One of the most troubling issues facing physicians is the constant threat of a malpractice claim. To address this threat, as a first step in a comprehensive plan, every physician practice group and each individual physician should obtain the appropriate level of medical malpractice liability insurance coverage. In addition, both the group and each individual physician should also protect their respective assets in the event of a successful claim in excess of the policy limits. Due to the high cost and frequent unavailability of adequate medical malpractice insurance in Florida, many physicians are only able to purchase policies with undesirably small limits or to proceed without any medical malpractice liability insurance coverage at all.
If an aggrieved patient brings suit, it will usually be against both the physician and the physician's employer which, if successful, will enable the patient to proceed against both the physician's and the group's assets. If the physician has properly implemented an asset protection plan to insulate his or her personal assets from creditors' claims, the aggrieved patient will then be able to look only to the employer's assets to satisfy the judgment. The most likely asset a creditor will identify to satisfy an outstanding judgment is the physician practice group's accounts receivable (A/R). A/R usually represent the largest single asset of a group and one which is critical to provide an ongoing revenue stream to keep the practice operating.
In order for the group to protect it's A/R, the simplest solution is to obtain a loan from a bank or other lending institution collateralized by it's A/R and other assets. Once the loan is issued, the lending institution will secure the lien (much like a home mortgage) by a security agreement and the filing of a Form UCC-1 listing the practice assets including the A/R. The UCC-1 lien serves as a strong deterrent to a judgment creditor, forcing the creditor to pay off the UCC-1 lienholder (the lending institution) before the A/R may be liquidated to satisfy the judgment. Thus, in essence, since the bank will be repaid before the creditor realizes any cash from the A/R, the creditor will be left with little incentive to attempt to attach the A/R.
At the time that the funds are borrowed, the physician practice group should distribute the proceeds of the loan out of the group to avoid the proceeds becoming the target of a judgment creditor. However, getting often sizeable sums of cash into the hands of the physicians requires careful tax planning. This planning starts with a determination of the type of entity in which the physician practice group operates.
If the practice entity is a C corporation and the proceeds are distributed to the stockholders as a "dividend," the C corporation would not obtain a deduction for the payment and the physician stockholders would receive income taxable at the maximum capital gains rate of 15% (under current tax law). If the proceeds are paid to the group's employees as compensation for services, the recipients would report the distribution as compensation taxable at ordinary income tax rates (the top rate is currently 35%) and would incur additional employment taxes at the rate of 2.9%, assuming that $106,800 in annual compensation was otherwise paid. The compensation payment to the physicians would represent a tax deductible item, leaving the corporation in a loss position for the amount of such additional compensation, if the corporation "zeroes" out its other income for tax purposes through annual bonuses. The loss generated by the corporation would be carried forward to subsequent years. The expectation is that the loss would carry over until the loan is repaid and would then be offset against the "phantom" income generated when the loan is repaid.
If the group is organized as an S corporation, limited liability company or partnership ("Pass Thru Entity"), a distribution of cash in excess of the physician owner's income tax basis in his or her interest in the Pass Thru Entity will result in capital gain to the physician owner which is also taxed at the maximum capital gains rate of 15%. In some cases, the physician owners can increase their respective income tax basis in the ownership interest by personally guarantying the loan from the lending institution, thereby reducing or eliminating capital gains tax. Alternatively, the Pass Thru Entity may implement a compensation plan by using the loan proceeds to pay its physicians a bonus taxable at ordinary income tax rates. A compensation payment would create a corresponding loss which would pass through to each physician owner to the extent of his/her tax basis in the ownership interest and to the extent there is insufficient basis can be carried forward until such loss can be used to offset future taxable income of the Pass Thru Entity. Overall, to the extent the physician owner has sufficient tax basis in his ownership interest to absorb the loss, the net tax cost is the 2.9% employment taxes.
Regardless of the plan which works best in each individual case, it is imperative that the net after tax proceeds available to the physician are invested in protected investments and structures (i.e., annuities, life insurance, qualified plans, homestead property, tenants by the entireties property, family limited partnerships, or domestic and/or offshore asset protection trusts) and should not be spent as they may be needed later to pay federal income tax (including tax on the "phantom income" created by the repayment of the principal of the loan) and, possibly, to repay the lender.
In addition to the tax issues discussed above, counsel for the physician practice group must address a significant number of Florida rules protecting creditors and providing remedies for fraudulent conveyances. Nevertheless, the major benefit of the above-described plan is its relative simplicity. Some proponents of A/R financing utilize life insurance or annuity policies in an attempt to defer the income taxation, others structure so-called "rabbi trusts" and "secular trusts" into the plan. These alternate structures are often beneficial but always quite complex and create additional legal and economic issues which must be addressed.
The major drawback of the simplified approach described above is that if the practice group needs the physician owners to return some or all of the distributed funds, all of the physician owners may not have the funds readily available when needed. Another potential drawback could be the income tax consequences arising from the distribution. A final problem is the interest carrying charges and the tax deductibility of the interest payments. All asset protection planning for physician practice groups is complex and requires extensive knowledge and expertise in taxation, employee benefits, corporate law, creditors rights and fraudulent conveyance law, and health law.
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