Three Ways Medical Practice Owners Can Improve Their Cash Flow
Updated: Mar 15
Most medical professionals who own a private practice did not pursue their chosen career to become business managers. The business side of owning a practice demands constant attention – patients must be billed, practices must collect payments, employee salaries must be paid, supplies and equipment must be maintained, and so on – otherwise, the practice cannot function, let alone generate a profit. Since most doctors do not enjoy spending hefty chunks of their time on these things, they typically hire a practice manager to handle them.
While hiring a good practice manager to keep the business end running is extremely helpful, it does not address a critical aspect of the financial side of owning a medical practice: maximizing tax benefits, and therefore optimizing cash flow for the doctor who owns the practice. This brief article offers three tips for improving the cash flow your medical practice can generate for you as a business owner.
1. Consider a Cash Balance plan for yourself and your employees.
A Cash Balance plan is like a pension plan (known as a “defined benefit” or “DB” plan) that has separate accounts for each employee, like a 401(k), which is a “defined contribution” or “DC” plan. There are some compelling reasons to consider establishing a Cash Balance plan, especially if you, as the owner, are much older than your employees, as is often the case in a medical practice. First, business expenses reduce your personal taxes (again, assuming your practice is an LLC or S-Corp), and 100% of the contributions made to a Cash Balance plan qualify as a business expense. And, since Cash Balance contributions are age-dependent (the older the participant, the higher the allowable contribution), if you are a good deal older than your employees, most of the total contributed will go to your account (note: this also assumes your employees’ salaries are lower than yours). You defer taxes on the amount invested through the Cash Balance plan, like a 401(k). This strategy may not make sense if you are fairly young with employees close to you in age or older.
2. Don’t overlook a home office deduction.
If you have a space in your home dedicated to working for your practice, such as paperwork related to patients’ treatments, or research on developments in your field, you could take a home office deduction on your tax return. The deduction would be based on the percentage of the total square footage of your home that dedicated space represents and your deductible home-related expenses (mortgage interest, property tax, insurance, etc.). The home office deduction commonly draws the attention of the IRS, so be sure you legitimately meet all of their criteria for claiming this deduction if you don’t want to get in trouble.
3. Do a mega-backdoor Roth 401(k) conversion.
You could do a mega-backdoor Roth 401(k) conversion if you are a sole practitioner. This maneuver involves establishing a Solo 401(k) Plan with a Roth 401(k) option for your practice. Some healthcare professionals can do this through their employers. Considering our own experiences, we’d guess this is a possibility somewhere between 10 and 25% of the time. Here is how this works:
With a traditional 401(k), you can contribute up to $19,500 to a traditional 401(k) on a pre-tax basis, along with a $6,500 pre-tax “catch up” contribution if you are over 50. And, because as the owner of the practice, you are also your employer, you can also contribute up to 25% of your salary to your 401(k) on a pre-tax basis. You can also make an after-tax contribution on top of that, up to a total maximum contribution limit of $58,000, or $64,500 if you are 50+. You can then convert that after-tax portion to a Roth 401(k).
Maximizing pre-tax deferrals may not be the best strategy if you expect to be in a high tax bracket in retirement. An alternative is to make your employee contribution (maximum of $19,500 plus $6,500 if over age 50) to the Roth 401k, make no (0%) employer contribution and then make the maximum allowable after-tax contribution to the Traditional IRA ($38,500 in the example) and then do an in-plan Roth rollover of the after-tax money. None of the money in the Roth 401(k), including the growth in the value of your investments over time, would be taxed when you withdraw those funds in retirement. Big caveat: as of the time of this writing, Congress may eliminate mega-backdoor Roth 401(k) conversions. Talk with your Gold Medal Waters advisor to investigate whether it makes sense for you to pursue this strategy in 2022.
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The common theme here is that the best way to maximize cash flow from your practice is to minimize taxes. As always, we recommend you discuss the recommendations proposed in this article with your GMW advisor to determine what is most appropriate for your situation.