With the legislation President Obama has signed into law this year, nearly all physicians will see their federal income, Medicare and capital gains taxes increase in the coming years. When you add to these federal tax increases, the various proposals in place to increase state and municipal taxes and fees, you could see your combined marginal tax rate increase by 10% (up to 45% to 58%, depending on your state). This could be an increase of up to 20% on the taxes paid on dollars earned over $250,000. This is no small set of changes and they should not be taken lightly.

Though many of your colleagues are complaining and some have been threatening to leave the country, we want to offer more practical advice in this article. The good news is that there are techniques most doctors can implement in 2010 to help reduce your taxes in 2011… and beyond. 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:

1. Utilizing the ideal corporate structure; and
2. Maximizing tax-deductible benefits for the doctors in the practice.

The most important thing a doctor reading this article can do is keep an open mind. Just because you have operated your practice a certain way for 5, 10 or 20 years, you don’t have to keep doing the same thing and volunteering to pay more than your fair share of taxes. Share this article with your tax advisors or call the authors to see how you can proactively address the tax law changes that will come. It could be the easiest $10,000 to $100,000 you ever see. Let’s explore a couple simple things you can start doing today.

1. Using the 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, after examining over 1,000 medical practices of our clients, many doctors get it wrong. Here are a few ideas to consider when thinking about your present corporate structure:

A. You must 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%-70% 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. However, Congress is considering legislation which may hamper some of the benefit of S corporations for service professionals.

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% of medical practices operate as “C” corporations. Why? We believe it is because most doctors, bookkeepers and accountants focus on avoiding the corporate + 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. This alone could counter-act all of the proposed tax increases.

D. Get the Best of Both Worlds – Use 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. These benefits are both tax reduction and asset protection. If you have not explored the benefits of using both an “S” and “C” corporation to get the best of both worlds in planning, the threat of significant tax increases should be plenty of motivation as this strategy could offset your increased tax liabilities.

2. Maximizing Tax-Deductible Benefits for the Doctors in the Practice

If you are serious about reducing your taxes, EFFICIENT benefit planning must be a focus. Benefit planning can definitely help you reduce taxes, but that is not enough. Benefits plans that deliver a disproportionate amount of the benefits to employees can be deductible to the practice, but too costly for the doctor owners. These plans can be considered inefficient. To create an efficient benefit plan, doctors need to combine qualified retirement plans (QRPs), non-qualified plans and “hybrid plans.”
Nearly 95% of the physicians who have contacted us over the years have some type of QRP in place. These include 401(k)s, profit-sharing plans, money purchase plans, defined benefit plans, 403(b)s, SEP or SIMPLE IRAs, and other variations. This is positive, as contributions to these plans are typically 100% tax deductible and the funds in these plans are afforded excellent asset protection. However, there are two problems with this approach: i.) many QRPs are outdated; and ii.) QRPs are only one piece of puzzle.

First, most physicians have not examined their QRPs in the last 2 years. The Pension Protection Act of 2006 improved the QRP options for many doctors. In other words, many doctors may be using an “outdated” plan and foregoing further contributions and deductions allowed under the most recent rule changes. By maximizing your QRP under the new rules, you could increase your deductions significantly for 2010.

Second, the vast majority of physicians begin and end their retirement planning with QRPs. Most have not analyzed, let alone implemented, any other type of benefit plan. Have you explored fringe benefit plans, non-qualified plans or “hybrid plans” in the last two years? The unfortunate truth for many doctors is that they are unaware of plans that enjoy favorable short-term and long-term tax treatment. If you have not yet analyzed all options for your practice, we highly encourage you to do so.

Nearly every one of you reading this article will see your various forms of state and federal income taxes increase in 2010 and likely again in the years that follow. We hope that you make managing your short- and long-term taxes a priority. If you would like some assistance identifying and structuring plans that may work for your practice, we would be happy to discuss this with you further. The authors welcome your questions. You can contact them at (877) 656-4362 or through their website http://www.ojmgroup.com

SPECIAL OFFER: For a free (plus $5 S&H) copy of For Doctors Only: A Guide to Working Less and Building More, 2nd edition, please call (877) 656-4362.

David Mandell, JD, MBA, is an attorney, author of 5 books for doctors, and principal of the financial consulting firm O’Dell Jarvis Mandell LLC, where Carole Foos works as a CPA and tax consultant. They can be reached at 877-656-4362.