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Pass Through Deduction in New Tax Bill Unlikely to Slow Trend Toward Industry Consolidation

The Tax Cuts and Jobs Act of 2017 signed into law on December 22, 2017 by President Trump added a new deduction for noncorporate taxpayers (i.e. S corporations, partnerships, sole proprietorships, and trusts) who have qualified business income.  This deduction, found in section 199A of the Internal Revenue Code, is also referred to as the “business pass-through income deduction.”  As presently written, prior to any technical correction enactments, joint committee explanations, or other guidance, the amount of deduction generally is the lesser of (1) 20% of a taxpayer’s qualified business income or (2) 20% of the taxpayer’s taxable income.  Qualified business income generally includes ordinary income less ordinary deductions from each pass-through business of a taxpayer (i.e. partnership, S corporation, or sole proprietorship).

There are, of course, limitations and special rules that may apply depending on the facts and circumstances of the taxpayer.  One such limitation applies to owners of certain services businesses.  Generally, section 199A denies the business pass-through income deduction to income generated by a “specified service trade or business.”   The definition of specified service trade or business includes any trade or business in the field of health; and therefore, applies to physicians and other healthcare providers.

At first glance it appears as though healthcare professionals will not qualify for this new pass-through income tax deduction.  In fact this is true for those healthcare professionals who have taxable income that exceeds $207,500 ($415,000 in the case of a joint return).

However, Section 199A also provides an exception from the definition of specified service trade or business for taxpayers with taxable income under $207,500 ($415,000 in the case of a joint return).  Through this exception, healthcare providers with taxable income under $157,500 ($315,000 for a joint return) can generally claim the full deduction equal to the lesser of (1) 20% of a taxpayer’s qualified business income or (2) 20% of the taxpayer’s taxable income.

Healthcare providers with taxable income from $157,500 to $207,500 ($315,000 to $415,000 for a joint return) will qualify for  a reduced pass-through income deduction with being phased out to zero as the healthcare provider’s income reaches the $207,500 (or $415,000) threshold.  This phase out is based on a complex formula which is further limited by the amount of W-2 wages that the business pays.

The application of the above rules can best be illustrated by the following two examples.


Assume a physician filed a joint return and has income and deductions as follows:

Medical Practice Income from Partnership $300,000
Interest and Dividends 10,000
Spouse W-2 Income 100,000
Retirement Plan $50,000
Self-Employed Health Ins. 20,000
Self-Employed Tax Deduction 20,000
Home Mortgage Interest 25,000
Charitable 20,000
State Income and Property Tax 10,000 (145,000)
Taxable Income   $265,000


Because taxable income is at or below the phase-out threshold of $315,000, the business pass-through deduction would be $53,000 which is the lesser of 20% of $300,000 business income or 20% of taxable income of $265,000.  This results in a federal tax reduction of $12,270 ($53,000 x 24% tax rate).


Assume the same facts as in Example 1, except that physician has $500,000 of income from the medical practice.  In this case, taxable income is increased to $465,000, which exceeds the full phase out limit of $415,000, so the physician gets no pass-through deduction.

While independent physicians commonly utilize pass-through entities to structure medical practices, it is questionable as to whether the new tax law will result in sweeping changes to the healthcare marketplace. The deduction is simply too narrow to reverse or significantly slow the recent trend toward consolidation and away from independent, small medical practices. The income thresholds will render specialists and other providers who practice in areas with historically high reimbursement rates ineligible for the deduction.

Independent physicians who would otherwise qualify (i.e., those whose annual income falls below the thresholds) are unlikely to eschew employment by a hospital or health system simply because of this relatively modest tax benefit. The forces driving consolidation are not only financial, but also derive from a myriad of factors, including increased regulatory burdens, fraud and abuse concerns, falling reimbursements for independent practitioners, and changing delivery models.

Rather, the impact of the deduction in The Tax Cuts and Jobs Act of 2017 for noncorporate physician taxpayers will likely be relatively modest on an industry-wide scale. The prime beneficiaries will be those providers who practice in (1) specialties with relatively low rates of reimbursement, such as primary care and pediatrics, and (2) geographic areas which are less susceptible to the recent trend towards acquisition and consolidation, such as small towns and rural areas. However, given that maintaining access to healthcare outside of population centers is quickly becoming a national problem, any financial benefit afforded to such providers is a step in the right direction.

This blog post was drafted by Reed Williams and Crystal Howard, attorneys in the Spencer Fane LLP Overland Park, KS office. For more information, visit spencerfane.com.