S Corporations: Traveling in Forbidden Lands
The newly elected United States Congress has identified corporate tax reform as one of its priorities; 2015 could hold major changes for dentists practicing as S corporations. By my own estimate, 50% – 80% of dental practices are S corporations.
In an event hosted by the Financial Services Roundtable, Representative Paul Ryan (R-WI) stated, “Where Tim [Pawlenty] and I come from, ‘overseas’ is Lake Superior, and Canadians are taxing all of their businesses at 15%. And our Subchapter S corporations, which are 90% of Minnesota and Wisconsin businesses, are taxed at as high as a 44.6% effective rate.” Corporate tax reform is needed to reinvigorate the economic growth of U.S. small business, including dentistry.
We are watching several potential tax law changes. If corporate tax rates are lowered substantially for regular corporations (e.g., to 20%) what will be the impact on S corporations? Will favorable corporate tax rates apply to personal service corporations, like dentistry? Will the payroll tax exemption on S corporation income above the owner’s salary be eliminated? Will liberalized Section 179 benefits of $500,000 be extended to the year 2015 and beyond? Current law anticipates expiration. Will basis issues that lead to the S corporation trap of lost depreciation deductions be changed? It is important that dentists follow any legislation for 2015, and adjust tax planning accordingly.
Currently, there are three reasons that dentists choose to practice in an S Corporation entity: the liability protection of the corporate form, the avoidance of payroll taxes on corporate income in excess of wages, and the ability to have payroll withholding instead of quarterly tax estimates at the personal tax level.
In exchange for these three benefits, dentists suffer major disadvantages caused by poor tax planning (which is universal among practices) on dentistry-specific issues. I rarely see an S corporation return where a dentist has not lost significant depreciation deductions for either equipment or a practice building. Likewise, children employed in such a practice are subjected to payroll taxes that eliminate many of the benefits of family income splitting.
All this said, S corporations currently offer advantages to dentists who understand their pitfalls and carefully plan capital expenditures. We have developed rules of thumb over the years, based on current tax law, to guide our dental clients in choosing and operating S corporations:
An S corporation may be a significant disadvantage for younger dentists or for dentists whose practice net income is less than $300,000 per year.
Young dentists who acquire a practice and have large capital expenditures are not well suited to practice as an S corporation because of the difficulty of benefiting from large equipment depreciation. Likewise, dentists who employ several children in the practice have payroll tax disadvantages.
If you practice as an S corporation, significant tax planning must be performed for any large (over $10,000) equipment purchase that is associated with a bank loan.
S corporations have a peculiar problem related to basis, an arcane tax concept generally defined as the amount of a capital investment in property. In July 2014, the IRS issued final S corporation regulations for basis and loans. To solve the “basis problem,” most dentists need to assure that the bank makes an equipment loan to them personally and the dentist then “lends” the money to the S corporation. This sounds silly and it is, but otherwise most depreciation deductions can be deferred for an indefinite period of time due to basis problems, which is not a desirable outcome.
Secondly, if you build your own office or purchase a building to rent to your S corporation practice, you need to assure that you make a “grouping” election to avoid losing large depreciation deductions due to the passive activity regulations.
S corporations only retain their forbidden-land status for the unaware traveler. Part of that awareness may be an ear to the ground during 2015 for possible major changes in the law.
The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2015, The BAM ALLIANCE