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The Most “Disruptive” Development of 2017 Goes to…Taxes!

by Ellen Badinelli | January 10, 2018

Physicians in the Cross Hairs: As states with business-friendly tax codes become a physician’s mecca, those of us in high-tax states may find a dwindling number of practitioners in the next decade.

As we take stock of the winners and losers of tax reform heading into 2018, let’s reflect on the details. First, as promised, change is certainly present for large C-corps (healthcare and non-healthcare). They will get fat and happy thanks to their 21% tax rate (decreased from the previous rate of 35%), particularly since there is no requirement to allocate any percentage of income to research and development, rank and file employee training, increased wages, or new hires, although several have committed to do so.

As states with business-friendly tax codes become a physician’s mecca, those of us in high-tax states may find a dwindling number of practitioners in the next decade.

Piles of Cash for Healthcare Corporations

For healthcare corporations, this no-strings-attached approach will result in greater piles of cash to spur stock buybacks, increased dividends and acquisitions, all of which offers some relief from the shackles thrown on healthcare in the past few years. No industry has found itself more at the mercy of a fluctuating political agenda as healthcare has—the new tax code and the industry’s new-found purchasing power frees it from being dictated by a variable it can’t control. HCO mergers will give the combined larger entity greater bargaining power with payers. Cross-industry mergers and acquisitions provide diversity in healthcare to better manage risk for all organizations in its ecosystem while complementing one another’s core competencies and bottom lines (e.g., CVS’ Aetna, and Cigna’s Brighter, just the beginning of a massive trend).

Additionally, it seems only a matter of time before larger organizations will be granted the same relief from ACA requirements that the current administration granted their small business counterparts, freeing them to restore businesses’ and insurers’ offerings and giving consumers increased affordability and choice.  Seems rosy, right?

Not So Fast. Hospital systems still face many financial challenges. More than 55% of hospitals operate at a loss. Further, Medicare reimbursement has remained flat at 90% of patient expenses, a losing equation from the start. The repeal of the individual mandate means health facilities will treat more patients without reasonable expectation of payment, forcing many into the debt-collection business and further eroding the support of sicker, more costly patients. A lack of payer-provider convergence with respect to financing patient care triggers frequent and costly contract negotiations.

 

How will Physician Practices Fare?

More than 45% of physicians are partnerships, and as service providers they are exempt from benefiting from the new lower S-corp. tax rate of 25% for pass-through businesses. Instead, they face individual tax rates of 35% for Single Filers earning over $200,000. Anjali Jayakumar, CPA of FIT Advisors, examines the real estate of her physician practice clients and the feasibility of establishing it as a separate entity. This permits separation of the medical practice (the service side of the business) from the real estate operation, which is eligible for the lower tax rate. However, Jayakumar cautions her clients to look to 2019 for IRS rules and regulations to be issued in response to this year’s filings.

Similar to the highly capitalized companies above, expect mergers and acquisitions of smaller scale (e.g., physicians joining or merging practices, or purchasing a standalone pharmacy). An argument could be made for even acquiring the local cooking school, gym or corner bodega, reasoning that those businesses are integral to social determinants of health, a priority of CMS; although there is a lack of guidance on how the IRS would view this.

Physician compensation accounts for an average of 10% of a community hospital’s operating budget. Many hospitals are overstaffed as patients are referred to skilled nursing facilities, outpatient surgical facilities and home care, leaving more beds unoccupied and the trend continues. In response, there is an increase in unaffiliated physicians, with privileges at several facilities. Yet, as referenced above, the new tax rate benefits filers with incomes under $200K, and married couples with incomes under $400,000. With the average medical student graduating with $200,000 in debt, the elimination of the federal deduction for state income tax and a cap on deducting property taxes above $10,000, earnings below those levels decrease the viability and sustainability of such practices and practitioners in high-tax states.

 

The Great Migration?

As business-friendly states become a physician’s mecca, high-tax states will find a dwindling number of practitioners in the next decade, largely through attrition. As medical school applications increase in states without income taxes and lower property taxes (e.g., Texas, Florida and Nevada) and graduates seek residencies there, most will build careers in those regions without incentives to settle elsewhere. Much as states have wooed Amazon, they may find themselves bending over backwards with concessions to reverse the coming trend of fewer physicians in high-tax states, or perhaps insurers will be pressured into larger reimbursements. Absent that tipping point, we may be at the beginning of a professional migration, not seen since the Gold Rush, when the pick and shovel salesmen found the quickest way to riches. Likewise, your local business and medical supply retailer stands ready to outfit your new Midwestern office.

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