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September 01, 2018

How the New Tax Law Affects “Choice of Entity” Decisions in Healthcare

Robert W. Patterson, Bond, Schoeneck & King, PLLC Buffalo, NY

The Tax Cuts and Jobs Act of 2017 (TCJA) made wholesale changes to federal tax laws.  This article will briefly discuss the possible impact of the TCJA on “choice of entity” decisions by U.S. healthcare businesses.

Background:  The “Choice of Entity” Decision

A basic legal decision that every United States business must make is the type of organization – corporation, partnership, limited liability company (LLC), sole proprietorship, or some other form – in which the business will operate.  In making this “choice of entity” decision, as it is usually called, the business’ owners must consider state laws that govern the various organizational forms (state corporation, LLC, and partnership laws, for example), creditors’ rights laws, securities laws, and especially, tax laws. 

For federal tax purposes, the most important choice of entity decision for most businesses is whether to be classified as a “C corporation” – that is, as a corporation taxed under Subchapter C of the Internal Revenue Code (Code) – or as some kind of “pass-through entity.”  A pass-through entity is an organization that is taxed as either an “S corporation” (an organization subject to Subchapter S of the Code) or a partnership.    

Since the Internal Revenue Service (IRS) issued the so called “check-the-box” regulations in the 1990s, U.S. businesses have had significant discretion to determine whether to be taxed as a pass-through entity or as a C corporation.  As the name suggests, these regulations permit businesses to simply choose a tax classification, subject to certain conditions and requirements.   For example, the regulations allow an LLC to be taxed as a C corporation, an S corporation (provided the owners are qualified shareholders) or a partnership.  A wholly owned LLC can choose to be classified as a C or S corporation, or to be “disregarded” for tax purposes, so that all of its activities are reported on its owner’s individual tax return.  (This type of disregarded entity is often referred to as a “sole proprietorship.”)  Moreover, under certain circumstances the regulations permit an existing entity to change its classification, so that (for example) an LLC classified as a partnership can convert to be taxed as a C corporation.

The Preference for Pass-Through Entities

The salient characteristic of C corporations is that business profits are taxed twice – at the entity level, at corporate tax rates, and again at the owner level, at individual rates, when after-tax profits are distributed to shareholders as dividends.  (Pass-through entities, on the other hand, are generally taxed only at the owner level, as business profits are “passed through” to owners and taxed only there.)   Largely because of this “double tax” disadvantage, most privately-owned U.S. businesses have elected to be taxed as pass-through entities (sole proprietorships, S corporations or partnerships) rather than as C corporations.  This can be seen by examining the number of tax returns of each type (that is, the returns applicable to each tax classification) that are filed.  For 2013 (the most recent year for which this information is available), the numbers were as follows:

Table 1:  Tax Returns Filed by U.S. businesses, 2013




2013 Returns


Pct.  of Total

Pct.  of Total Corporate & Partnership Returns





Sole proprietorship








S Corporation




C Corporation








As is apparent from the third column of Table 1, the great majority (more than 72 percent) of businesses are taxed as sole proprietorships.  This simply reflects the fact that most U.S. businesses are small – almost 90 percent of sole proprietorships had less than $100,000 of revenues in 2013, and almost 70 percent had less than $25,000.   The fourth column, which excludes sole proprietorships, gives a better picture of what tax classifications are chosen by larger U.S. businesses.  As shown in the fourth column, more than 82 percent of such businesses filed as pass-through entities (S corporations or partnerships), while only about 17 percent filed as C corporations.  It appears, then, that pass-through entity status is a very strong preference among larger (non-sole proprietorship) U.S. businesses, on the order of four to one or more over taxation as a C corporation. 

These statistics in Table 1 are for all U.S. businesses. What about healthcare businesses?  The IRS has published statistics on tax return filings, broken out by industries.  In the healthcare industry, the filings were as follows: 

Table 2:  Tax Returns Filed by U.S. businesses in Healthcare, 2008




2008 Returns


Pct.  of Total

Pct.  of Total Corporate & Partnership Returns





Sole proprietorship








S Corporation




C Corporation








Table 2 indicates that, compared to U.S. businesses in general (shown in Table 1), healthcare businesses have a similar, but slightly less pronounced preference for the pass-through classification (74 percent of filings other than sole proprietorships were either partnerships or S corporations; the corresponding figure for all U.S. businesses was 82 percent).  

TCJA Changes Affecting C Corporations

The most significant corporate tax change made by the TCJA is the reduction of the tax rate on C corporations to a flat 21 percent.   Previously, corporations were taxed at graduated rates which topped out at 35 percent for taxable income over $10 million. 

In addition, the TCJA repealed the corporate “alternative minimum tax” (AMT).   As its name suggests, the corporate AMT is an alternative to the regular corporate income tax, under which certain deductions, credits, and other tax preferences are limited or eliminated.  The TCJA eliminates the corporate AMT for taxable years after 2017, and permits prior AMT carryover credits (which previously could only be used to reduce the alternative corporate tax) to be used to offset a corporation’s current and future regular income tax.

The flat 21 percent tax rate represents an enormous tax cut for businesses taxed as corporations.  The new flat rate is 40 percent lower than the old maximum rate of 35 percent, and only one percent higher than the old corporate AMT rate.  This huge tax break may make the corporation a more desirable organizational form (and tax classification) for many healthcare businesses.  At minimum, the corporate tax changes may lead many healthcare businesses to reconsider their choice of the pass-through classification.  (As shown in Table 2, about three-quarters of U.S. healthcare businesses, excluding sole proprietorships, were taxed as pass-through entities in prior years.)

Changes Affecting S Corporations and Partnerships

Individual Tax Rates

Partners, LLC members and S corporation shareholders are taxed at the shareholder level on most items of the pass-through entity’s income.  Under the TCJA, the highest marginal rate for individuals has been reduced to 37 percent (from 39.6 percent) – a significant reduction, but much less dramatic than the 40 percent cut in the C corporation rate.

Deduction for Pass-Through Income

Along with the huge reduction in the corporate rate, Congress also included a significant tax benefit for pass-through entities in the TCJA.  For taxable years 2018 through 2025, taxpayers can deduct 20 percent of the “qualified business income” (QBI) of an S corporation, partnership, LLC or sole proprietorship allocable to the taxpayer.   (The deduction is taken by the business owner on his or her individual tax return.)  A taxpayer who receives the full benefit of this deduction would in effect have his or her top marginal tax rate reduced from 37 percent to 29.6 percent (80 percent of 37 percent = 29.6 percent.) 

The 20 percent QBI deduction is subject to a number of conditions and limitations.  In order to obtain the full benefit of the QBI deduction, the owner’s taxable income must be less than $157,500, or less than $315,000 if the owner is a married taxpayer filing a joint return.  Once a taxpayer’s taxable income exceeds these threshold amounts plus $50,000 (in other words, once taxable income exceeds $207,500 for a single filer or $415,000 for a joint filer), the QBI deduction is subject to limitations based on the business’s total employee wages and the amount it has invested in depreciable property.  Specifically, the QBI deduction is limited to the lesser of:

  • 20 percent of QBI, or 


  • the greater of (1) 50 percent of the total W-2 wages paid by the business, or (2) 25 percent of such W-2 wages plus 2.5 percent of the unadjusted basis immediately (after the acquisition) of qualified depreciable property.  

In addition, the QBI deduction is subject to special limits with respect to income from any “specified service trade or business” (SSTB), defined as “any trade or business involving the performance of services in the fields of health” (or certain other listed fields, including law), or any other business where the principal asset is the reputation or skill of one or more of its employees or owners.   In the case of an SSTB, the qualified business income deduction is only fully available to taxpayers with taxable income of $157,500 or less (or $315,000 or less for joint filers), and it is phased out completely for taxpayers with taxable income of $207,500 or more (or $415,000 or more for joint filers). 

Importantly, then, the 20 percent QBI deduction generally will only benefit healthcare providers with income below these phase-out thresholds, under the SSTB rules.  Moreover, the "field of health" category of SSTBs would clearly include the provision of medical services by physicians, nurses and other healthcare professionals, but it is possible that other health-related businesses would not be covered.  For example, a medical device manufacturer probably would not be considered an SSTB.   It remains to be seen whether other health-related businesses, like physical or occupational therapy centers, home health providers, or assisted living facilities, will be considered SSTBs for purposes of the 20 percent QBI deduction.  

In any case, because of the SSTB rules the new 20 percent deduction for pass-through income will not be available to members of professional medical groups (nor, possibly, to other health-related businesses) with incomes above $207,500 (or $415,000 for joint filers). 

Possible Impacts of TCJA Changes on Choice of Entity Decisions in Healthcare

The effect of the TCJA changes on any given healthcare business will obviously depend on a number of factors specific to that business, including many non-tax factors.   The highly simplified example below is intended only to demonstrate how the TCJA changes might affect choice of entity decisions in the healthcare industry. 

Table 3:  Hypothetical Example Showing the Impact of TCJA on Effective Tax Rates

Suppose that a hypothetical healthcare business has $1 million in income, $100,000 in miscellaneous deductions, pays state income taxes at the rate of seven percent, and distributes 80 percent of its after-tax profits to its owners.  Here is a (highly simplified) analysis of the federal tax consequences to the group and its owners if they operated as a C corporation or as an S corporation, before and after the TCJA. 



C corp.


C corp.


S corp.

   S corp.
Post-TCJA w/o
QBI deduction

   S corp.
Post-TCJA w/
QBI deduction



















State taxes (7%)






Taxable income






Federal taxes*






Net after-tax profits












Tax on dividend (23.8%**)






Effective fed.  tax rate***






*     Imposed on the C corporation at the highest corporate rate (35% pre-TCJA and 21% post-TCJA) and on the S corporation owners at the highest individual rate (39.6% pre-TCJA and 37% post-TCJA).

**    The 23.8% tax rate on dividends includes the highest income tax rate on qualified dividends (20%) and the 3.8% Medicare surtax on net investment income.

***   Total federal taxes (at the entity and owner levels) divided by taxable income.

In this example, the aggregate effective tax rate on the C Corporation and its shareholders has decreased dramatically as a result of the TCJA, from 47.4 percent to 36 percent.  This post-TCJA effective tax rate is still significantly higher than the effective rate on the hypothetical S corporation that qualifies for the QBI deduction (29.6 percent), but is actually slightly lower than the effective rate for the S corporation that does not qualify (37 percent). 

Furthermore, the effective tax rate for the hypothetical C Corporation would be even lower if the corporation did not distribute 80 percent of its after-tax profits to its shareholders, because the “double tax” on dividends would be that much less.  If, for example, the corporation distributed only 50 percent of its profits, the effective federal tax rate would be only 30.4 percent, rather than 36 percent (computed in the same manner as in Table 3).  And if the corporation retained all of its after-tax profits – to invest in new equipment, for example – the effective tax rate would be equal to the new corporate rate, 21 percent – greatly less than the effective rate on the S corporation shareholders (37 percent). 

Note, however, that the simplified example in Table 3 does not show how the QBI deduction can be used by smaller healthcare providers.  As noted earlier, even if a healthcare entity is an SSTB, its owners can use the 20 percent deduction to reduce taxable income of $207,500 or less (or $415,000 or less for joint filers).  For healthcare businesses of this size, the effective tax rate would be 29.6 percent – still substantially less than the corresponding rate for corporate businesses. 

In summary, it seems that the following businesses, in particular, may wish to consider the C Corporation tax classification:

  • Healthcare businesses that do not qualify for the 20 percent QBI deduction, because they are subject to the “specified service trade or business” rules and have income above the SSTB thresholds, and
  • Healthcare businesses that invest a high percentage of their profits in equipment or other property, rather than distributing them as dividends.

On the other hand, all other things being equal, pass-through entity status probably will remain the preferred choice for healthcare businesses that can fully utilize the QBI deduction because they are not subject to the SSTB limitations, and for smaller healthcare providers that can use this deduction even under the special limitations imposed on SSTBs (taxable income of $207,500 or less (or $415,000 or less for joint filers). 


Ultimately the choice of entity decision involves a large number of factors, including many that are not related to federal income tax.  But the major changes enacted by the TCJA may influence many U.S. healthcare businesses to re-analyze these factors.


Public Law No: 115-97 (12/22/2017).


The most important Code provisions that govern the taxability of corporations are found in Subchapter C of Chapter 1 of Subtitle A of the Code.  Subchapter C comprises sections 301-385 of the Code.


Subchapter S of Chapter 1 of Subtitle A of the Internal Revenue Code, which comprises sections 1361-1379 of the Code. 


Treas.  Reg. (26 C.F.R.) sections 301.7701-1 through 301.7701-3. 


Treas.  Reg. section 301.7701-3(c).


Source:  Internal Revenue Service, SOI Tax Stats - Integrated Business Data, Table 1 (accessed at (hereinafter, “IRS, SOI Tax Stats”).


The percentages in the fourth column are the number of forms of each type filed compared to the total number of forms of the three named types filed.  There are a great many other types of tax forms, including Form 1040 for individual income tax filers. 


Source:  IRS, SOI Tax Stats, Table 2.  Again, this is the most recent year for which this information is available.


Source:  IRS, SOI Tax Stats, Table 3.  Once again, this is the most recent year for which this information is available.


See note 7.


Of course, many hospitals and other healthcare providers operate as tax-exempt, nonprofit organizations.  Tax-exempt entities are not shown in the two tables above, and the effect of the TCJA on tax-exempt entities is beyond the scope of this article. 


Code section 11(b), as amended by TCJA section 13001(a).


Code section 55, as amended by TCJA section 12001(b)(6).


Code section 53(d)(2), as amended by TCJA section 12001(b)(2).  Under pre-2018 law, a corporation's tentative AMT equaled 20% of the corporation's “alternative minimum taxable income” in excess of an exemption amount, minus the corporation's AMT tax credit.  The TCJA permits these AMT credits from prior years to offset a corporation’s regular income tax liability after 2017.


Code section 1(j), as amended by TCJA section 11001(a).


Code section 199A, as added by TCJA section 11011(a). 


Code section 199A(g)(1).


Code section 1202(e)(3)(A), incorporated by reference into Code section 199A(d)(2)(A). 


PLR 201436001 9/5/2014) (the trade or business of a pharmaceutical company that specialized in experimental drugs was not “the performance of services in the field of health” under Code section 1202(e)(3)(A)); PLR 201717010 (4/28/2017) (developer of a tool that provides testing information to physicians was not engaged in the field of health under Code section 1202(e)(3)(A)).  Note that the SSTB rules in Code section 1202(e)(3)(A) are incorporated by reference into Code section 199A.


The IRS has not yet published regulations under Code section 199A.  Hopefully the IRS will issue guidance in the near future that will define the scope of the SSTB category, and clarify certain other uncertain aspects of the new QBI rules.


For example, state law rules that govern LLCs and partnerships are generally more flexible than those that apply to corporations with respect to matters such as voting rights, allocation of profits and losses, transfer of ownership interests, and management.  The formation and operation of corporations generally require observance of more legal formalities and, accordingly, corporations are usually more expensive to form and operate than LLCs and partnerships.

Robert Patterson

Mr. Patterson (or Robert) advises physicians, medical practice groups, human services agencies, faculty practice plans and other healthcare providers with respect to compliance, reimbursement, and regulatory matters, including Federal and state self-referral and anti-kickback laws, HIPAA compliance, governmental and payor audits, reimbursement issues, structuring healthcare transactions and other healthcare matters.  He may be reached at [email protected].