How to Prepare for the Unexpected
It's as certain as death and taxes: One day you will stop practicing.
Are you ready?
BY KEN HICKS, C.P.A., Vicksburg, Miss., and JERRY HAYES,
O.D., Ponte Vedra, Fla.
DIGITAL IMAGERY BY ANTHONY
In a perfect world, you work to age 65 and then sell your practice at a premium to a young associate or to another optometrist. The details of your practice transition have been well thought out and documented in a lengthy buy/sell agreement. A professional appraiser validates the price of the practice, and the buyer's bank finances a cash sale.
To ensure the smooth transition of the practice, you agree to work part time. Your career as a full-time optometrist now concluded, you go home to your significant other. You enjoy life and play with the grandchildren.
In the real world, however, you must prepare for the unexpected. What happens if you're forced to leave your practice unexpectedly? What would you do if a fire or flood temporarily leaves you without a practice? How would your family survive without you?
Practice interruptions take many forms. They can be as final as death or permanent disability. It's important to have a contingency plan for the termination of a practice, as well as temporary interruptions such as surgery, family illness or a leave of absence in connection with the military or national defense. No matter how permanent or temporary the practice interruptions, being prepared with a detailed plan can improve a practice's chance of survival.
Why start planning early?
Most optometric practices are sole proprietorships or incorporated with only one shareholder. If a solo optometrist is temporarily or permanently removed from the office, the practice stops and the economic benefits -- your earning power -- disappear almost immediately. Early and continuous planning can improve, insure and protect most of that earning potential.
Where do I start?
To plan for unexpected interruptions, begin by recognizing the "real value" of your practice, as opposed to the market value you would later identify in a buy/sell agreement, which we will discuss later. Value results when your practice provides a good livelihood for you and your family for years, and annually funds your retirement. Your emergency plan should respect, nourish and protect your earning power with:
- a business plan
- annual budgets.
Perform regular financial checkups and review your business plan to make sure you continue on the right track in each of these three areas. After your review, adjust accordingly. Develop and maintain a well-managed and profitable practice, and you greatly improve your chances of attracting a young associate
O.D. or potential buyers for your practice. Buyers are more interested in bottom-line profitability than volume.
In short, a healthier and more profitable practice stands a much better chance of surviving any type of practice interruption.
Tax advantages of early planning
While the profits of optometric practices grow steadily, income and payroll tax liabilities accelerate at an even faster pace. To maintain the highest levels of profitability, analyze your practice to determine if you should be a sole proprietorship, a C-corporation, an S-corporation or another form of entity. Consider the various options available. For example, an S-corporation can:
- minimize payroll taxes
- eliminate double taxation (C- corporations can be taxed twice; once at the corporate level and once at the shareholder level.)
- offer capital gains tax rates (C-corporations do not have this benefit).
You also need to evaluate real estate ownership and rental options. Consult with your tax advisor to ensure that you are maximizing your profits and minimizing your tax liabilities.
Insurance and benefits
Many practice interruptions are the result of illness or injury. With rising health-care costs, the benefits of insurance coverage exceed the premiums, especially if you suffer a serious injury.
Insurance and other benefits play an additional role in planning for an interruption. As your practice grows and prospers, you must expand benefits to attract and retain good people. A practice that experiences high employee turnover will be less attractive to buyers. And if an emergency were to occur, there's greater peace of mind relying on an experienced staff which has been in place for a number of years.
The following are options with tax advantages for any optometric practice to consider.
Accident and health plans
Fully insured plans. These are plans issued by insurance companies for the benefit of employees. Health insurance premiums are deductible by the employer and benefits received under the plan are tax free to covered employees and their dependents.
Self-insured medical reimbursement plans. With these plans, the company reimburses employees for costs not covered by insurance. If certain nondiscrimination rules are met, the benefit is excludable from employee wages and deductible by the employer.
Tax years beginning after 2001:
The percentage of self-employed health insurance that is deductible as an adjustment to income is increased as follows:
2003 and thereafter.....100%
Disability insurance benefits
For disability insurance plans, taxability of benefits received depends on who paid the premiums.
Employee-paid premiums. Premiums paid by the employee for disability insurance don't qualify as medical expenses and aren't deductible. Disability benefits received by the employee are excluded from income.
Employer-paid premiums. Premiums paid by the employer are deductible as employee benefits. The premiums aren't included in taxable income of the employee. However, benefits from an employer-paid disability policy are generally taxable to the employee to the extent the amounts exceed qualified medical expenses for the current year.
Group-term life insurance
An employer can provide up to $50,000 of group-term life insurance coverage to employees and former employees tax-free. However, the employer may not discriminate nor be directly or indirectly the beneficiary under the contract. Amounts provided in excess of $50,000 are taxable to the employee as wages subject to Social Security tax withholding.
No deduction is allowed for the premiums paid if the company is directly or indirectly a beneficiary. The proceeds generally are not taxable. Life insurance can be a valuable tool in funding a buy/sell agreement and providing cash flow after the death of an optometrist.
Worker's compensation insurance
Depending on the size of a business, employers are required to carry workers' compensation insurance, which covers employee occupational disabilities--illness or injury brought on by a person's job. Workers' compensation covers lost wages, medical care and rehabilitation. However the insurance does not cover injuries or an illness that aren't job related.
Many small businesses are exempt from purchasing worker's compensation insurance, and rules vary from state to state. In Mississippi, for example, worker's compensation insurance is required for businesses with five or more employees, excluding owners. From personal experience, we recommend coverage. If an employee is seriously hurt on the job, the costs to the practice can eliminate cash reserves and cripple operations.
Long-term care insurance
Many planners recommend long-term care insurance for people between the ages of 55 and 72 with a net worth between $150,000 and $1 million, excluding house and car. Individuals with a low net worth probably don't have enough to make the high cost of premiums worthwhile. Wealthy individuals may be able to fund long-term care through personal wealth, but shouldn't dismiss insurance, as long-term care costs are skyrocketing and could wipe out a personal fortune.
Qualified Retirement Plan
Contributions to an IRA, Keogh or 401(k) plan, for both the optometrist and the employees, are generally deductible. Earnings in the plan are tax deferred until withdrawn. A QRP for the
O.D. and his employees is part of the business plan that has to be in place to protect against practice interruptions.
It is critical that you consult your tax advisor before implementing the above plans as treatment may vary from practice to practice.
Plan your exit
After you've built your practice to the point that it's meeting your family's current needs, it's time to consider an exit plan. For most optometrists, that's accomplished by selling to a partner, associate or new optometrist as you near retirement age.
Early planning with an appraiser or practice management consultant will help you understand what buyers are looking for and allow you to enhance the potential sale price of your practice to another optometrist.
When an optometrist withdraws from a family-owned practice, partnership or closely held corporation, the business can be destroyed by problems associated with forced transfer of ownership and management. A buy/sell agreement is a plan designed to protect a business entity from harm caused by the death, disability or retirement of an owner. A properly designed and executed buy/sell agreement will ease the transition, protect the financial security of the optometrists and his or her heirs, and can be used as a powerful tool for income and estate tax planning.
A buy/sell agreement is enforceable by law, regardless of the buyer's circumstances or wishes at the time the seller ends his practice. In a typical buy/sell agreement, the buyer pays the seller over a 3- to 5-year period. The selling price is based on a formula or a percentage of revenues, as well as the number of patients that remain with the practice. This condition of the agreement assures that the seller, usually a retiring optometrist, encourages his patients to remain with the buyer's practice.
An optometrist usually enters into a buy/sell agreement with a younger partner. However, a solo practitioner can team up with another solo practitioner to draft reciprocating buy/sell agreements. Each would agree to purchase the other's practice, usually at a discount, in the event one of the practices is terminated.
It's critical for solo practitioners to consider a buy/sell agreement. The value of a solo practice rests solely on the optometrist's ability to maintain professional relationships with his patients. When the
O.D. stops practicing, the value of the practice quickly plummets to a fraction of its former figure. With a buy/sell agreement in place, heirs are protected with a selling price that was negotiated before the interruption.
Because of the complexity of issues involved with buy/sell agreements, such as contract law and tax rules, anyone considering setting up a plan should do so with the assistance of competent legal and tax accounting professionals.
Involve your loved ones
You must also prepare family members or trusted friends for emergencies. You should name a business advisor, someone who will act as a point person during the transition. Attorneys, bankers and certified public accounts are often selected because of their familiarity with the law and their connections to the business community.
The advisor will have to represent the family through a highly emotional time. The family must have complete confidence in this person to handle all the affairs of the transition. Timely, decisive action on his part will minimize turmoil and facilitate the execution of your plans. Here are some tips:
Discuss which optometrist to call if something happens to you. The most likely candidate is a respectful competitor whom you would trust to care for your patients.
Be aware that your state optometric association may have an Emergency Professional Assistance Plan Committee to assist in these matters. In addition, many states and local societies may have informal networks of optometrists who agree to cover for each other in the case of unexpected death or illness.
Below is a checklist of things you should have in place as part of your contingency plan.
- A to-do list for your spouse or family that contains a list of all the key people they should contact, all your bank accounts and all insurance policies or holdings.
- A buy/sell agreement that has been negotiated with the optometrist purchasing your practice that provides for an income stream to your family for the next 3 years.
- A trusted advisor who knows your practice and your intentions in the event of your death, disability or illness.
- Business continuation insurance to provide cash flow.
- An adequate amount of life insurance to support your family if you die.
- A substantial retirement plan that is available to you and your family in the event you live but can't work.
Taking care of business
No one likes to think about it, but disaster does strike sometimes in the form of unexpected death or disability. It's your responsibility to plan now so that the people you care about -- your family and patients --will be taken care of, even if you're not there to do it yourself.
Ken Hicks is a principal in the accounting firm of May & Company, Vicksburg, Miss.
Jerry Hayes, founder and director of Hayes Consulting, is a frequent writer and speaker on practice management issues.
Optometric Management, Issue: June 2002