Gates Advocates for Proactive Tax Planning for Medical Practices

Page 1December 2, 2013

Prepared for Tennessee Society of CPA’s Healthcare Conference

Proactive Tax Planning for Medical PracticesTennessee Society of CPA’s Healthcare Conference

December 2, 2013

Presented by Greg B. Gates, CPA, J.D., Principal

PYA GatesMoore

Atlanta, GA



Characteristics of a Proactive Adviser• Bring ideas to “the table” (arrows in your quiver)

• Contact clients with matters of benefit, interest, or concern

• Return client calls and emails TIMELY

• Annual review with staff

– What are we doing for the client they can do for themselves

– What are we not doing in advising the client that we should

• Bottom line: Take a real interest in the client and do not take them for granted.

P.S. – “Anybody” can prepare a tax return.



Overview of ….• Micro Captive Insurance Companies (CIC)

• Cash Balance Retirement Plans

Historically

• 401(k) Safe Harbor Profit Sharing Plans

• Medical Expense Reimbursement Plans (C Corporations)

• Conversion from LLC to S Corporation

• Deferred Income Tax Liability (C Corporations)



What a CIC is not ….

• Offshore (but it can be)

• A replacement for Professional Liability Insurance (Malpractice)

• Life insurance



When meeting with a client regarding a CIC have everyone in the room who may be a participant or a

‘Naysayer’

(“The confused mind always says ‘No’.”)

e.g. Attorney

Investment Advisor

Other?



Captive Insurance Companies - 831(b)

Medical Practice

Physician Owners

Physicians or Family

Members

CIC

Provides insurance coverage for various risks

$350K* to $1.2 million of annual insurance

premiums*Practical not statutory

Premium $’s



Qualifying Factors

• First & foremost: this is an insurance company

• $1.2 million ceiling on annual premium income

• Design the insurance to fit practice needs

• Viable for medical practices with “excess cash”



Introduction to 831(b) Captive Insurance Companies

IRS 831(b) provides that:

• Insurance companies with less than $1.2 million of annual premium pay $0 income tax on insurance “profits” (premium income)

• Investment income is taxed as income to C-Corporation

• 831(b) must be timely elected and cannot be revoked without the permission of the Secretary



IRC Sec. 831(b) – Code Language• 831(b) Alternative tax for certain small companies

• (1) In general

• In lieu of the tax otherwise applicable under subsection (a), there is hereby imposed for each taxable year on the income of every insurance company to which this subsection applies a tax computed by multiplying the taxable investment income of such company for such taxable year by the rates provided in section 11(b)

• (2) Companies to which this subsection applies

• (A) In general

• This subsection shall apply to every insurance company other than life (including interinsurers and reciprocal underwriters) if –

• (i) the net written premiums (or, if greater, direct written premiums) for the taxable year do not exceed $1,200,000, and

• (ii) such company elects the application of this subsection for such taxable year

• The election under clause (ii) shall apply to the taxable year for which made and for all subsequent taxable years for which the requirements of clause (i) are met. Such an election, once made, may be revoked only with the consent of the Secretary.



Captive Insurance Company Policies• Everything a practice currently self-insures:

– Deductibles (e.g., Medical Malpractice)

– Excess losses above coverage limits

• Loss of income as a result of:

– Losing key employee

– Loss of license/professional risks (professionals)

– Weather

– ‘Downtime’ of clinical equipment, e.g., PET scanners, CT’s, MRI’s

• Liability risks for which practice does not insure

– Employee lawsuits – sexual harassment, wrongful termination, discrimination, etc.



Examples of Captive InsurancePolicies Written

• Professional Liability Coverage

• General Liability Gap

• HIPAA/Billing Audit Liability • Professional Misconduct

• Contractual Liability • Directors and Officers Liability

• Cyber Liability • Punitive Damages

• Environmental Liability • Loss of Key Employee

• Employment Practices • Employee Dishonesty

Do Not Insure Things That Are Not Pertinent e.g., Patent Infringement If You Have No Patents



The Ground Rules

• Premiums and policies must be market-comparable

• Actuarial support needed

• Insurance formalities complied with



Real Life Example - Results

Do Nothing with $1.2M Captive 831(b)

• No risk management, asset protection, buy-out/retirement benefits of CIC

• Risk management, asset protection, buy-out/retirement benefits of CIC

• Earn money, income taxes • Create trust to own CIC (or have family members own)

• Taxable/tax deferred investments

• CIC invests in tax deferred investments

• Die, pay estate taxes • Tax efficient withdrawals from CIC



Tax Planning Benefits1. Deductibility of premiums paid by Medical Practice –

IRC§162

– Assuming premiums are market comparable – determined by an actuary

2. CIC is not taxed on first $1.2 million of annual premium income

3. Distributions from CIC taxed at capital gain rates

4. Can transfer wealth if owners of CIC are family members

5. And… Asset Protection



Captive Insurance Companies - 831(b)

Medical Practice

Physician Owners

Physicians or Family

Members

CIC

Provides insurance coverage for various risks

$350K* to $1.2 million of annual insurance

premiums*Practical not statutory

Premium $’s

CIC Assets Protected

Dividends(Tax Savings)

If Owners Are Family Members(Wealth Transfer)



CIC team of Advisors

• Knowledgeable attorney

• Actuary

• CPA (need tax return and audit)



Cost for Establishment andMaintenance of CIC

• $80,000 to establish

• $55,000 annual maintenance

– Audit fee of $8,500

– Tax Return fee of $2,500

• Capitalization

– Cash or letter of credit



Greater Tax Deferral Using

Cash Balance Plans



Why Cash Balance and Why Now?

1) The new tax targets• >$250,000

2) Catch-up• Make up for 401(k) losses• Make up for QDRO’s



401(k)

Profit Sharing

DefinedContribution

Qualified Plans

DefinedBenefit

TraditionalHybrid

CashBalance



How Does Cash Balance Differ from a DB Plan?

• Complex formula (contribution is actuarially determined)

Defined Benefit Plans Cash Balance Plans

• Account balance,

$100,000

• Unfamiliar/archaic • Familiar: 401(k)

• Age-sensitive • Less age-sensitive



401(k) with Tax

Age Profit Sharing Cash Balance TOTAL savings*

60 - 65 $56,500 $220,000 $276,500 $110,600

55 - 59 $56,500 $201,000 $257,500 $103,000

50 - 54 $56,500 $153,000 $209,500 $83,800

45 - 49 $51,000 $117,000 $168,000 $67,200

40 - 44 $51,000 $90,000 $141,000 $56,400

35 - 39 $51,000 $68,000 $119,000 $47,600

30 - 34 $51,000 $52,000 $103,000 $41,200

*Assuming 40% tax bracket, taxes are deferred

2013 Contribution Limits

401(k) Profit Sharing & Cash Balance Plans



How Do Cash Balance Plans Work?

401(k) Cash Balance

Interest Crediting

Rate (~5%)

ContributionContribution Earnings



Plan Investments

Earnings …next year’s contribution

Earnings …next year’s contribution

7-year make-up



Investment Dynamics

TARGET RETURN

Too low:• Greater expense / larger

contribution required• Underfunding limitations

Too high:

• Lower contribution• Smaller tax deduction• Potential excise tax



CASE STUDY: Small Business

Plan options?

CASE STUDY: Small Practice

Owners Age Compensation

Doctor 1 62 $ 250,000

Doctor 2 41 250,000

Employees

Jones 49 $ 89,000Keeler 63 88,000Marion 31 53,000Baldwin 29 50,000Dupre 41 48,000Ophir 25 39,000Smith 33 40,000Sabotin 48 35,000Parotta 22 15,000Keebler 30 14,000



Employees

All IRS-governed Plans:2 basic rules



The Give to Get

Owners Age Compensation

Employees

Above the line

Below the line

The Give to Get



Comparability

CASE STUDY: Basic PlanProfit TOTAL

Doctors 401(k) Sharing CONTRIBUTION

5% of pay

Doctor A $ 22,500 $ 12,250 $ 34,750

Doctor B 17,000 12,250 29,250

$ 64,000Employees 5% of pay

Jones 4,450Keeler 4,400Marion 2,650Baldwin 2,500Dupre 2,400Ophir 1,950Smith 2,000Sabotin 1,750Parotta 750Keebler 700

Subtotal $ 23,550 $ 23,550

Total $ 87,550

Percent to Doctors 73%



CASE STUDY: New ComparabilityProfit * TOTAL


13% of pay

Doctor A $ 22,500 $ 33,000 $ 55,500

Doctor B 17,000 33,000 50,000

$ 105,500Employees 5% of pay

Jones 4,450Keeler 4,400Marion 2,650Baldwin 2,500Dupre 2,400Ophir 1,950Smith 2,000Sabotin 1,750Parotta 750Keebler 700

Subtotal $ 23,550 $ 23,550

Total $ 129,050


* Assume new comparability (cross-tested) plan

CASE STUDY



CASE STUDY: Cash Balance OptionsCASE STUDY: Cash Balance Options

Profit

Doctors Age 401(k) Sharing

Doctor A 62 $ 22,500 $ 33,000 $0…$ 213,000

Doctor B 41 17,000 33,000 $0… 69,000

Employees 7.5% of pay

Jones 49 $ 6,675 $ 650Keeler 63 6,600 650Marion 31 3,975 650Baldwin 29 3,750 650Dupre 41 3,600 650Ophir 25 2,925 650Smith 33 3,000 650Sabotin 48 2,625 650Parotta 22 1,125 650Keebler 30 1,050 650

Cash

Balance



CASE STUDY: Cash Balance ActualCASE STUDY: Cash Balance ActualProfit TOTAL


Doctor A $ 22,500 $ 33,000 $ 213,000 $ 268,500

Doctor B 17,000 33,000 25,000 75,000


Jones 6,675 $ 650 7,325Keeler 6,600 650 7,250Marion 3,975 650 4,625Baldwin 3,750 650 4,400

Dupre 3,600 650 4,250Ophir 2,925 650 3,575Smith 3,000 650 3,650

Sabotin 2,625 650 3,275Parotta 1,125 650 1,775Keebler 1,050 650 1,700

Subtotal $ 35,325 $ 6,500 $ 41,825

Total $ 385,325


Cash

Balance

Summary of Cash Balance Contribution

Doctors $238,000 92.7%

Staff – Additional PSP

11,775

Cash Balance 6,500

$ 18,275 7.3%



89% to Owners

($343,500)+$112,305

No Plan Plan

60% to Owners

($231,195)

40%

tax bracket

$385,325

40% tax($154,130)

11% to employeesversus Uncle Sam

Is the Cash Balance Plan tax-efficient?Is the Cash Balance Plan

Tax-efficient?



Practical Illustration

Cash Balance Adjusted Total Hypothetical Additional Cash Balance Total Profit for Account Cash for Account for both

Sharing %'s Balances Balance Balances %'s Plans %'s Summary Practice 1 Totals Doctors $105,750.00 56% $ 150,000.00 - $ 150,000.00 92% $ 255,750.00 73% Staff 82,846.29 44% 11,200.41 1,623.66 12,824.07 8% 95,670.36 27% Total $188,596.29 100% $ 161,200.41 1,623.66 $ 162,824.07 100% $ 351,420.36 100%

Practice 2 Totals Doctors $198,000.00 42% $ 300,000.00 - $ 300,000.00 89% $ 498,000.00 62% Staff 271,082.97 58% 34,381.80 4,123.55 38,505.35 11% 309,588.32 38% Total $469,082.97 100% $ 334,381.80 4,123.55 $ 338,505.35 100% $ 807,588.32 100%

Combined Doctors $303,750.00 46% $ 450,000.00 - $ 450,000.00 90% $ 753,750.00 65% Staff 353,929.26 54% 45,582.21 5,747.21 51,329.42 10% 405,258.68 35% Total $657,679.26 100% $ 495,582.21 5,747.21 $ 501,329.42 100% $ 1,159,008.68 100%



Why Cash Balance Plans Appeal to Medical Practices

1. There is direct tracking of contribution (what goes in, plus interest, comes out).

2. Portable: If doctor retires or leaves the practice, rolled to IRA or the new plan

3. There can be contribution flexibility among partners.

4. Liability among partners can be minimized.

5. There are options if cash flows decrease.



Seven Basic FeaturesYou Need to Know You Need to Know



Feature #1

The cash balance contribution is required.



$

Cash BalancePlan

IRA

Other QualifiedPlan

Rollover

Assets are portable.

Feature #1Feature #2



Feature #2

Doctors can have different amounts contributed for them.

Cash Balance Contribution

Doctor 1, age 50: $112,000

Doctor 2, age 50: $0

Contribution flexibility among partners

Feature #3



Feature #3

Contribution amounts can change, but use caution.

What are doctors most concerned about

these days?

Feature #4



Feature #3

What if the cash flows decrease?

1. Reduce 401(k) and/or Profit Sharing.

2. Amend plan to change contribution amounts. (3 years)

3. Freeze plan.

1/1 12/31

Plan amendment deadline(1,000 hours/~June 15)

Feature #4 - Continued



Feature #4

Funding of the Plan

1/1/13 12/31/13

Funding deadline

3/15/14

Plan year

9/15/14

Funding extension

Filing of the practice tax return

Feature #5



• 40% of eligible participants- Example: 8/20 = 40%

OR

• 50 total

Feature #5

Participation requirement

(How many people need to be in the CB Plan?)

Feature #6



Feature #6Non-discrimination testing primarily satisfied in theProfit Sharing Plan

(gateway contributions 5%-7.5%)

Feature #7

Profit TOTAL

Owners 401(k) Sharing CONTRIBUTION

Doctor 1 $ 22,500 $ 33,000 $ 213,000 $ 268,500

Doctor 2 17,000 33,000 25,000 75,000


Jones 6,675 $ 650 7,325Keeler 6,600 650 7,250Marion 3,975 650 4,625Baldwin 3,750 650 4,400Dupre 3,600 650 4,250Ophir 2,925 650 3,575Smith 3,000 650 3,650Sabotin 2,625 650 3,275Parotta 1,125 650 1,775Keebler 1,050 650 1,700

Subtotal $ 35,325 $ 6,500 $ 41,825

Total $ 385,325

Percent to Owners 89%

Cash

Balance



Conclusion:

• See What Arrows Are In Your Quiver.

• Pull Them Out To Suit Clients Needs.

Be Proactive!

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Gates Advocates for Proactive Tax Planning for Medical Practices

Health & Medicine