Bear in mind that a sole proprietorship does not exist apart from its owner. All of the proprietor's assets, whether used in the business or not, are at risk because the business liabilities are the owner's personal ones. Sole proprietors include all the business' income and expenses on their personal tax returns. If we consider how the expense side of medical practices has changed in the past fifty years, this can be alarming.

Changing the Paradigm
The first lesson to learn: a medical practice is, first and foremost, a business and for any business to be profitable, one must control expenses. In four years of managing medical practices, I have found it difficult to drastically cut expenses for two reasons.

To begin with, physicians need resources, both human and material, to ensure good patient care. Those resources do not come cheap. Secondly, repayments are decreasing constantly even though costs are rising. The quandary of business ownership has found healthcare and we must look to other accounting lines to control expenses. A good start is to make the most of tax deductions allowed by the IRS.

To Deduct Or Not To Deduct?
This eternal question is easily answered if you can honestly say that you would not have incurred a given expense if you were not in business. Because today's medical practice is not the residential practice of yesteryear, it incurs the same expenses as any other business. These include but are not limited to:

• Salaries
• Liability
• Health and disability insurance
• Laboratory and office supplies
• Rent and utilities
• Car and travel expenses
• Stationery and postage
• Professional and business licenses
• Fees and dues including civic clubs
• Legal and accounting fees
• Training and continued education
• Public relations and advertising

All that said, just as physicians should not heal themselves, they need to work with a strong tax adviser in order to benefit from optimum deductions.

Sooner or Later?
Medical technology is changing by leaps and bounds. Physicians can benefit from tax breaks while striving to maintain modern facilities, if they purchase equipment in a way that maximizes the tax breaks allowed.

As in any business, equipment used by physicians is depreciated over either five or seven years, depending on the apparatus purchased. While a 20% deduction per year over five years, or a 14.29% over seven years, is acceptable, it is not always the best!

Hence, we turn to the IRS' section 179 deduction. This deduction gives sole proprietors a well-deserved break by allowing an immediate write-off of up to $20,000 in equipment addition per year. Keep in mind these provisos, though: it can not be carried over to the next year, the equipment must start being used in the purchase year, and more than half of it must be used for business purposes.

With the high replacement cost for medical equipment, even established physicians can benefit from the maximum deduction, while keeping up with new technology. It is important to analyze the expected lifetime of equipment when determining whether to depreciate or to purchase under Section 179 deductions. Choose the method which best reflects its useful fee earning life.

The exponential of change with technology is increasing so quickly that some equipment will be obsolete long before the depreciation period is over. Therefore, the straight, same-year deduction is a real benefit when buying a computer, but the seven-year depreciation period works best for exam tables.

Pay Now, Pay Later?
The technological advances in medicine also cause another need -- to have money on hand to replace existing assets. This in turn impacts another tax habit common to doctors, that of deferring income. Physicians have traditionally deferred their income to their second year in practice, then the second year taxes become due in the third year and so on.

When I asked doctors how they feel about deferred taxation, I found their enthusiasm for it decreased as the years they have worked increased. While it is wonderful to avoid tax on income immediately at start-up, physicians find that the taxes owed increase at alarming rates as their practices grow.

Blend this with the rapid changes facing healthcare, and a physician's financial health is severely jeopardized. Remember that tax debt, like credit card debt, compounds fast and usually at a time when you need some financial flexibility for growth.

This strongly impacts physicians who are sole proprietors. While this type of business structure gives the individual increased autonomy, the growth of the business is limited by the extent of that individual's assets. A good part of those assets are permanently tied up in the business as working capital thereby determining the ceiling of the business. This is further complicated when, as a sole proprietor, you have to meet a tax demand on past year's earnings while expenses are rising, requiring capital transfusions.

Prevent Rather Than Cure!
The limit of growth is perhaps the largest restraint facing physicians who are sole proprietors. Moreover, these doctors find themselves in a win/lose situation where taxes are concerned and can, at best, mitigate them. Much as in averting illness through preventative medicine, we must factor the coming tax burden in the growth plan and make provisions for it.

Remember that in taxes, as in medicine, there are no quick fixes and Band-Aid cures only postpone reality. Accept that taxes will not go away and get to know the rules of the game. Read up on the topic or employ a good accountant and tax adviser.

Finally, consider transforming your sole proprietorship into an S-Corporation. The tax advantages are good and this business structure often allows a wider portfolio of fee income streams which are not readily available to the sole proprietor.

Originally published by SmartPros on May 15, 2000.

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