Medical and Spa Businesses Have an Opportunity to Improve Cash Flow with Effective Tax Planning
By Marc Lion & Jesse Sirotkin
Smaller businesses (usually businesses with less than $25m gross receipts annually) have the option to account for income taxes on the cash or accrual basis. By making a change of accounting method on their 2019 tax return from the cash method of tax accounting to the accrual method they may be able to improve current cash flow.
Under the cash method, income is generally recognized when cash is received, and expenses are generally deducted when they are paid. Alternatively, under the accrual method, income is recognized when it is earned or when actual services are provided, and expenses are deducted when they are incurred.
Many small businesses prefer the cash basis of accounting for simplicity and potential timing benefits, however, it is not advantageous for all businesses.
In addition to providing a more accurate picture of financial performance by matching revenue with related expenses, under the accrual basis of accounting, businesses with significant advance payments for services not performed in the year of payment are able to push the recognition of taxable income until the following year. If a business has significant advance payments, they may benefit from using the accrual method.
The Accrual Method’s Advantage for Plastic Surgery Practices & Medical Spas
Medical spas and plastic surgery practices typically have significant advance payments for procedures to be performed in the future. If a spa on the cash method of accounting receives an advance payment for a procedure prior to performing the procedure, this can lead to a faster recognition of income for tax purposes than if the business was on the accrual method.
A business can change its accounting method if advantageous.
The year the change in accounting method is filed, the taxpayer compares the income and deductions they have taken historically to the income and deductions they would have taken under the accrual method, resulting in a one-time adjustment to taxable income in the year of the change.
In the case of a medical spa or plastic surgery practice with significant advance payments, the one-time adjustment could result in a large deduction to taxable income. This may be a good way for a medical spa or plastic surgery practice to increase cash flow, through a refund or reduced taxes owed. Below is a simple illustrative example of the potential tax savings for an owner of such a business.
Facts and Assumptions
(i) A medical spa held in an S-Corp with a single owner in the highest marginal tax brackets; (ii) The spa is in New York City and the owner is a resident of New York City;
(iii) The spa has $2,000,000 of cash receipts in 2019 and $1,000,000 of cash expenditures. Of the $2,000,000 of cash receipts, $500,000 represents advance payments for procedures to be performed in 2020;
(iv) Similarly, in 2018 the spa collected $500,000 of cash payments for procedures to be performed in 2019; and
(v) Besides advance payments, the spa does not have any other material cash vs. accrual differences.
|Continue Under Cash Method||Switch to Accrual|
|2019 Net Income before Accounting Change Adjustment||$1,000,000||$1,000,000|
|One-time accounting method change deduction||N/A||($500,000)|
|2019 Final Net Income before entity level tax||$1,000,000||$500,000|
|Spa NYC Entity Level Tax 8.85%||$89,000||$44,000|
|Net income After deduction for entity level tax||$911,000||$456,000|
|Owner Shareholder Federal, New York State, NYC combined income tax of 49.7%||$453,000||$227,000|
|Cashflow Before Tax||$1,000,000||$1,000,000|
|Cashflow After Tax||$458,000||$729,000|
|Cash Savings from Switch||$271,000|
If a medical spa or plastic surgery office’s advance payments in 2020 for services to be performed in 2021 have been reduced due to the current economic circumstances brought on by the coronavirus pandemic, the switch to the accrual method may increase taxable income in 2020 (reduce taxable loss) as compared with staying on the cash method.
An accounting method change to accrual accounting from cash provides a more accurate timing and matching of revenue and expenditures. Given the current financial environment, it may also provide the opportunity to improve cash flow management for a medical practice or spa that has suffered an economic loss due to the current economic conditions brought on by COVID-19.
Reach out to your Mazars advisor to find out if a change in accounting method is right for your business! To learn more about how Mazars can help your business, contact us at email@example.com.
For a discussion of additional business and financial planning opportunities for your medical spa please refer to our prior article “Treat Your Medical and Spa Business to a Financial Facelift; A Multi-Dimensional Approach To Building Practice Value”
 $2,000,000 of cash receipts in 2019; minus $1,000,000 of cash expenditures in 2019
 $1,500,000 of income earned related to cash payments and procedures performed in 2019; $500,000 of income earned for cash payments in 2018 for procedures performed in 2019; minus $1,000,000 of expenses accrued in 2019
 To reflect the fact that the 2018 cash received for procedures performed in 2019 was already recognized by the spa in 2018 for tax purposes when it was under the cash method of accounting. Avoids double inclusion of the same income.