It’s been just over a year since the Tax Cuts and Jobs Act (TCJA) went into effect, establishing a 20% deduction on so-called qualified business income for passthrough businesses (ones where the income is taxed through your personal tax return). Since most therapy practices are set up as such passthrough entities, you can almost certainly take advantage of this 20% deduction as you work on your 2018 tax return. We certainly plan to :).
Early last year, I wrote a short Q&A about how the TCJA would affect your private therapy practice. However, now that it’s been in effect for a full tax year, I interviewed our CPA to find out what they learned over the past year on the ways a therapist in private practice could benefit from the new tax law.
As a caveat, the following is intended to be informational, and a starting point for a conversation with your tax professional. It is not specific tax advice for anyone in particular.
As a more personal caveat, this is tax stuff, so I had to content myself with making it helpful. Making it fun is beyond me, sorry :).
Q. Is there any business entity or setup for a therapy practice where you don’t benefit from the new 20% passthrough deduction?
A. The only entity that can be used by a therapy practice but doesn’t benefit from the so-called Qualified Business Income Deduction (QBID) is the C-corp. This is because the new tax law established a fixed 21% tax rate for C-corps, and the QBID was designed to help owners of other entities, such as sole proprietorships, LLCs/PLLCs (sole-member disregarded, sole-member taxed as S-corp, or multi-member), and S-corps.
Q. Since C-corps are only taxed at 21%, would that be a better setup for your practice?
A. Although a C-corp’s profit is indeed taxed at 21%, profits distributed to the owners (without which you can’t really get much enjoyment from them) are taxed again as individual income – thus they’re taxed twice, and without the benefit of the 20% deduction. Thus, from a tax perspective, changing to a C-corp is usually a bad idea.
Q. Can your therapy practice take advantage of the 20% deduction?
A. Health professionals providing medical services directly to a patient or client are considered a specified service business (SSB), which limits your ability to claim the 20% deduction. However, if your individual taxable income for 2019 is $160,700 or less if single ($321,400 or less if married), the deduction is allowed even for SSBs. Above that limit, the deduction phases out gradually until your taxable income hits $210,700 for an individual ($421,400 if married).
Q. Does the 20% deduction apply to all income from your practice?
A. Not necessarily, which is why finding an accountant who specializes in small businesses, and has experience with medical and especially therapy practices can be very valuable. If your practice is a sole proprietorship, you can fully deduct any salaries you pay to others, if any. Profit you take as owner drawing doesn’t affect net income so you get the 20% deduction. If you do take a formal salary, it’s deductible to the business, but is then taxable at the personal level without the 20% deduction.
Q. Do you have to set up a formal payroll for your therapy practice and take a salary?
A. That depends on the entity type you use. Sole proprietorships don’t pay a salary to the owner, but S-corp shareholders are required to take a reasonable salary and should have a formal payroll set up. Qualified business income for S-corps must be reduced by the amount of reasonable compensation, even if it was not actually paid.
Sole-member LLCs that report their profits via a Schedule C on your personal tax return are treated the same as a sole proprietorship. If you elected to have your LLC taxed as an S-corp, you have to take a defensible salary from the business, and only remaining profits can be drawn as a distribution.
For partnerships, qualified business income does not include any guaranteed payments to partners. Those payments don’t benefit from the 20% deduction.
On the other hand, profits drawn from a sole proprietorship (or LLC taxed as one) are subject to self-employment taxes of up to 15.3%, so it’s important to consult with the right tax professional to figure out which setup will make your taxes lowest.
Q. Does the 20% deduction replace your other business deductions, e.g. those taken on a Schedule C?
A. In short, no. This deduction applies to qualified business income, which is what’s left after you deduct all business expenses, whether on a Schedule C or in a corporate tax return if you have to file one (e.g. for an S-corp).
Q. What determines how much of your practice income is eligible for the 20% deduction?
A. On the simplest level, the Qualified Business Income Deduction is 20% of the lesser of taxable income or qualified business income. However, the calculation is complicated. For example, the IRS applies additional tests when taxable income reaches certain thresholds. Other factors include W-2 wages paid, the type of business, depreciable property owned by the business (e.g. if you own your office space), whether you have more than one source of qualified business income, whether your spouse has business income, whether you have capital gains, etc. The complexity seems overwhelming, but actually offers opportunities for tax planning through which the right accountant can help minimize your taxes.
Q. As a practice owner, what other (legal ;)) ways can you use to reduce your taxable income?
A. The answer depends on how you set up your practice (e.g., LLC, S-corp, etc.). Some possibilities include contributing to a Health Savings Account (assuming your health plan qualifies), contributing to a qualified retirement plan (e.g., SEP-IRA, SIMPLE IRA, solo 401k, etc.), using the self-employed health insurance deduction, etc. This is another place where the right CPA can save you a nice chunk of change.
Q. How do you know which CPA you should work with?
A. As with any professional service provider, you want to work with someone who has the specific expertise and experience needed for your situation. For therapists in private practice, this means someone with lots of small-business experience, especially helping therapy practices. You also want to talk with the accountant before deciding, to see if he or she makes you feel comfortable and confident.
Once you have all that handled, you can concentrate on making a difference for your clients through your expertise and experience as a therapist, and let your accountant make a difference for your financial results. If you’re interested in more information, here's a free PDF of a case study of how two private therapy practices take advantage of the opportunities provided by the new tax law.
If you’re looking for coaching to address business challenges beyond taxes, shoot me an email and we’ll have a free, no-strings-attached call to see if we’d be a good fit to work together.
The above information is a snapshot in time of current understanding of the new tax law from our CPA, Bowman and Company CPA, PC. Specializing in serving the needs of small businesses and individuals since 1987, they provide small businesses with affordable, one-stop services ranging from bookkeeping and payroll to business consulting, tax planning, and wealth management. Having worked with them for many years, my wife and I frequently refer therapists to them. As we tell them, have a look at the CPA’s website, and if they seem like they may work for you, give them a call.