Few physicians receive any advice on asset-protection planning from their certified public accountants, and unfortunately when they do the advice is often wrong. Here are four common mistakes CPAs typically make when advising doctors about protecting their assets.
As a certified public accountant (CPA) with 20-plus years of experience and an attorney lecturer to CPA groups nationwide, we are always surprised how few physicians have received any advice or even direction on asset protection from their CPAs. Ask yourself: Has your CPA helped you shield your assets from unnecessary exposure? Likely not.
Unfortunately, even when doctors do get asset-protection advice from their accountants, that advice is often plain wrong. Common mistaken advice ranges from, “You don’t need to worry about asset protection, you have insurance,” to “Why create a professional corporation for protection? It’s not worth the expense,” to "Just use a ‘disregarded entity’ for tax-filing purposes," to “Just put the assets in your spouse’s name, it’ll protect you.”
Let’s look at each of these four common CPA myths separately:
“Your Insurance Protects You.” While we strongly advocate property and casualty (P&C) insurance as part of your asset-protection plan, an insurance policy is 50 pages long for a reason. There are a variety of exclusions that most doctors never take the time to read, let alone understand. This is true for personal policies, such as homeowner's, car and even umbrella insurance, as well as business policies, the most important of which for physicians is medical malpractice insurance.
Even if your policy does cover the risk in question, there is still a chance that claims will go beyond coverage limits (malpractice judgments do periodically exceed traditional $1 million to $3 million coverage), or the insurance company may file for bankruptcy protection. In any of these cases, you could be left with the sole responsibility for the loss. Lastly, even if all of your losses are covered within coverage limits, you may see your future premiums skyrocket.
For these reasons, it is quite unwise to rely solely on insurance for your protection -- especially when many asset-protection techniques actually will save you taxes and help you build retirement wealth.
“You Don’t Need a Professional Corporation.” We have talked to probably 100 physicians over the years who have followed this advice from their accountant. The main justification seems to be the expense ($1,000 or so to create a corporation, plus a few hundred dollars each year to maintain it) and the additional paperwork (tax return, taking minutes, etc). What is so troubling here is that physicians seem to follow this mistaken advice. In our experience, no other owner of a significant business ($100,000 or more in annual revenues, with employees, etc.) would allow a business to operate in his or her own name.
When you fail to use a PC or other similar entity (PA, PLLC) to run your practice, you expose all of your personal wealth to any claim from the practice. While CPAs are quick to point out that the PC will not protect your assets from malpractice anyway -- and here they are right -- they ignore all liability risks created by employees that you might have nothing do with. For example, a receptionist may have a car accident while driving for the business (to pick up lunch for the office, etc.), or a staffer may slip and fall in the office, or have a car accident in the parking lot, among many other potential scenarios. If implemented correctly, the PC would protect your personal wealth against all of these potential liabilities and more, but, without one, all of your personal wealth would be vulnerable.
For this kind of protection, the small cost and paperwork seems to us well worth it. In fact, most CPAs themselves have such an entity in place -- and nearly 100% of solo attorneys use one. Why is it not good enough then for small medical practices?
“Use a ‘Disregarded Entity’ for Tax Purposes.” This is common misguided advice given to solo practitioners — to create a professional entity, but then choose to have the entity taxed as a “disregarded entity” by the Internal Revenue Service. Essentially, a sole-owned corporation or LLC can elect not to be treated as a separate entity with its own employer identification number (EIN). Instead the business is treated as a “disregarded entity,” identified by the Social Security number of the physician. While CPAs recommend this as a cost-saving measure -- saving the whopping cost of a simple tax return, perhaps $1,000 per year -- by using this form, the physician now endures the same risk as having no entity at all. By doing so, a lawsuit against the practice could “pierce the corporate veil” and attack all of the doctor’s personal assets, even if he or she was not involved in the activity that created liability.
While subjecting all of the physician’s personal assets to these types of risks in order to save $1,000 per year is bad enough, this is advice is also detrimental from a pure tax perspective. By choosing a “disregarded” status for a sole-owned LLC, the doctor may also pay more taxes on his or her income every year, than if the taxpayer chose a different tax status (typically, the “S” tax status would be superior here).
Thus, this advice is wrong on two levels: for asset protection and from a tax-planning standpoint. Nevertheless, just in the last six months, we have worked with two extremely successful solo physicians who had been following the CPA advice to have disregarded entities. These are physicians with over $1 million of annual income and significant net worth. If they’ve taken this type of advice from their advisors, anyone can.
“Just Put Your Assets in Your Spouse’s Name.” Other advice often given by CPAs concerns putting assets in a spouse’s name, on the mistaken assumption that those assets cannot be touched in the event of a lawsuit. We cannot tell you how many physicians have come to us with their assets in the name of the non-physician spouse and assumed those assets were protected from lawsuits against the physician. To see how this legal interpretation is wrong, ask yourself:
• Whose income was used to purchase the asset?
• Has the doctor used the asset at any time?
• Does the doctor have any control over the asset?
• Has the doctor benefited from “the spouse’s assets” in any way?
If the answer is “yes” to any of these, most courts find that at least half of the value will be exposed to the claims against the doctor. In community-property states, it may be 100% of the value, as a community asset.
Another good litmus test is to ask the CPA what he or she thinks will happen in a divorce if you follow that advice and put all the assets in the spouse's name. We would bet that your CPA will say that the court would treat these assets as joint, because you are still treating them as joint (such as living in the house, withdrawing funds from the accounts, paying the taxes, etc). The court knows that you haven't really "given the asset away" to the spouse. Most likely, this is exactly the way the court would treat them for creditor purposes as well.
In today’s environment, asset protection should clearly be part of any physician’s financial plan. It is unfortunate that so many doctors are often tripped up by poor advice from accountants. On our end, we try to educate CPAs in continuing professional education lectures around the country. On your end, you should watch out for such poor advice and meet with an advisor well-versed in these matters to be part of your team and work with your CPA.
David B. Mandell, JD, MBA is an attorney and principal of the financial consulting firm O’Dell Jarvis Mandell LLC, in Cincinnati, where Carole C. Foos, CPA works as a tax consultant. For a free (plus $5 shipping and handling) copy of For Doctors Only: A Guide to Working Less and Building More, please call (877) 656-4362.
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