When establishing a new business, it’s important to choose a legal structure that will minimize taxes, as well as to create a financial plan that assures sufficient cash flow to pay your taxes. “Phantom income” occurs in LLCs and S-Corps when an urgent care center’s earnings get “passed through” to the owner’s personal income tax return, but the business does not distribute sufficient cash for the owner to cover his/her tax liabilities. Most likely cash from the business is going to debt service or to fund capital growth. As a result, the business owner may be unable to pay his/her taxes, resulting in interest and penalties from the IRS. Avoiding “phantom income” is thus one reason why it’s so important to utilize professional consultants when developing an urgent care center. Alan Ayers has more!
Good evening, this is Alan Ayers and I am Just Checking In from beautiful Boca Raton, Florida which is currently hosting the Summer 2016 Medical Success Summit.
Tonight, I am going to be talking to you about issues of “phantom income”. This is very important because it goes to how you set up a new urgent care entity. In general, there are three types of corporate entities according to the IRS. The first is a C corporation. A C corporation pays taxes. The problem with a C corporation as a professional is if you own a C corporation, the corporation itself is going to be taxed, and then whatever dividends that corporation issues to its owners that will also be taxed at the owner’s tax rate. So in a sense, a C corps requires what is called double taxation, or the same income taxed twice by the government.
So to avoid that, professionals typically set up either a limited liability corporation or an S corporation. LLCs and S corporations are called “pass-through” entities. The reason why is whatever income earned by the business gets reported to the owner of the business in the form of a Schedule K. The owner of the business then takes that Schedule K, they report that as income on their Form 1040, and then they in effect pay taxes for the business at their personal income tax rate.
Now, the challenge with an LLC or S corp goes into an issue called “phantom income”. So you can have $100 of earnings into an urgent care center, that $100 of earnings will be passed through to the owners personal 1040 and they would responsible for the taxes on the entire $100. But, this is often what happens… $100 of earnings/ cash comes into the urgent care business, you have to pay debt expense from that, or you may need to invest into the business. Let’s say you need to buy a new x-ray machine or you’re opening a new center. So at the end of the day, even though you have $100 of earnings, you may not necessarily have $100 in cash, or let’s say $30 of cash or even $20 of cash.
So what can happen is the $100 of earnings “passes-through” to the owner’s form 1040 – they owe let’s say $28 in taxes but they may only receive $10 in cash from the business, so then that creates a tax liability that the owner may be unable to meet. I’ve actually seen provides end up in situations with the IRS where they cannot meet these tax obligations, they get hit with interest and penalties and significant tax issues because they didn’t plan their cash flows correctly to assure they had enough cash coming into the business to cover those cash flows.
While I am not an attorney, I do have a Masters in Accounting but I am not a licensed CPA. Our intent is not to give you tax advice but it is to make you aware of some of the issues that come up in the way that you structure an urgent care company.
Here at Practice Velocity, we have helped with over 150 urgent care start-ups and we have expertise and we have relationships with experts in law and accounting who can help you set up your urgent care center so that you can avoid these common pitfalls.
Again, here from Boca Raton this is Alan Ayers, Just Checking In. If you have any additional questions feel free to contact us at the email address you see on your screen.