Many healthcare practices are organized as pass-through entities, such as partnerships or S corporations, which pay only one layer of tax and funnel their net income through to the physician owners’ personal tax returns.
For medical practices/physicians there are two main hurdles for claiming the full 20% deduction. The deduction may be reduced, or even eliminated, under these tests:
- Specified service businesses: This includes virtually every occupation that provides a personal service other than engineering and architecture. If your taxable income exceeds a threshold of $157,500 for single filers and $315,000 for joint filers, the deduction is reduced pro-rata under the “phase-in rule.” The phase-in is complete when income reaches $207,500 for single filers and $415,000 for joint filers. Above these upper thresholds, you get no deduction—period.
- Wage and capital limit: The deduction is limited to the greater of (a) 50% of W-2 wages for your business or (b) the sum of 25% of W-2 wages and 2.5% of the unadjusted basis of all qualified business property (i.e. depreciable property available for use in your business). This limit is phased in pro-rata based on the same income thresholds as the ones stated above for personal service businesses. Once you exceed the upper threshold, the phase-in of the limit is complete.
Certain types of investment-related items are excluded from qualified business income, e.g., capital gains or losses, dividends, and interest income. Employee compensation and guaranteed payments to a partner are also excluded. Taxpayers whose taxable income exceeds the threshold amount of $157,500 ($315,000 in the case of a joint return) are also subject to limitations based on W-2 wages paid by the business and the business’ unadjusted basis in acquired qualified property.
Taxpayers who have income below the lower income threshold have no worries at all. They are entitled to the full deduction. However, individuals in certain service professions, such as physicians, may not qualify for any deduction. The deduction for taxpayers in other businesses can vary widely. For these reasons, always consult your tax professional on your unique situation.
Key Business Changes
|Prior Law||New Law||Comments|
|Corporate tax rate||Corporate tax brackets are as follows: 15%, 25%, 34% and 35%. Personal service corporations a flat 35% rate.||Corporate tax rate a flat 21% rate effective for 2018 tax year.||Personal service corporations (covers heathcare) no longer have a special rate.|
|Pass-through deduction on qualified business income(QBI)||Net income earned by owners of pass-through entities is reported on their individual income tax returns and is subject to ordinary income tax rates.||For years beginning after 12/31/17 taxpayers with QBI entitled to deduction of QBI or 20% of taxable income. In general deduction is limited to 50% of wages or 25% of wages plus 2.5% of qualified property. Deduction phases out when taxable income exceeds $157,500 ($315,000 for joint return)||Because the phase out applies to service based businesses, such as those in healthcare, many will not see the full benefit of the deduction.|
|Alternative Minimum Tax (AMT)||C Corporations subject to AMT if average annual gross receipts over $7.5M for preceding three years||Corporate AMT repealed beginning with 2018 tax year. Prior year minimum tax credit allowed to offset regular tax liability.|
|100% bonus depreciation||50% bonus depreciation for 2017 on new asset purchases with tax life less than 20 years. Dropped to 40% in 2018 and 30% in 2019.||100% expensing for new and used property placed in service after 9/27/17.||Ability to expense used equipment as well as new will have an impact.|
|Section 179||In 2017, businesses may expense up to $510k of assets placed in service. Limitations exist when current year additions exceed $2.03M or based on taxable income.||Expensing increased to $1M. Phase out increased to $2.5M. Eligible property now includes qualified improvement property and certain improvements to non-residential property.||The increased Section 179 along with 100% bonus will give great flexibilty for expensing capital improvements. Not all states will conform to federal law.|
Key Individual Changes
|Prior Law||New Law||Comments|
|Individual rates||Seven brackets were as follows: 10%, 15%, 25%, 28% 33%, 35% and 39.6%||Seven brackets beginning 1/1/18 are as follows: 10%, 12%, 22%, 25%, 32%, 35% and 38.5%||Taxpayers will see rate cuts and higher income limits at most brackets|
|Alternative Minimum Tax(AMT)||Taxpayer’s must compute their regular tax, and their AMT. Tax liability will be the greater of regular tax or AMT||For tax years beginning after 12/31/17 and before 1/1/26, AMT is retained and the AMT exemption and phase out increased.||The increased exemption, the increased phase out, and the limiting of state income tax deductions will likely result in fewer taxpayers being subject to AMT|
|State and local tax deduction||Individuals may claim the state and local income or sales tax as an itemized deduction.||Individuals may deduct state and local sales, income or property taxes up to $10,000 per year.||Taxpayers in high tax states will be negatively impacted by this provision.|
Tax Planning Guidance for Your Medical Practice, and Physicians
The TCJA is the largest overhaul of the tax code in more than 30 years, and we’ve covered only the highlights of the pass-through business rule changes and tax provisions here. If you have questions or would like guidance for tax planning, please contact us. Keep in mind, there are additional rules and limits that apply – so always consult your tax advisor before taking action.