How do these changes affect the DSO/PC tax structures you have in place?
In short, it depends….
Highlights of the Tax Changes
The most significant changes are as follows:
1) Corporate tax rates for Personal Service Corporations (PSC’s) and C Corporations were lowered from 35% to 21%.
2) The top individual tax rate was lowered from 39% to 37%.
3) A new deduction was created for pass through entities equal to 20% of qualified business income.
4) For companies with gross revenues greater than $25 million dollars, the deduction for business interest is now limited to 30% of EBITDA (earnings before interest, income taxes, depreciation and amortization).
Current Tax Structures
The tax structures of dental practices (PC’s) range from PC’s being taxed as Partnerships to S Corporations and Personal Service Corporations.
Entities that are structured as S Corporations and Partnerships are considered pass through entities. As a result the entity’s owners are taxed on the PC’s profits or losses, regardless of whether profits are distributed, on their individual returns.
Entities that are taxed as PSC’s incur their own tax at a corporate rate of 35%.
In the event that the PSC distributes profits to its owners, the owners would then be taxed on the so called dividend at a rate of 23.8%. This is where the term “double taxation” comes from.
Thus under the old law, owners of pass through entities were taxed at 39% and owners of PSC’s were taxed at an effective rate of 50.5%.
Tax rates for owners under the new law
Pass-through Entities 37.00%
Tax on the Corporation 21.00%
Dividends Received (Net of Corporate Tax) 18.80
New Tax Rate 39.80%
Am I eligible for the 20% deduction?
It is worth noting that the 20% deduction for pass through entities is not available for dental practices and potentially service businesses, i.e. management companies, if the owner’s individual taxable incomes exceed a range from $315,000 to $415,000.
In those situations where the owners taxable incomes fall within the range above, it may behoove the PC to remain a pass through entity.
What is the best type of entity for me?
To determine the optimal entity type under the new tax law system, consider the following:
A. Will you be able to receive a 20% deduction against the pass through income, i.e. will your taxable income be between $315,000- $415,000.
B. How much of the profits of the practice will be distributed over the next 3-5 years?