New Tax Law Changes Will Impact Physicians

The question of whether 2014 tax law changes will impact physicians is easily answered: Yes. The more difficult question to answer is, how significant will that impact be?

“It could be onerous,” says Bijan Golkar, CFP, vice president and senior advisor with FPC Investment Advisory, Inc. “If a physician has 50 employees, [the tax changes] could add a lot of expenses.”

Understanding those changes, and their potential impact, is critical.

Net investment income

One of the tax changes brought about by the Affordable Care Act is an additional 3.8% Medicare tax on net investment income. That’s 3.8% added on to any type of net investment income, including interest, dividends, annuities, royalties, and rents. This impacts physicians with adjusted gross incomes in excess of $250,000 if filing married, and $200,000 if single.

In addition, the top marginal tax bracket was increased from 35% to 39.6% for income in excess of $457,600.

“That affects a lot of people,” Golkar explains. “The physicians I work with, for the most part unless they’re at some large HMO, fall into this category, especially if their spouses are working.”

But it doesn’t end there.

“When you jump into that higher tax bracket, your long-term capital gains rate is going to jump an additional 5%—up to 20% from 15%,” Golkar says. “So, if you’re in that 39.6% bracket, you essentially see a 23.8% long-term capital gains rate rather than the previous 15%. That’s a huge increase.”

And there’s more. Golkar explains that physician employees earning in excess of $250,000 will pay an additional Medicare tax of 0.9% on top of the 1.45% that’s already being withheld.

“A lot of people don’t know about that,” Golkar says. “It’s very stealthy.”

Offsetting the increases

Golkar says that one basic strategy to help offset these tax increases is for physicians to be smart about the way they compensate themselves. For example, if you own your own practice, salary is not the only way to receive compensation. With a Simplified Employee Pension (SEP) IRA, a physician can contribute up to $52,000 annually and pay zero tax on that amount.

“If you have a husband and wife working together, a SEP IRA is a cool trick,” he says. “Defined benefit plans, especially if the physician is a lot older and has a younger staff, a defined benefit plan can be a good option.”

Golkar stresses that the 2014 tax law changes don’t impact an isolated few physicians, and that the days of assuming 15% capital gains are long gone.

“I don’t have one physician that I work with who’s in the 15% capital gains bracket any more,” he says. “These changes are going to impact a lot of people.”

Selling the practice

One particular strategy that Golkar employs with his physician clients is structuring a practice buy-out that avoids additional Medicare taxes. Gone are the days when a physician would sell his or her practice, take the long-term capital gains, and call it a day. Today, more businesses are opting for an installment sale—spreading out the sale over a period of years.

“If a practitioner has a younger physician that they’re kind of mentoring and doing an apprenticeship type thing, if you get someone you really like and the plan is for them to take over the practice, start early,” Golkar says.

Next to a physician’s home, his or her medical practice is likely the largest item on their balance sheet. By starting early and doing an installment sale rather than taking all the funds in one lump sump, you’re able to spread the taxes out over several years.

“It’s very attractive,” Golkar says. “It allows the physician to benefit not only from the tax-saving aspect, but its kind of a gradual movement away from the practice. You keep yourself under the bracket and also retain some control.”

Good public relations

The gradual transition also offers benefits in the form of good will among patients. A sudden change in physicians can be traumatic to those who have been patients for many years. A smooth, gradual transition can directly benefit the physician’s financial bottom line by way of the installment sale, and indirectly through patient word of mouth.

“One day there’s a new doctor, and patients say, ‘What the heck is that?’” Golkar points out. “So, it’s a cool way to sell a practice from a financial perspective, but also all of the other benefits as well.”