GOOD NEWS: THE LLC AND TRUMP’S PROPOSED TAX PLAN
We have all heard that “What happens in Vegas, stays in Vegas.” I often tell my clients that this is how they can understand the legal benefits of a properly structured and maintained business entity such as a Limited Liability Company (“LLC”). The LLC limits the liability of the owner(s) to the assets within the LLC. In other words, LLC’s effectively provide a “wall” that disallows a creditor of the LLC to attach the “outside” assets of the LLC’s owner(s) in a lawsuit. In this way, “What happens in an LLC, stays in an LLC.” However, for this strategy to be effective, the rules of the LLC must be followed and its form respected. Furthermore, some states differ in the amount of protection they are willing to offer single-member LLCs—but that is a topic for a different day.
The reader will notice that I have chosen the LLC to illustrate my examples throughout this article. Given the many considerations that go into choosing the right business entity for my physician clients, the LLC is my preferred model whenever available—not all states permit a physician to practice out of this type of structure. The LLC provides the asset protection, flexibility, and relatively low maintenance my clients desire without sacrificing tax benefits corporations currently provide.
ASSET PROTECTION ADVANTAGES OF A LLC
To illustrate, we recently had a deck collapse and crush a tenant’s leg outside of one of our Cardiologist client’s rental properties. Fortunately for our client, his rental property is owned by his LLC. His exposure was therefore limited to only the assets owned by that LLC (i.e. equity in the rental property, small cash operating account, etc.).
Likewise, the “wall” also protects the assets of the LLC from “outside” creditors. For example, a few years ago, an Anesthesiologist client hit a bicyclist in the crosswalk with his car after a long night of being on call. In this situation, the bicyclist creditor would not have been able to access the assets inside of the client’s various LLCs. The LLCs provided a wall that protected the assets inside the LLCs from the creditor arising from an outside activity. Thus, a properly structured and maintained LLC (and other business entities) provide “inside” and “outside” creditor protection.
Many doctors across the country are beginning to understand the importance of establishing business entities as crucial tools to limit their liability for asset protection purposes. Doctors are using them to protect assets ranging from medical practices, including separate LLCs for their medical building and equipment, to rental properties and even certain investment accounts. These days, doctors may not only have asset protection reasons to form business entities, but compelling tax reasons as well.
TAX ADVANTAGES OF A LLC
Recently, the Trump administration announced that Trump’s plan is to lower the corporate tax rates to 15% (from the current 35%). But the real news for doctors across the country is that this 15% tax rate will also apply to pass-through businesses such as LLCs and other partnerships. These businesses’ profits are “passed through” to the owners, who then pay taxes based on the individual income rates topping out at 39.6%.Under this plan, a doctor with an LLC would not pay taxes at, say, their 35% personal tax bracket on their income, but instead pay taxes on that income at 15%.
Let’s look at an example to illustrate the some of the far-reaching implications of this proposal. Our firm works with dozens of Kaiser Permanente-affiliated doctors on the West Coast. Some are paid as “W-2” employees and others retained as “1099” independent contractors. Imagine two Radiologists performing the same duties and falling within the same 28% tax bracket. One is paid a salary as an employee and the other is paid on a 1099 as an “independent contractor.” The Radiologist paid as a contractor is self-employed in the eyes of the IRS and can therefore set up an LLC in which she is the only member and manager. The benefit of creating an entity is that instead of paying taxes on her Radiologist income at the 28% bracket as an un-incorporated 1099 contractor (and like the W-2 employee must do), she will pay taxes on her doctor income at only the 15 percent bracket
The potential to drop taxes from the doctor’s personal tax bracket to the flat 15% bracket would easily justify the relatively simple and comparatively inexpensive incorporation process of contractors and private practice doctors. It might even justify doctor employees asking their employers to release them from their employment contracts and rehire their services through a newly-formed business entity. The employers would be all too happy to do this in many circumstances because they would be relieved of providing benefits (401(k) matches, health insurance, etc.) and paying payroll taxes and unemployment insurance.
LOOKING AT THE BIG PICTURE
Not surprisingly, Republicans and Democrats do not agree on the economic benefits and detriments, timeline or the likelihood that Trump’s proposal will be signed into law. But if one thing is certain, it is that after November of last year, America is ready to believe anything is possible. It would behoove doctors to be prepared. Staying apprised of the ever-changing tax and legal environment and implementing an effective strategy can dramatically affect their ability to flourish in their medical practice and in life.
Business entity planning has perhaps never had greater implications for doctors as it has now. Not only are there asset protection considerations, but under the Trump administration’s new proposal, there are potentially significant tax benefits as well. If the proposal (or anything like it) is signed into law, I think a more appropriate phrase will be “What happens in Vegas stays in Vegas…and while in Vegas, pay half the tax you would if you lived anywhere else.”
Randy is a trusted resource for doctors and high-net-worth individuals and families, offering comprehensive financial planning as well as rare private equity opportunities for his clients. Randy earned his J.D. and LL.M. in Taxation from Washington University in St. Louis. Randy is a Certified Financial Planner® as well as a Missouri-licensed attorney. In addition to co-founding 25, he founded The Larson Law Firm, LLC, practicing in the areas of estate planning, business law, and asset protection for physicians and dentists.