As the end of the year approaches, radiologists, imaging professionals, and other health care executives should already be turning their attention to tax planning. The areas of focus will be different depending on whether an individual owns an imaging center or functions as an employee at one. A lack of the proper planning at various intervals throughout the year, however, will cost dearly this coming tax season.
For imaging centers, year-end planning strategies will vary based on the size, structure, and tax reporting policies of the business. Specifically, what basis of accounting is being used for tax reporting? There are generally two types of tax bases: cash basis and accrual basis. Under the cash basis, revenues are recognized when received and expenses are deducted when paid. Under the accrual basis, revenues are recognized when earned and expenses are deducted when incurred.
Most imaging centers use the cash basis of accounting for income tax reporting. It is generally beneficial to do so since most revenue is collected over longer periods of time, while most expenses are paid over shorter periods. Under the accrual basis, imaging centers are required to pay tax on revenues earned even though such revenues have not been collected. With the extended collection periods that exist on collections from third-party payors for imaging services, a center would be paying tax on income that will not be received for some time.
So why would an imaging center ever choose the accrual basis for tax reporting? The answer is they would not. But they may not have a choice. The Internal Revenue Service Code provides certain instances whereby a business must use the accrual basis. For an imaging center, this generally applies when the imaging center is structured as a “C” Corporation (or in partnership with a “C” Corporation) and its annual gross revenues are greater than $5 million.
Accrual-Basis Imaging Centers. There are certain steps an “accrual-basis imaging center” can take to minimize taxes. The primary step that should be taken is to record revenues net of contractual allowances as opposed to recording gross fees. Contractual allowances are reductions in the amount of cash collected due to managed care contracts or other disallowances such as those imposed by Medicare. When recorded immediately against gross fees in the imaging center’s books and records, the result is an effective deduction for these disallowances, since the books and records will reflect only the net fees.
A mistake that many imaging centers make is to regard such disallowances as “bad debts” and to record a general “reserve” in the imaging center’s books and records to provide for an estimate against future write-offs of the uncollected piece of the fees due. The recording of such a reserve results in a nondeductible expense. Bad debts are deductible only when actually written off. “Written off” according to the tax code means all collection efforts have been exhausted and the receivable has been physically eliminated from the imaging center’s books and records. An exception does exist to this rule that allows an imaging center to deduct a portion of the reserve based on historical write-off experience. However, the amount of the deductible will generally be considerably less than the amount of the reserve.
Another step that can be taken by accrual-basis imaging centers is to “pull up” expenses and defer revenue. To the extent possible, deductible expenses such as repairs and maintenance should be incurred prior to the end of the year rather than pushing them off until the following year. Conversely, an imaging center is better off tax-wise if revenues are generated at the beginning of the following year rather than the end of the current year. This timing of revenues and expenses is not always easy to do. However, when the option exists to control the date that a particular revenue item is earned or a particular expense is incurred, this strategy should be considered. And remember that the timing of the collection of cash and payment of expenses does not impact the taxability. It is based solely on the date the revenue is earned and expense incurred.
Cash-Basis Imaging Centers. For cash-basis taxpayers, there is a timing strategy as well. But, contrary to that of accrual-basis taxpayers, the timing of cash collections from revenues and payments for expenses is significant. To minimize taxes for the current year, an imaging center should defer cash collections and accelerate cash payments. It is somewhat easy to control the timing of payments, subject to cash flow availability; however, the timing of receipts is controlled primarily by third-party payors and an imaging center cannot control the timing of such receipts. From a management perspective, operators would want to accelerate these cash receipts if they could. But it would result in an adverse tax consequence.
Regardless of whether you are an accrual-basis or cash-basis taxpayer, you can take advantage of favorable depreciation deductions. Depreciation is defined as the systematic allocation of the cost of a capital asset over the useful life of the asset. Such depreciation charges are tax deductible in the year to which the portion of the cost is allocated. These deductions are significant for imaging centers due to the capital-intensive nature of their business as well as the high cost of the diagnostic imaging equipment used.
For quite some time, the tax code has offered accelerated depreciation deductions whereby a larger portion of the cost of an asset was able to be deducted in the earlier years as opposed to spreading out the cost evenly. Over the past couple of years, this benefit has become even more attractive.
Commencing with the Job Creation and Worker Assistance Act of 2002, imaging centers could deduct 30% of the cost of qualified assets immediately and then continue to depreciate the remaining cost in accordance with the normal accelerated depreciation standards. In addition, if the total price of capital assets purchased for the year was below $200,000, the imaging center could immediately deduct $25,000 of the cost of an asset or assets prior to applying the 30% provision. The result was a fairly substantial write-off of the cost of purchased assets in the year they were purchased.
Effective with the Jobs and Growth Tax Relief Reconciliation Act of 2003, the acceleration of the depreciation of the costs of newly purchased assets has become even more considerable. Instead of a 30% initial write-off of the cost, it is now 50%. And instead of an immediate deduction of $25,000 if total assets purchased are below $200,000, it has been increased to an immediate deduction of $100,000 if total assets purchased are below $400,000. The significance of this change is not only to allow for a larger deduction, but to allow more imaging centers to qualify since the total purchase threshold has been raised. While not a concern for 2003, these provisions do expire, beginning at the end of 2004. Imaging center operators should plan capital purchases accordingly.
Imaging centers that have undergone substantial leasehold improvements should be aware of the concept of a “non-structural component” of leasehold improvements. Failure to do so could result in a significantly reduced depreciation deduction and, therefore, a higher tax. Structural leasehold improvements have a statutory depreciable life of 39 years. This means that the cost of such improvements must be depreciated evenly over 39 years. However, if any improvements were made to accommodate machinery and equipment and are not structural in nature, the costs associated with these improvements can be depreciated over the same life as the equipment. For most diagnostic imaging equipment, this life would be 5 years. To the extent that an improvements project has a structural and a nonstructural component, the imaging center should obtain from the contractor a breakdown of the costs associated with each.
PERSONAL INCOME TAX
For imaging center owners, radiologists, and employees, there are many areas for which personal tax planning can be done. While the Jobs and Growth Tax Relief Reconciliation Act of 2003 provides for some crucial changes and advantages that impact all individuals, it is relatively small in scope. Its primary purpose is to accelerate some of the deferred provisions of prior tax legislation.
Long-term Capital Gains and Dividends. The new act does have one significant element that impacts most individuals. The long-term capital gains tax rate for federal income tax purposes has been reduced from 20% down to 15%. To qualify as a long-term capital gain, a taxpayer must hold a capital asset (eg, stock, real estate, business asset) for at least 1 year. Perhaps even of more significance is the treatment of qualified dividends as long-term capital gains for purposes of applying the federal tax rate. Consequently, such dividends are now taxed at 15% as opposed to ordinary tax rates, which are currently as high as 35%.
These reduced rates provide for significant planning opportunities. With the disparity in the rates having widened, it becomes even more beneficial to have the sale of an asset be taxed at the long-term capital gains rate as opposed to the ordinary tax rate, which is applied to short-term capital gains and ordinary income, including interest income. These factors should influence a taxpayer’s decision as to whether and when to sell an asset.
The new tax rate applied to dividends offers an interesting decision for imaging center owners who operate as a corporation. Prior to the change in rates, it was commonplace to pay salaries to active shareholders of the corporation that operates an imaging center at an amount that is approximately equal to the profit of the center prior to such salaries. In this way, corporate tax was kept to a minimum. The goal was to keep corporate tax to a minimum due to the “double taxation” phenomenon whereby profits are taxed once at the corporate level and then again when distributed to the shareholders.
However, due to the lower rates on dividends, imaging center owners should re-evaluate this strategy and determine whether it would be more beneficial to forego additional salaries and distribute profits as dividends. While they will likely arrive at the same decision, the lower dividend rate causes there to be less of a benefit to avoiding the double taxation. Shareholders of these corporations may have other reasons to forego salaries and the cost of doing so has been diminished by the new rules.
While no specific planning can be done as a result of the following, individuals should be aware that federal income tax rates have been lowered and tax brackets have been adjusted, which will result in lower federal income taxes in 2003. In addition, the child tax credit has been increased for 2003. Furthermore, the adverse tax consequence of the “marriage penalty” has been mitigated by the adjustment of certain rates and thresholds applicable to married taxpayers who file joint income tax returns. And finally, the adjustment to certain elements of the “alternative minimum tax” is expected to provide relief from this “supplementary” tax to taxpayers who would otherwise be negatively impacted by it.
Hopefully, it is clear from the list of topics discussed herein that it is important to perform proper tax planningnot only toward the end of the year but all throughout. The many existing provisions of the tax law, as well as those resulting from new legislation, make planning a virtual necessity. There are many steps that can be taken to minimize taxes and improve one’s tax posture, from both a business and personal perspective. It is equally important to consult with a tax advisor to make certain that you are taking advantage of favorable provisions of the law as well as avoiding the pitfalls of unfavorable ones. Ensuring proper planning will save you money this tax season as well as set the tone for many tax seasons to come.
Philip Goldfarb, CPA, is a partner with Weisberg, Molé, Krantz & Goldfarb, LLP, in Hicksville, NY. He advises radiology practices and imaging centers on all aspects of accounting, tax, and financial management.