Practice Economics
Avoid "C" Corporation Tax Trouble
Part 2: Start by documenting all shareholder-physician tasks.

BY MARK E. KROPIEWNICKI, J.D., LL.M.

In Part 1 of this series of three articles, I discussed the Pediatric Surgical Associates, P.C. vs. Commissioner of Internal Revenue case. It dealt with the problems a professional corporation (PC), a "C" corporation for federal income tax purposes, might have in being able to legally deduct the full amount of the salaries and bonuses it pays its shareholders. This month, I'll suggest ways to stay out of trouble with the IRS.

THE ISSUE IS PROFITS

What this issue really comes down to is whether all the money paid to a PC's shareholder-physicians is legitimate compensation purely for the personal services the shareholder-physicians rendered, or whether some of it is a disguised distribution of corporate profit that should be subject to additional federal tax. As the Tax Court said, this is a factual question to be decided on the basis of the particular facts and circumstances of each case.

It appears that the PC in the tax case could have done more to document the significant services rendered by its shareholder-physicians. Better documentation could have justified their bonus compensation. The practice could also have taken a more businesslike approach to bonuses and year-end planning. Don't make the same mistakes with your PC.

TAKE THESE PRECAUTIONS

First, you need to document all the work that the shareholders do to assist the nonshareholder employees. The shareholders are all active to some extent in training and supervising the associates. Nurturing, mentoring and developing associates are crucial to making them effective, but can reduce a shareholder's actual personal income production.

Second, don't forget all of the management services that shareholders render in running the business of the practice and supervising its managers and administrators. The shareholders generally share responsibilities for running the practice to some extent. These activities go far beyond each physician's own production. Physician-shareholders assist in staff recruitment, compliance activities and personnel reviews. They are also likely to be closely involved in planning, negotiating with HMOs and supervising various personnel. These are all services worthy of compensation.

Third, you should include references to all of those shareholder services in your corporate minutes every time your PC pays additional compensation to its shareholders, whether the payments represent interim or year-end bonuses. The more documentation you have, the better.

ASSESS YOUR COMPENSATION PLAN

You also should make sure the compensation payments to your PC's shareholder-physicians are meant to compensate them for all of the personal services they render. PCs can generate other profit that the IRS might consider as nondeductible disguised dividends instead of deductible shareholder-physician compensation.

In each of those areas of ancillary services and personnel, the shareholder- physician must devote significant time, energy and human expertise to generate this profit. Does your compensation plan reflect all of that shareholder-physician time and effort? Those shareholder-physician services tend to encompass many personal responsibilities, such as supervision, management and the like.

If your PC is generating excess profits and none of my proposed solutions totally eliminates the problem, consider paying at least some of the profit as a dividend. It would mean paying some corporate tax, but it may not have to be a large amount. At a minimum, discuss this possibility with your accountant, tax advisor and attorney.

CONSIDER A RESTRUCTURING

Another option is to restructure your PC into a "pass through" entity such as an "S" Corporation. In Part 3, I'll consider such a conversion.

Mark E. Kropiewnicki, J.D., LL.M., is a principal consultant with The Health Care Group, Inc., and a principal and president of Health Care Law Associates, P.C., in Plymouth Meeting, Pa. He regularly advises physicians and practices on their contracting matters and business law obligations. He can be reached at (800) 473-0032.