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Tax Court Decision on Doctor’s Repayment of Loan

Tax Court Decision on Doctor's Repayment of Loan

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The United States Tax Court recently examined the tax treatment of a loan extended by a healthcare provider to a newly recruited physician in Salloum v. Commissioner, No. 17709-15, T.C. Memo. 2017-127 (T.C. June 29, 2017).  In its decision, the Tax Court agreed with the Internal Revenue Service (“IRS”) and held that the amount transferred by the hospital to Dr. Salloum constituted a loan, and thus, he wasn’t entitled to deduct the loan’s partial repayment.

Background

In 2009, Centerpoint Medical Center of Independence, LLC d/b/a Centerpoint Medical Center (“CMC”) actively recruited Ellis J. Salloum, M.D. to join their medical practice as a vascular surgeon. Dr. Salloum and CMC entered into a physician recruitment agreement (“Agreement”). Per T.C. Memo. 2017-127, CMC and Dr. Salloum agreed to the following in the Agreement:

  1. Dr. Salloum was to join CMC’s medical practice in Independence, Missouri for a period of at least 36 months during which he was to engage in the private practice of medicine as a vascular surgeon;
  2. Dr. Salloum was to work in CMC’s medical practice as an independent contractor; and
  3. CMC was to loan Dr. Salloum $146,500 to be advanced in monthly installments over a period of six months.

Additionally, the loan carried interest and was evidenced by a promissory note. As security for the payment of principal and interest on the loan, Dr. Salloum granted the hospital a security interest in, and irrevocably assigned to the hospital, all the accounts of his private practice of medicine.

Dr. Salloum had an unconditional obligation to repay the loan. However, as is commonly found in physician recruitment agreements, Dr. Salloum’s Agreement included loan forgiveness. The agreement provided that if he worked for the hospital for at least six months, CMC would forgive 1/30th of the loan for each month after the initial 6-month advance period that he remained on staff. The documents made it clear that amounts forgiven, if any (as well as any imputed income), would be reported as taxable compensation on a Form 1099-MISC, Miscellaneous Income. The 1099-MISC was to include any compensation that Dr. Salloum received, regardless of whether he received cash compensation from CMC or compensation from CMC as a result of the “forgiveness of amounts owed” to CMC.

Facts & Circumstances

In 2009, pursuant to the Agreement, CMC loaned $146,500 to Dr. Salloum during the first six months of his employment. Dr. Salloum did not include any of the borrowed amounts in his gross income during those six months and did not include the $146,500 loan in gross income for the taxable year ended December 31, 2009. Therefore, that amount was not taxed on disbursement to him during that year. However, during 2009 and 2010, CMC also paid Dr. Salloum non-employee compensation in the amount of $4,876 and $53,414; respectively. CMC appropriately reported the corresponding amounts on the Forms 1099-MISC that were issued to him during each of those years.

Dr. Salloum terminated his employment with CMC in February 2011. He did not receive any non-employee compensation from CMC in 2011 or 2012. Therefore, CMC did not issue any Forms 1099-MISC for years ended December 31, 2011 and 2012.

Pursuant to the compensation guarantee with forgiveness provision and the promissory note that were part of the physician’s recruiting agreement, Dr. Salloum made payments to CMC in 2012 totaling $46,883.54 in repayment of the remaining balance of the $146,500 that CMC had loaned to him in 2009.

On his 2012 Form 1040, U.S. Individual Income Tax Return, Dr. Salloum included a Schedule C, Profit or Loss From Business, where he reported non-employee compensation and  associated expenses. His 2012 Schedule C included the repayments in the amount of $46,883.54 as “Other expenses”.

Upon review, the IRS disallowed the deduction for Dr. Salloum’s repayment expenses of $46,883.54. The IRS argued that the amount paid by Dr. Salloum to CMC was a repayment of a loan and therefore not deductible on his Schedule C. Dr. Salloum was issued a notice of deficiency which included the additional tax due as well as an accuracy-related penalty under Internal Revenue Code 6662(a).

Tax Court Ruling

The Tax Court noted that the resolution of this case was dependent upon whether the $146,500 that was transferred to Dr. Salloum in 2009 constituted a loan pursuant to the Agreement.

As stated in T.C. Memo 2017 -127, “[t]he determination of whether a transfer of funds constitutes a loan is a question of fact (Fisher v. Commissioner, 54 T.C. 905, 909 (1970). In order for a transfer of funds to constitute a loan, at the time the funds are transferred there must be an unconditional obligation (i.e., an obligation that is not subject to a condition precedent) on the part of the transferee to repay, and an unconditional intention on the part of the transferor to secure repayment of, the funds.”

The Tax Court outlined the following factors supporting the IRS’ position that the transfer of funds at issue constituted a loan:

  • Salloum executed a promissory note in which he agreed to repay to CMC all amounts that CMC transferred to him and that the compensation guarantee with forgiveness agreement referred to the “Loan Repayment Amount” (i.e., $146,500);
  • There was a loan agreement with respect to CMC’s transfer to Dr. Salloum of the $146,500 in question that comprised the Agreement, the compensation guarantee with forgiveness agreement, and the promissory note;
  • Salloum agreed to pay interest on the $146,500 that he received from CMC at the rate specified in that note;
  • Salloum agreed to secure the repayment of the $146,500 loan and the interest thereon by granting CMC a security interest in all accounts receivable of his private practice of medicine;
  • Salloum had the ability to repay the $146,500 that CMC transferred to him;
  • Salloum in fact repaid the $146,500; and
  • Salloum and CMC treated the $146,500 that CMC transferred to Dr. Salloum as a loan evidenced by the fact that CMC did not report the $146,500 loan in Form 1099-MISC or in any other information return that it issued to Dr. Salloum for his taxable year 2009 and Dr. Salloum did not include the $146,500 in gross income for taxable year 2009.

Dr. Salloum contended that “there was no unconditional obligation to repay” the $146,500 he received from CMC. However, the Tax Court determined that Dr. Salloum failed to “carry the burden of establishing that the $146,500 that CMC transferred during 2009 was not a loan.”

Dr. Salloum did not dispute that if the Tax Court were to find that the $146,500 constituted a loan, he would not be entitled to the claimed 2012 Schedule C repayment expenses of $46,883.54.

Conclusion

Physician recruitment agreements are often used by healthcare systems in an effort to attract the best physicians in the healthcare industry’s competitive environment. More often than not, these agreements extend loans to newly recruited doctors which in turn may help physicians cover start-up expenses, operating expenses and may even offset the inconveniences and costs of a job change or relocation.

It is important for physicians and hospitals alike to fully understand how these types of advancements should be treated for tax purposes. Individuals may not realize that forgiveness of a loan creates taxable income, even though there is no cash transfer or withholding related to it in that same year. Therefore, physicians should provide copies of their physician recruitment agreements to their tax advisers to ensure income is reported properly and repayments of loans are not improperly included as offsetting expenses.

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