart set on actually owning a particular piece of equipment, it's now cheaper to borrow money than to save it up for such purchases. "I'd rather pay 10 percent interest or less on the million I need to buy an MRI. It's cheaper than paying Uncle Sam 35 percent on my money plus state taxes," says Kropiewnicki.

Think long-term benefits

Investing in physician and staff education can also bring money back into the practice. Borglum recommends physicians send themselves and their employees to coding seminars to boost billing accuracy.
"These seminars cost a few hundred dollars, and I rarely see a doctor increase his earnings by less than $5,000 a year [as a result]," says Borglum.

In addition, Borglum recommends sending employees for any continuing education seminars that will help them do their jobs better. The closer the seminar is to the end of the year, the better it is for the practice tax-wise.

Even if long-term growth of the practice is not your goal, physicians should put the full amount allowable into tax-sheltered retirement and profit-sharing plans each year,  to maximize any pre-tax programs such as medical savings accounts and education savings plans.

"Try to provide as much of the compensation package to physicians on a pre-tax basis as possible," he emphasizes.

Beyond that, if practices keep money in the till from year to year, experts say it's a simple matter of facing Uncle Sam come April. "It's a matter of sucking up the tax consequences," says Kropiewnicki.

Still, says Kelleher, "I haven't stopped trying to save. [I do] my own payroll and tax deposits; I come in early to vacuum midweek. We know that it is because of these little cost savings that [staff] are getting 5 percent matches in their 401Ks after only six months."

Suz Redfearn can be reached via
editor@physicianspractice.com.

This article originally appeared in the January/February 2003 issue of Physicians Practice.