By Roccy DeFrancesco, Esq.
As the frequency of medical malpractice claims increase, so do outrageous jury verdicts. While the likelihood of having a jury verdict in excess of your malpractice policy limits is very low, it is still a possibility that puts your personal assets, and potentially your practice’s accounts receivables (A/R) at risk. By factoring your office’s A/R, you can completely asset protect the A/R and turn the topic into a very nice income tax reduction plan/supplemental benefit plan for key physicians.
After talking with several personal injury (PI) attorneys that specialize in medical malpractice cases, I’ve come to the conclusion that a medical office’s A/R is technically at risk in every malpractice case. The A/R is basically the last possible asset a PI attorney will look at to satisfy a judgment, but since the A/R is technically at risk, why not protect it if, when doing so, a plan can also reduce your income taxes and increase funding for a supplemental benefit plan?
What is factoring?
Very simply, factoring is selling an A/R at a discount. The concept of factoring has been around as long as A/R itself has been around. Most of the time factoring is used when a manufacturing company has a large A/R on the books that would represent the entire profits for the company for the year. That particular A/R might not get paid prior to year end from a client that has no money. That means the manufacturing company will have no profit for the year unless they can figure out a way to collect the A/R.
To send a client to collections and hope to get paid on a large debt prior to year’s end is unrealistic. Physicians know too well how long it takes to collect from patients that have no money (sometimes it takes years to collect). What’s the alternative to waiting to go through the collection process? Factoring. There are companies out there that specialize in purchasing other company’s A/R at a discount, due to the fact that the purchasing company has confidence that 100 percent of the debt will be collected in a timely fashion.
Factoring is good for the seller because they get money today in hand, and good for the purchaser who can afford to wait to collect 100 percent of the debt that was purchased at a discount. Discounts on A/R range from 10-40 percent.
Let’s look at an example for a physician. A physician office has $1,000,000 of “real” A/R (not the fluff A/R that comes from what is billed). A factoring company contracts with the medical office to purchase the $1,000,000 for $800,000 and will cut a check to the medical office today for that $800,000. The factoring company runs the risk that the million dollars will not be collected by the medical office, but when and if the $1,000,000 is collected, the factoring company makes a nice profit.
While a medical office can borrow against their A/R to create a supplemental retirement plan for key physician(s), A/R leveraging also helps asset protect the A/R by putting another creditor in front of any potential patient that might go after the A/R in a lawsuit.
A/R factoring goes one step further in that the medical office is actually contracting to sell the A/R so there is absolutely nothing for a creditor to go after. Since the medical office does not own the A/R, the creditor (patient) can not make a claim against that A/R. There is no better way to asset protect your office’s A/R then by factoring.
If I just stopped here you might be wondering that, if you sold your A/R at a discount, you may have asset protected the A/R – but you also have a guarantee that you lost money since you now won’t take home 100 percent of what you normally collected. There is one company in the marketplace I am aware of that will factor your office’s A/R and through a marketing incentive will contribute 88 percent of that factored amount into a supplemental benefit plan for key physician(s).
Income Tax Reduction
The best way to illustrate how A/R factoring works to reduce taxes and fund a supplemental benefit plan is through an example.
Dr. Smith (age 45) earns $800,000 a year as an orthopedic surgeon in his company, Dr. Smith P.C. He is tired of being limited by his 401k/profit sharing plan as a tax deductible vehicle and is not interested in a defined benefit plan or 412i plan because of the amount of money he would have to kick in for the staff to allow him to put away more money in a tax deductible manner. Dr. Smith hears of A/R factoring and decides that he would like to reduce his income $100,000 a year if he could put that into a favorable tax planning vehicle.
Dr. Smith P.C. contracts with a factoring company to sell $500,000 of his A/R at a 20 percent discount ($400,000). Dr. Smith then takes home income of $700,000 (pre-tax) for the year.
The factoring company contributes 88 percent of the factored amount ($100,000 x .88 = $88,000) into an investment (life insurance). The 88 percent represents 89 percent of the total premium going into the life policy.
Dr. Smith on a post tax basis will become an investor in that same life insurance policy where Dr. Smith will put in 11 percent of the premium ($10,876) and now co-owns the policy with the factoring company.
By contract Dr. Smith will have access to all the cash value in the policy via policy loans (tax free income) and the factoring company when Dr. Smith dies will get the majority of the death benefit.
If we assume Dr. Smith factored $500,000 of his A/R for 10 years at a 20 percent discount, a 7.9 percent return in the stock market pre-tax and 7.9 percent in the life policy, with post tax investing, the available funds at age 66-85 would be $95,294 a year after tax from a brokerage account. By contrast, the A/R Factoring’s Life Policy would yield $243,871 in income tax free via life policy loans. A/R factoring as illustrated is 155 percent better then post tax investing.
It is very difficult for one doctor out of five or more to get an income tax reduction plan approved. I submit that a fellow partner should welcome the opportunity to have a partner implement the A/R factoring plan. Why? Because A/R is owned from a creditor standpoint by the medical office and if one physician wants to asset protect $500,000 or more of that A/R via the factoring plan, the partners should welcome that with open arms.
What does A/R Factoring accomplish? It protects your medical office’s largest asset- its A/R, reduces the income taxes of key physician(s), creates a supplemental benefit plan that does not require funding from for other employees and functions 155 percent better then post tax investing.
Roccy DeFrancesco, Esq., is President of FMG, L.L.C. in New Buffalo, MI, and is author of The Doctor’s Wealth Preservation Guide.