How the new corporate tax laws could affect
independent owners of multiple practices
Financial season is in full swing, and practice owners are evaluating last year’s performance and setting goals for 2018. For many dentists, this includes growing their practice by adding new technology and additional operatories, or even starting up or purchasing a new practice location. Before multipractice owners take a bite out of their capital stash, however, they need to balance changes in spending and income with the financial implications of the new federal tax overhaul.
Multilocation practice models offer plenty of benefits to independent dentists. Operating several dental offices creates economies of scale for almost everything, including purchasing supplies, lab, services and staffing; having more power when negotiating reimbursement rates; and offering more in-house specialty procedures and longer office hours to better compete with DSOs. Multilocation practices also typically provide stronger systems, marketing, established policies and practice management efficiencies that make the business attractive to potential buyers in a sale or retirement transition.
While practice expansion seems like a solid investment, the new tax laws have the potential to complicate tax considerations for business owners—especially when considering equipment expenditures, partner earnings and business structure. Showing profitability and earnings growth is vital to obtaining credit, as is the dentist’s ability to manage a personal financial profile.
Most independent practitioners operate as a pass-through entity, which includes Schedule C, partnership and S corporation. The new tax laws allow for a “pass-through income” deduction of up to 20 percent, although higher earners might qualify only for a partial deduction—or none at all.
According to Cataldo Financial & Consulting Group in Philadelphia, young practitioners and married practitioners in single-income households will likely benefit most from this change.
For multipractice owners who cannot take this deduction, changing the legal structure of the business to qualify for the lower, 21 percent corporate tax rate might seem beneficial, but the advantages aren’t so straightforward. For example, there’s commonly a cost to incorporate the business, and assets and profits may be subject to higher taxes despite the lower corporate tax rate, meaning top earners could be further penalized.
“Even though the corporate tax rate is reduced, the shareholder dentist would need to withdraw funds through payroll or a taxable dividend,” says Angelisa Cataldo, a CPA at Cataldo Financial & Consulting Group. “A salary will be taxed at individual income rates, while a dividend will be taxed at 15 percent or 20 percent plus net investment income tax for certain taxpayers. This is a critical consideration because the practice income is usually the main income stream for a practice owner. In a C corporation situation, a dentist could pay a flat 36 percent to 44.8 percent on practice income taken as dividends, as a result of double taxation on the corporate profit and the subsequent withdrawal of income as a dividend.”
Dentists planning to add equipment or technology to their practice will need to think about 2018 tax implications as well. The tax overhaul increases bonus depreciation of assets put into service to 100 percent, including used assets, and is automatically applied to taxpayers’ filings. Section 179 deductions for equipment placed in service increased to $1 million, with a phase-out beginning at $2.5 million.
“Taxpayers can take only one of these deductions, so they need to consult with their tax adviser about whether to elect Section 179 or bonus depreciation,” Cataldo said.
These adjustments can have a positive impact for dentists considering expanding their practice or upgrading the technology in older acquired practices that will require significant equipment expenditures. Cataldo noted that there could be further complications with using Section 179 in the form of a tax penalty if a dentist decides to incorporate the business and is paying loans for equipment that no longer has asset basis.
Consider this example: A practice owner purchased $300,000 in equipment in 2017 for which she claimed Section 179 and took out a $200,000, 7-year term loan. In 2019, the loan balance is $175,000 and the practitioner decides to convert her sole proprietorship to a C corporation. This transaction would result in $175,000 in taxable income because the IRS views the transaction as if the practice owner contributed assets of no value to the C corporation while transferring $175,000 of liabilities to the corporation.
The bottom line is that even though the new corporate tax reductions sound enticing, dentists should discuss their individual potential savings with their tax adviser and attorney before making any capital expenditures or acquisitions.