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By: Hugh Bromma
With the advent of HMOs, some practitioners found that their capability to collect from the ultimately was a longer time line than usual, and have used the factoring methodology agreeable to receiving current payment.
A number of clients are professional corporations which work as part of a group which is not a formal partnership or corporation. Each has their own LLC, professional corporation or other entity. In such groups, each physician has their own qualified plan. Prior to 2002, these were most commonly Profit Sharing plans combined very often with Money Purchase Pension Plans to be able to maximize contributions. Many physicians had Defined Benefit plans. These used to be known as Keogh or HR-10 plans, but they are all qualified plans.
Along with their IRAs, these qualified plans would finance the accounts receivable from each others entity. Particularly interesting was one group that had a regular receivables line that they provided to each other. Within the group, once the receivable was established it would automatically become a candidate for each plan of another physician. Each physician would establish ahead of time whether they need or wanted the acceleration of payment. The receivables are carefully allocated to ensure that ones own plan would not be factoring one’s own receivable, as this would be not permitted under the prohibited transaction rules. Each “company” establishes its current cash needs and “request” funding under another company’s receivable line. Careful attention is also paid the yield on the portfolio, as each dollar that is returned to the pension plan is, of course, tax deferred.
Physicians often are able to maximize the contributions to their plan. This provides an original small funding amount for defined contribution plans (Keoghs), as the contribution limit is 25% of compensation to a maximum of $40,000. The Entrust Individual (k) ™, a profit sharing plan with the 401(k) feature, provides the additional benefit for “lower income” sole proprietors to maximize the contribution. A physician’s sole proprietorship or LLC can have a 401(k) combined with their plan. This means that company pays compensation of $50,000 to one doctor in 2003 can have a contribution of $12,500 to their profit sharing plan, plus the doctor may also defer up to $12,000 (14,000 because she is 50 (or over), for a total of $26,500. The company takes advantage of the deduction, and the doctor also reduces her personal tax for the deferral amount. Also, because her compensation is low, she also makes a $3,500 contribution to her Roth IRA ($3,000 plus a catch up provision of $500 because she is 50 or over). Altogether, she know has an additional $30,000 in her plan to fund investments just for 2003. (The Roth IRA contribution is made to her Individual (k) under the 2003 tax rules). Also, under the 2002 tax law changes, she is also able to roll her pre-tax IRA assets to her Individual (k). The advantages to her and her group are manifold:
The group is able to self direct each plan. Because they have elected to each provide for their own record-keeping. Each has elected to be the trustee of their plan. This means they have control over the assets of their own plan without involving a third party when it comes to their Individual (k) s. Each physician has a check book as trustee for their plan. The ministerial tasks are usually handled by a bookkeeper for each of the doctor’s companies. Each portfolio buys the receivable based on each doctor’s personal financial goals and objectives.
The “revolver” keeps each physician’s income current, and the factoring is actually done in each others plans. The plans have their tax free component in 2003, and of course the tax deferred component for their pension plan non IRA funds. All of the groups’ doctors have rolled over all of their pre-tax IRA (old contributory IRAs, SEP-IRAs and some eligible SIMPLE-IRAs) into their plan. Many doctors still have post tax dollars, including some Roth IRAs, which currently must remain under our custodial arrangement. Some doctors have opted to also direct us to purchase receivables with these funds, combining them with their pension plans.
An example of the potential is two the doctors companies, they factor each others receivable to receive advantageous yields for each others pension plans. The yield of about 18% to the plan is tax deferred, and the doctors receive weekly payments from the factored amounts. This not only permits the doctors to achieve a weekly cash flow from the receivable funding, but their retirement gets funded with a high yielding asset. The security interest in the receivable is perfected as part of the ministerial task. In addition, the plan is active in collection of past due receivables. Because the pension plan, in each case is active, the doctors are able to have their pension plans pay for office space used for the purposes of the plan. The office space is owned by the group’s doctors and is part of their practice. This is not a violation of prohibited transaction rules, as the rent is appropriate for the purpose of the plans involved.
So the flow is as follows: Dr. Kornblau, Inc.’s profit sharing plan is funded by his corporation. His compensation is $100,000. 25% of compensation is $25,000 which Dr. Kornblau, Inc. is able to use as a deduction. Dr. Kornblau, who is over 50 years old, also makes a $12,000 deferral from his compensation, plus $2,000 for a catch up provision, for a total of $14,000 for the 401(k) portion of the plan. Because he has a joint income` with his spouse under $160,000, he also makes a Roth IRA contribution to his plan of $3000, plus $500 for his catch up portion. The total qualified plan contribution and deferral amount is %25,000 plus $14,000 for a total of $39,000 (less than $40,000), plus $3,500 for the Roth, which is not counted as part of the $40,000 maximum qualified plan contribution/deferral limit. So he has a total of $42,500 added to his plan from $100,000 in compensation. The Kornblau Individual (k) plan is directed by Dr. Kornblau to buy Dr. Ban and Johnson Medical Corporation receivables through the line he has previously established. His plan factors about $5,000 weekly and average collection is 45 days. The companies and each other plans have elected to factor at a 20% discount for each other’s receivables, thus providing an excellent yield with a 95% collection and only 5% 90 day or more past due on the average original amount factored. As not every receivable is factored to the plan, normal receivables also provide current income to Dr. Kornblau. The Ban/Johnson medical group pension plan also buys a similar amount of Dr. Kornblau Inc.’s receivables, on the same basis,` thus providing benefits to their plan as well. In both cases, each plan handles the collection of the receivables, and credits the plan’s back for the cash collections. All income is tax deferred, except for the Roth IRA portion, which is tax free. The plans for both corporations also rent space for the activities involved in plan administration from their own respective practices.
Dr. Hunter, Inc. has not only his medical practice, but also has an imaging clinic, Northeast Imaging. Northeast provides separate compensation to Dr. Hunter. Dr Hunter has a plan for each corporation, and thus has an upper limit of $40,000 of contribution/deferral for each company. The maximum he can defer is $12,000 (100% of compensation to $12,000 is a single limit for all sources of income) and he is under 50. He has a total of $80,000 he contributes to the two plans for 2003. His imaging equipment is owned by Dr. Kornblau’s and Johnson/Ban profit sharing plan which formed a corporation , Imaging Results, Inc. with each plan owning 33 1/3% stock interest to purchase the equipment. That equipment is rented by the corporation owned by the plans to Northeast imaging. The corporation pays dividends to it’s shareholders, the three profit sharing plans. The receivables from Northeast Imaging are factored by Imaging results as well, thus generating additional income to Imaging results. It is important to factor in the potential of unrelated business income tax. Some or all of the tax rate can be obviated by establishing well designed entities with assistance of competent legal and tax counsel.
As can be seen from these examples, proper use of qualified plans and IRAs provide a stable source of funding cash flow instruments. The objectives of all parties and entities are accomplished with proper structuring and having an understanding of the objectives of the parties involved. Yield can be excellent, and other objectives of the parties can be met through the best use of the plans involved.
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