U.S. District Court Decision Court Treats Physician Loans as W-2 Income Rather Than Bona Fide Debt
A recent federal court decision illustrates how “loan” arrangements between physicians and their employers, if not properly structured, may be treated as the payment of taxable compensation and the employers may be hit with substantial tax, penalties and interest for failure to properly withhold income and payroll taxes.
In order to recruit and retain qualified physicians, The Vancouver Clinic, Inc. (the “Clinic”) gave newly hired physicians “loans” that would be forgiven by the Clinic if the physician receiving the loan remained employed by the Clinic for the full five-year term of the physician’s employment agreement. During the years 2007 through 2009, the Clinic made over 100 loans in an aggregate amount in excess of $1.5 million. The Clinic anticipated that the vast majority of these loans would be forgiven, rather than repaid. For federal income and payroll tax purposes, the Clinic treated the loans as bona fide loans, rather than W-2 compensation income, and thus did not withhold income or payroll taxes from the physicians when advances were made. The IRS audited the Clinic, and assessed withholding and payroll taxes, together with interest, in excess of $625,000. The Clinic paid the assessment, and sued for a refund, but a federal district court agreed with the IRS, and held that the physician loans were taxable compensation income when made. The district court stated that for a transaction to constitute a bona fide loan, there must be an unconditional promise to repay at the time the funds are advanced, and that in this case the applicable facts and documents strongly suggested that the parties did not actually intend repayment. (The Vancouver Clinic, Inc. v. United States, 111 A.F.T.R.2d 2013-1571 (W.D. Wash., 2013)).
It is often difficult to attract a physician to a community, and it is important not only to attract qualified physicians, but to have them stay for an extended period of time. Given the substantial up-front costs incurred to recruit and train a new physician, an employer should structure the compensation arrangement to encourage the physician to stay for a sufficient period of time to allow the employer to at least partially recoup its investment. As the Vancouver Clinic decision demonstrates, however, tax issues must be carefully considered when structuring recruitment and retention packages. Referring to a given arrangement as a “loan” or calling a document a loan agreement is not sufficient to make it a bona fide debt for income tax purposes if the applicable facts and circumstances indicate that the parties did not actually intend for such amounts to be repaid in accordance with its terms. As illustrated by the Vancouver Clinic decision, if the loan arrangement is not properly structured the advances may be treated as the payment of taxable compensation and the employer may be hit with substantial tax, penalties and interest for failure to properly withhold income and payroll taxes.
Similarly, physician recruitment agreements are very popular by and between hospitals, employer medical practices and individual physician recruits. There are specific requirements to ensure compliance with the Federal Anti-Kickback Statute and its practitioner recruitment safe harbor, as well as the federal Stark Law and its physician recruitment exception. The Stark law also has an exception for physician retention arrangements in underserved areas. While failure to satisfy the AKS safe harbor does not make an arrangement illegal per se, the federal government will review the facts and circumstances to determine the parties’ intent and AKS compliance. Stark is a strict liability statute so ensuring adherence to the requirements of the physician recruitment exception OR the physician retention exception in underserved areas is critical.
Business items, fraud and abuse issues, and tax considerations must be carefully considered and addressed as such issues are directly relevant to all physician recruitment and physician employment relationships.
Saul Ewing’s healthcare and tax attorneys routinely counsel clients and draft and review recruitment arrangements, employment contracts and employer-employee payment arrangements, and continue to monitor developments in this area. Please click here for more information about our Health Practice and here for information about our Tax Practice.