Structuring your medical practice to protect the family home
Are you a medical practitioner? Trading as a trust may be the best way to minimise your personal exposure in the event of bankruptcy.
Depending on your priorities and risk profile, you may wish to trade as a trust to prevent mortgage payments being “clawed back” in the event of bankruptcy. Here, Mahoneys partner Antony Harrison weighs up the pros and cons of such an arrangement for medical practitioners.
What you need to know when structuring your medical practice
Medical practitioners who carry on business as sole traders can only distribute monies received from the medical practice to themselves.
This means that any contribution the medical practitioner makes to an asset (for example, the family home) owned by another person (usually a spouse) is open to be clawed back (usually within 4-5 years of the contribution, but indefinitely in some instances 1) if the medical practitioner becomes bankrupt. 2
The trustee in bankruptcy’s ability to claw back contributions made to or on behalf of a spouse extend beyond distributions and can attach to the equity in the asset (i.e. market value increases) in certain circumstances.
However, if the medical practitioner traded as a trust (Medical Trust3), then:
- Distributions could be made directly from the Medical Trust to the spouse 4; and
- Those distributions to the spouse would not be subject to the same claw back in bankruptcy because they are distributions made by the Medical Trust, not the bankrupt 5.
Presuming the medical practice has no other doctors generating income (and that the personal service/exertion income tax rules (PSI Rules) apply), trading as a trust has no taxation benefits.
Distributions to the spouse are still taxed as if they are distributed directly to the medical practitioner.
If a claim arises from acts or omissions of the medical practitioner, there is also no real asset protection benefit to be gained by trading through a Medical Trust
Therefore, the principal benefit is to prevent the application of bankruptcy claw-backs.
To guard against mortgage payment clawback, it is important that the distributions are, in fact, made to the spouse. You need to ensure that:
- Distributions are first paid into the Medical Trust from the relevant patient or Government (through the Medicare number);
- Distributions are transferred to a joint bank account in the name of the spouse and the medical practitioner with a notation “trust distribution” (it would be preferable to deposit the amount directly into a bank account solely in the name of the spouse, however this may not be practical as exact distributions will not be known until the end of the financial year);
- Payments from that joint bank account to the mortgage clearly state “[spouse name]– mortgage payment”.
- Financials and tax returns (including associated minutes) are carefully prepared and documented to ensure that he amount distributed to the spouse exceeds the amount payable for the asset (whether as a mortgage payment or otherwise).
Not only does the ownership of the medical practice in the Medical Trust reduce the chances of the “claw back” provisions applying, it may have other benefits. For example, should the medical practitioner widen the practice to include other income earners (such that the PSI Rules no longer apply), then there may be tax benefits on future distributions to the spouse without the need to restructure the medical practice.
Family home ownership
Regarding the ownership of significant assets (notably the family home), our preference is as follows:
- If the spouse is low risk (e.g. cares for children full time, Government employee), the property should be 100% in the spouse’s name; or
- If the spouse is of equal risk to the medical practitioner (i.e. another medical practitioner), either 100% in a trust or 50% each (noting that with the latter, 50% is open to attack). This is usually as joint tenants, but depending on estate planning considerations, may be better held as tenants in common in equal shares.
Another option where the spouse is low risk would be to have the home 99% in the spouse’s name and 1% in the medical practitioner’s name as tenants in common – the theory being that the property cannot be sold or mortgaged without the medical practitioner’s approval. What this option does not take into account is:
- The 99% can be sold without the consent of the 1% holder – granted, who would want to buy a 99% interest in a property?;
- The 99% can be mortgaged without the consent of the 1% holder – naturally financiers may ask for the consent of the 1% holder;
- The 1% is an asset of the medical practitioner so is not protected – including the equity on that 1%;
- A search of the land register using the medical practitioner’s name will immediately locate this asset – bringing it to the fore of discussions before any bankruptcy;
- The value of that 1% is not as simple as 1% of the value – in law, a tenant in common owns the designated percentage (in this case 1%) of the whole property – owning a 1% interest (and effective veto) could be worth more; and
- The chances of the medical practitioner being found to have an equitable ownership in the property is increased.
Flow of funds
The below diagram shows the flow of funds Mahoneys recommends.
Contact Mahoneys partner Antony Harrison for more information on structuring your medical practice to minimise personal exposure.
1 A transaction done with an intention to defeat creditors has no time limit.
2 e.g. Bankruptcy Act 1966, s 120.
3 Usually with the medical practitioner as trustee and appropriate persons as appointors
4 Presuming the trust deed has been drafted appropriately
5 Distributions made by the Medical Trust in the ordinary course of trading are generally not subject to “claw back”. However, transactions intended to defeat creditors or where the Medical Trust was not, for example, solvent would not gain the benefit of that exception. The extent of exposure therefore depends on the frequency of the distributions (usually up to 12 months if distributions made annually but this could be quarterly, monthly or even weekly – however administration costs increase proportionately).