2010 tax increases: Protect your wealth now; avoid greater liability next year

Key Points

All signs lead to future tax increases. We have historic deficit levels, an aggressive legislative agenda and a president whose campaign promises included raising taxes on households with annual incomes above $250,000.

Nearly every physician can expect to see his/her federal income tax liabilities increase within the year. When you add the proposed increases to many state and municipal taxes and fees, more significant tax deduction phase-outs and potential increases to self-employment taxes and FICA, you could see your combined marginal tax rate increase by 10 percent (up to 45 percent to 58 percent, depending on your state).

This could be an increase of up to 20 percent on the taxes paid on dollars earned over $250,000. This is no small set of changes, and they should not be taken lightly.

Many of these techniques are powerful enough to equalize or go beyond the proposed tax increases. Savvy doctors who take advantage of these strategies could expect to reduce their annual tax liabilities, even if all the proposed tax increases become law.

While there are countless ways to reduce taxes, we find that a dozen or so different strategies are most common among our physician clients. To keep this article manageable, we will focus on two strategies - utilizing the ideal corporate structure and maximizing tax-deductible benefits for the doctors in the practice.

Ideal corporate structure

Choosing the form and structure of one's medical practice is an important decision and one that can have a direct impact on the state and federal taxes you will owe every April 15. Yet, in our estimation, many doctors get it wrong. Here are a few ideas to consider when thinking about your present corporate structure:

A. Avoid using a partnership or proprietorship. These entities can be tax traps for physicians. These practice structures also leave significant holes in a doctor's asset-protection plan. The good news is that doctors who run their practices as a partnership or proprietorship have a tremendous opportunity to save taxes.

B. If you use an "S" corporation, don't treat it like a "C" corporation. We estimate that 60 percent to 70 percent of all medical practices are "S" corporations. Unfortunately, many physicians do not take advantage of their "S" corporation status, using inefficient compensation structures that completely erase the tax benefits of having the "S" in the first place. If your practice is an "S" corporation, you also have an opportunity to reduce your 2010 tax bill right now.

C. Implement a "C" corporation. Once upon a time, "C" corporations were the most popular entity for U.S. medical practices. Today, fewer than 15 percent of medical practices operate as "C" corporations. Why? We believe it is because most doctors, bookkeepers and accountants focus on avoiding the corporate plus individual "double tax" problem. While this is crucial to the proper use of a "C" corporation, it is only one of a number of important considerations a doctor must make when choosing the proper entity. A common mistake is to overlook the tax-deductible benefit plans that are only available to "C" corporations. If you have not recently examined the potential tax benefits you would receive by converting your practice to a "C" corporation, we recommend that you do so.

D. Get the best of both worlds by using multiple entities. Very few medical practices use more than one entity for the operation of the practice. Successful practices can often benefit from a superior practice structure that includes both an "S" and a "C" corporation. The benefits are both tax reduction and asset protection. If you have not explored the benefits of using both an "S" and "C" corporation, the threat of significant tax increases should be plenty of motivation.