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Health Care Update: Taxable Income Classification Alert

January 20, 2017
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A recent U.S. Tax Court decision held that a doctor with his/her own medical practice who also owns an interest in a surgical center where they  treat some of their  patients  is NOT liable for self-employment tax on his distributive share of the surgical center income AND the income from the surgery center is properly classified as passive.
In Stephen P. Hardy and Angela M. Hardy v. Commissioner, Dr. Hardy had purchased an interest in a surgical center, with the intention of providing his patients a cost- effective alternative to hospitalization for surgical procedures that required general anesthesia and could not be performed at his private office.  At first, the income for both his private practice and the surgical group were reported as active income.  After running through a checklist, Dr. Hardy’s CPA decided that the income from Dr. Hardy’s interest in the surgical center qualifies as passive income, since Dr. Hardy did not materially participate in the operations of the surgical center on a regular basis.  The court ruled that the income from the surgical center was indeed passive since he did not participate in the management of the surgery center and his income from the center was as an investor and not based on his use of the facility. You can read the full court documents here.
Though the Tax Court’s decision regarding income classification is positive for many taxpayers, the caveat relating to health care practices, is that the passive income will be subject to the 3.8% Medicare tax stemming from the Affordable Care Act.

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