Physiatry Practice Management Resources

Answer Taking money out of your practice in a form other than compensation always requires extra caution and careful planning.

Making sure that the transaction is proper and in compliance with the tax laws is especially important since the parties involved are related and will attract the IRS' attention.

The type of entity your practice is -- S corporation or C corporation, for example -- will determine how serious and expensive the IRS' potential recasting of your loan transaction.

The predominant question the agency will research is whether there was intent to repay when the funds were transferred. It is not enough for the involved parties to testify that repayment is planned; they must also demonstrate it with certain actions.

The IRS recently issued a list of 12 factors it will consider when evaluating whether payments to practice owners will be regarded as loans as opposed to compensation or other types of payments. These IRS factors were designed and released for corporations but can apply to your practice if organized differently.

One factor the IRS will consider is to what extent you control your practice. The probability that the transaction will be viewed as arm's length is greater if you don't own a majority interest in your practice either directly or through related parties.

The emphasis is on control as opposed to majority interest. If you own 20% of the practice but are the managing doctor who makes financial decisions, the loan may not be considered as being between a willing lender and borrower under arm's-length terms.

The IRS may look at whether the loan is secured. Lack of security may be an indication that your practice is not concerned about repayment as an outside party would. Securing the loan is another indication of an arm's-length transaction.

Also, the IRS will examine your financial position to determine if you have the ability to repay the loan from your practice. The IRS will request a financial statement of your personal net worth to determine if repayment is a possibility. The agency may look at your assets and liabilities when the loan was made or at the time of their examination.

Current market conditions may not support your ability to repay, but if it can be shown that at the time the loan was made repayment was highly likely or, upon the likely occurrence of a certain event repayment is inevitable, the loan will be less susceptible to challenge.

Other important factors that the IRS will consider are whether the loan provides for adequate interest, has a reasonable repayment schedule and has a set maturity date, and if there has been an attempt to repay.

The presence of these attributes will strengthen the loan's status with the IRS. Although it is not required, it is helpful to have a written note that stipulates the terms of the obligation. This, also, is suggestive of an arm's-length transaction.

If your practice is a C corporation, there are other issues to consider that may have serious tax consequences. If the corporation has earnings and profit and no dividend-paying history, it may encourage the IRS to recast the loan as dividend income to you with resulting significant income tax and penalties owed.

If your practice is an S corporation, the IRS will examine whether your practice reasonably compensates you for the services provided. If your compensation level is low, the loan payments may be reclassified to compensation, subject to employment taxes.

If you have other practice shareholders and the IRS reclassifies the loan as stock distribution with no corresponding payment to the other shareholders, your S corporation election would be in jeopardy with this "second class of stock" payment.

These factors are areas the IRS will examine to determine if it will accept the loan status. It will save you time and energy when defending your position under an IRS audit if you prepare the necessary documentation and make the appropriate loan terms to support an arm's-length transaction.

Question An opportunity to invest in a commercial real estate building with several other doctors has been presented to me. Traditionally, I have invested my excess funds in various mutual funds and thought that diversifying my portfolio into real estate might be complementary to my financial position. The building is in excellent condition, has a fine location, and anticipates a positive cash flow for the next five to 10 years based on its current leases. Are there any income tax issues to consider before I take the plunge?

Answer Diversification is attractive for mitigating risk and taking advantage of different investment vehicles. The recent roller-coaster ride with the stock market may encourage you to investigate alternatives for earning adequate returns on investment funds with potentially less risk.

Before you invest, review the cash flow projections and taxable income (or loss) projections. If the property generates an annual tax loss, it will most likely be a passive loss that may not be deductible until the property is sold if you have no other passive activities that generate passive income.

Calculate your rate of return on the investment by considering your initial cash outlay, the income tax benefits of the annual reported loss, if any, the cash flow from the property, and the unrealized appreciation on the building, net of tax.

Make sure you apply the appropriate marginal federal and state income tax rates to the annual rental loss and to the gain on the appreciation and consider the time value of your investment dollars and income taxes due.

The same mathematical exercise should be done if the property anticipates reporting annual taxable income. Once the numbers are determined, you can then decide if the rate of return is acceptable for the risk level or if you would do better with alternate properties or investments.

By Cathy B. Goldsticker