At no time in our practice have we seen a greater need to shield assets from potential lawsuits. Today, malpractice premiums have soared along with lawsuit judgments, forcing many doctors to reduce their insurance coverage.
In this article, we will discuss a strategy for shielding the most valuable of all practice assets — accounts receivable (AR). Obviously, this is an important objective for any medical practice. Also in this article we will deliver a stern warning. Most of the ways doctors have been implementing this strategy is very troublesome. In fact, this is one area where you must "do it right" or risk extremely costly negative tax consequences.
Why leverage your AR? Most physicians have significant AR balances that sit on the practice's balance sheet as an exposed asset.These AR balances are, in fact, the most vulnerable asset to a malpractice (or other type of) lawsuit. Any type of claim against you or any of your partners could threaten the entire practice's AR. For this reason, the AR must be shielded, even before you engage in any asset protection of personal assets. If not, you risk losing all of your AR in one claim against any physician.
What if you could asset-protect your AR in a way that actually made you more money for retirement without any more work? Without any calls or time in the office? Surely, you would be very interested, right? And, if you could also provide protection for your family in case you passed away, or provided a way to buy out older physicians — both, again, without forcing you to earn any more money — would this get you to focus hard on this opportunity? If you are like most doctors, these combined benefits make the AR leveraging idea a very attractive one.
What is 'AR leveraging'? From the many programs we have reviewed for clients, we can say with experience, that not all programs are the same. In fact, the point of this article is that nine out of the 10 such programs our law firm reviewed make false promises with respect to the tax implications of the program ... they put the physician at a serious tax risk by telling him/her that there is no present-year taxation when the reality is that very sizeable present-year tax liabilities may occur.
Beware of land mines Here, we will briefly describe what to look out for when evaluating such a strategy, in order to tell the good ones from the bad.
Nonetheless, the first part of the transaction is always the same — the practice gets a loan on its AR, pledging the AR as collateral. With the funds in hand, the practice must invest them in a way that is asset-protected and grow in a tax-advantaged manner, but not be exposed to the practice's creditors. It is in this effort that nearly all of the programs in the market fail. Let's examine how these risky programs work:
AR leveraging: 'The wrong way' While there are many variations on the theme, the typical "wrong" AR financing strategy works like this:
The practice takes the loan proceeds and funds a "deferred compensation plan" for the physicians. The interest on the loan is allegedly tax-deductible, making the financial "cost" of the loan 40 percent to 50 percent less.
As part of the deferred compensation plan, the practice buys annuities or a life insurance policy on the physician's life. The lender takes a security interest in the policy/annuity also.
The practice either transfers the annuity or policy to the physician, retaining some nominal rights in the annuity/policy (or allows the doctor to take loans out of the annuity or policy directly).
When the physician retires, he/she liquidates the annuity or policy, pays the practice the loan principal back and the practice then pays off the lender. The doctor takes the remaining balance and pays tax only at retirement.
Doesn't work We do not believe this type of arrangement works for tax purposes.