President Trump recently unveiled his tax reform proposal. As this is simply a proposal, it is not set in stone. However, here is an updated summary of what he is aiming for:
- Corporate tax rate will be reduced from 35% to 20%.
- Estate tax will be eliminated.
- The number of tax brackets will be reduced from seven to three, with the top rate going down from 39.6% to 35%.
- The standard deduction will double while personal exemptions and many itemized deductions (with the exception of mortgage interest and charitable donations) will be eliminated.
However, there is one big surprise that will affect many small business owners and especially physicians in private practice.
That is, the tax rate on pass-through earnings will be set at 25%!
I own such a pass-through entity, MZ Capital Management, through which I deliver my wealth management services. The earnings of the firm are not taxed at the firm level, rather they pass through to my tax return as personal income, thereby subject to my personal income tax rate. Since I am in the second highest tax bracket, the marginal tax rate on my pass-through income is currently 35%. (If I had not set up a defined benefit plan for myself, my marginal tax rate would have been 39.6%. This belongs to another article on tax mitigation.)
If Trump’s tax proposal becomes the law of the land, I will get a huge tax cut.
Many physicians also own pass-through entities like LLCs, S-corps or partnerships. For those who do not yet, it would not be hard to restructure their income as pass-through income, thereby capping their marginal tax rate at 25%.
For instance, let’s say Dr. John Doe is employed by a hospital and is drawing a $500k W2 salary. He is squarely in the top tax bracket. He could set up a firm called John Doe Medical LLC. He may do the same work for the hospital, but instead of getting paid a salary, he could ask the hospital to pay his firm instead, thereby converting his salary into pass-through income.
Personally, I am ambivalent about such a generous tax cut since it will be a tax loophole for every high-income person in the country, and it may blow a big hole in the nation’s budget deficit. However, if it does come to pass, you can bet that I will help my physician clients take advantage of it.
Michael Zhuang is a financial columnist for DoctorCPR.com and founder and principal of MZ Capital Management, a wealth management firm specializing in helping physicians build wealth and live well. You may download his Wealth Management Guide for Physicians.