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Our previous two posts examined a variety of issues related to Physician Recruitment Agreements. Recruitment agreements are complex, and have very serious implications that make it necessary for physicians to be well-advised before signing. Because recruitment agreements provide for a unique manner of compensation, it is critical that both the hospital and physician manage the payments appropriately.
Loans are often extended to physicians in order to attract them to a certain geographic area for a specified period of time. These “loans” are structured such that they are forgiven over time, allowing a physician’s repayment obligation to completely disappear after he has completed his commitment period. However, if the loans are mismanaged, they could be mischaracterized as income. In this circumstance, the physician would face unexpected taxes on that compensation.
A recent Tax Court examination of one such loan to a newly recruited physician highlights important considerations and portrays one situation where a physician actually aimed to characterize his payment as an advanced payment of his salary rather than a loan. In that case, the Hospital transferred the sum of $146,500 to the Physician pursuant to a recruitment agreement providing that Physician would practice in the area for at least 36 months. The recruitment agreement contained a compensation guarantee with forgiveness agreement and a promissory note. That year, Physician did not report the $146,500 on his 1099. Approximately two years later, Physician terminated his relationship with the hospital and therefore fell short of his 36-month requirement. Accordingly, Physician had to pay the Hospital the sum of $46,884 as repayment of the remaining balance on the Hospital’s loan. Physician then took the position that the $146,500 paid to him was an advance on his salary rather than a loan, thereby allowing him to claim the $46,884 repayment as a deductible expense on his Schedule C, Profit or Loss from a Business.The IRS challenged this deduction, contending that the original payment of $146,500 was in fact a loan.
In determining whether the original payment was a loan, the Tax Court pointed to two factors that must exist for a transfer to be considered a loan for tax purposes: 1) the repayment obligation placed on the transferee must not be subject to a condition precedent; and 2) the transferor must unconditionally intend to secure repayment of the funds. Physician argued that he was not unconditionally obligated to repay the amount transferred to him because he would only be required to repay if he breached the agreement. However, in examining the recruitment agreement and the related promissory note, the Tax Court disagreed. The Court found that all signs pointed to the fact that the payment was a loan, and that Physician had an unconditional obligation to repay the loan, even though the obligation was subject to a condition subsequent(i.e. the loan would be forgiven if the doctor continued to practice in the area and met all other requirements). Further, the Hospital did not report the transfer on Form 1099-MISC and the Physician did not include it in his 2009 gross income. Accordingly, the Tax Court ruled that the payment was in fact a loan and that Physician was not entitled to claim the $46,884 repayment as a deductible expense.
This case highlights a unique scenario in which the physician aimed to mischaracterize his recruitment payment as his salary in order to achieve a tax benefit after he was forced to make repayment on the loan. This should be instructive to physicians for two reasons: first, the repayment obligations pursuant to recruitment agreements are very real and physicians will in fact be held liable to make repayment if they fail to fulfill their obligations. Second, once repayment takes place, a physician will not be able to use creative accounting in order to lessen the blow of that liability.
Conversely, physicians may find themselves in trouble if they fail to acknowledge a loan as income at the appropriate time. In cases of forgivable loans, the amount received by the physician becomes taxable income once it is forgiven. Therefore, as a physician continues working and fulfilling his obligations, the loan becomes taxable income incrementally. This can be confusing, as a physician may realize taxable income even if there was no transfer of funds in that year.
For these reasons and more, it is imperative that physicians consult with a tax adviser immediately upon signing a recruitment agreement so that a clear tax payment plan can be delineated.
To learn more about the potential implications of your physician recruitment agreement, or to have your physician employment agreement analyzed by a physician attorney, call Laura Lauth Andrews at 317-979-0081 or Leigh Ann O'Neill at 317-989-4833.
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