The US tax code is infamous for its complexity, and the 2017 Tax Cuts and Jobs Act (love it or hate it) makes things even more complicated than before for therapists in private practice. Does the new 20% deduction apply to therapy practices set up as sole proprietorships? LLCs? PLLCs? S-corps? Is a therapy practice considered a Specified Service Business? If it is, does this mean you don’t get the 20% deduction? Does the 20% deduction apply to all your income from a pass-through business? What is a pass-through business anyway? Since my wife is a therapist in private practice and I’m a consultant in private practice, I’ve been researching all these questions and more, and want to try and make sense of this mess for all of us.
First, however, a disclaimer. I’m not a tax professional, and even if I was, the following is intended as a general overview and is not tax advice for any particular person or business. For such tax advice you should contact your tax professional. However, the following should at least help you ask the right questions.
The simplest way to present how this complicated new law affects you as a therapist in private practice is with a Q&A format, so here goes.
Q. My practice is a sole proprietorship / LLC / PLLC / S-corp. Is this considered a pass-through or flow-through entity or business?
A. Pass-through or flow-through entities or businesses are companies that do not pay any income tax because their profits are passed on in their entirety to the owner(s), who then pay any taxes due on profits and/or W2 wages they receive from that business. This includes the following entities relevant for solo therapists in private practice:
- Sole proprietorships (including sole-member LLCs or PLLCs where you did not elect to have them treated by the IRS as an S-corp)
- S-corps (including sole-member LLCs or PLLCs where you made the election to have them treated by the IRS as an S-corp)
- Partnerships (including multi-member LLCs and PLLCs)
Q. Does it make sense to change to a C-corp to take advantage of the 21% tax rate for those?
A. It’s true that a C-corp’s profit is taxed at 21%, but then, once you distribute the remaining money to your personal accounts, it’ll be taxed again as individual income that will not have the benefit of the 20% deduction for qualified business income. Thus, from a pure tax perspective, changing to a C-corp is probably a bad idea in most cases.
Q. Is a therapy practice considered a qualified trade or business?
A. This is one of those areas that will likely be subject to evolving rules from the IRS and bears watching. However, at first blush it appears that a therapy practice would not be considered a qualified business because (a) it is in the health field, and even if it wasn’t, (b) it can be described as a business where the principal asset of the business is the reputation or skill of one or more of its employees. Thus, a therapy practice will likely be deemed a specified service business (SSB).
Q. Does this mean the 20% deduction is not available to therapists in private practice?
A. Not necessarily. If your individual taxable income is $157,500 or less if single ($315,000 or less if married), the deduction is potentially allowed even if your practice is deemed to be a SSB. Even if you do make more than the above limit, the deduction phases out gradually until your taxable income hits $207,500 for an individual ($415,000 if married).
Q. Does the 20% deduction apply to all income from a pass-through entity?
A. No. If your practice pays you a salary based on a W2, that income is not considered qualified business income (QBI). Only domestic income other than wages or investment income is considered QBI. If beyond the W2 salary you also get distributions from your business, those will likely fit the QBI definition. If the practice should be paying you a salary and isn’t, the IRS may decide for you how much your salary should have been, and exclude that from your QBI.
Q. Does the 20% deduction replace the business deductions such as those on a Schedule C?
A. No. You can still deduct various business expenses on your Schedule C (or the business tax return if treated as an S-corp) before determining the profit from the business. Then, the remaining profit is eligible for the 20% deduction, to the extent that it is considered QBI (and subject to the above-mentioned taxable income limits).
Q. Are there any business deductions that disappear that a therapist might have used?
A. Yes. The business entertainment deduction that previously allowed you to deduct half the cost of taking a referral source to e.g. a ballgame is repealed. Initial interpretations were that the same provision repealed the 50% deductibility of business meals (such as taking that referral source to lunch), but current interpretations say this deduction has not changed.
In addition to all the above, the Tax Cuts and Jobs Act implements many changes that affect your personal tax return, including but not limited to reduced tax rates, expanded tax brackets, $10,000 limit on deductible state and local taxes (or sales tax) plus property taxes, repealing personal exemptions, almost doubling the standard deduction, and many more. These changes are outside the scope of this article, but may have significant implications to your tax liability.
The Bottom Line on the 2017 Tax Reform Law
This is an extremely complicated piece of legislation, with lots of new definitions, exceptions, exceptions to those exceptions, etc. That means that even the IRS hasn’t figured it all out yet. Accountants are still going through the language of the new law, attending webinars, etc.; companies that serve accountants are preparing those webinars, rewriting tax software, etc. The IRS will publish new policies and rules over the coming months (and possibly years), and tax advice and software will continue to evolve as a result.
The above information is intended to be a snapshot in time of current understanding of the new tax law. It is not tax advice for any individual or business, but can serve as a starting point in understanding the most significant changes that affect your practice, informing a conversation you should have with your tax advisor.
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