A change in the tax code may be just what the doctor ordered for specialists looking to keep the peace with the not-for-profit hospitals where they practice, as well as for hospitals trying to head off competition from physician-owned surgery centers.
The 2001 tax law that raised contribution limits on Individual Retirement Accounts also loosened restrictions on a lucrative tax shelter for highly paid employees of 501(c)(3) not-for-profit corporations. Though the changes are nearly 2 years old, organizations are just now beginning to implement compensation plans to take advantage, tax experts say.
Previously restricted to government workers, deferred-compensation plans under section 457(b) of the Internal Revenue Code now are available to highly compensated employees of not-for-profits, including physicians.
Also gone are the caps on the amount beneficiaries could defer each year, putting the 457(b) in the same class as the 457(f) that long has been popular.
Under 457(f), there is a "substantial risk of forfeiture," says Tom Blanchar, a retirement planning consultant in Indianapolis. Blanchar says if an employee leaves the company before becoming fully vested in the money-the law requires a minimum vesting period of three years-or if the company goes bankrupt, the employee's nest egg could be lost.
And when an employee does leave before retirement, the employer must pay any deferred compensation in a lump sum, at which time the money is fully taxable.
But 457(b) money now can be rolled over into another tax-sheltered account such as a 401(k) when the employee switches jobs or a company goes under.
However, those who already have 457(f) plans may not be able to move their money into a 457(b) without serious tax consequences, according to Blanchar.
Still, the 457(f) is a time-tested plan that has worked well for organizations with low turnover in their senior ranks, suggesting that the new 457(b) will prove successful as well.
"It allows physicians to make an unlimited amount of money tax-deferred," explains Javon Bea, CEO of Mercy Health System, Janesville, Wis., which has used the 457(f) for 13 years.
Not only does it keep the physicians happy, he says, it allowed the system to post an impressive 7.1% operating surplus in 2002.
Key to this success is the fact that Mercy has kept its specialists around and does not have to compete with the ambulatory surgery centers and specialty hospitals that have proven so rewarding to independent medical groups elsewhere.
Mercy has a staff of about 265 physicians, 70% of whom are specialists.
"The whole system saw the need to make it an attractive situation for all the specialists," says Mark Goelzer, M.D., the hospital's director of medical affairs.
Around 1990, Mercy embarked on a strategy of buying nearby physician practices for the cost of the physical assets only.
Instead of paying for a physician's sweat equity and patient base, the hospital incented practitioners with the chance to defer all or part of their salaries through the 457(f) mechanism. "We've never paid goodwill for a doctor's assets," Bea says.
Physicians sign professional services agreements with the hospital, which makes them employees for Internal Revenue Service purposes, but they retain autonomy over their practices and are compensated based purely on financial and clinical performace.
"By being part of the system, we get the facility fee, they get the professional fee and we take care of all the billing," Bea says. "We don't have to worry about these guys bringing in their own ancillaries."
By putting extra cash into a deferred-compensation plan, top producers can reduce taxable income by hundreds of thousands of dollars a year.
"As pre-existing practices have joined us, everybody has reported higher incomes," Goelzer says.
The administrative burden on practices is minimal, as if they were in a management services organization. Mercy has just five clinic managers for its 45 ambulatory clinics.
"Functionally . . . psychologically and culturally, it does function like an MSO, (but) it's 1,000% better than an MSO," Bea says.
"All the incentives we have as a physician practice and as a system are aligned," Goelzer says.