Tax code clarification spells relief for DVMs

WASHINGTON — It took almost 10 years and $20,000, but Dr. Thomas Kendall's battle with the Internal Revenue Service (IRS) has ended with a federal tax interpretation that favors the veterinary profession.

The administrative change restructures the IRS Veterinary Audit Technique Guide for practices filing as subchapter C-corporations, shedding light on a discrepancy that's prompted a decade of audits and back taxes for hundreds of DVMs.

According to the 64-page guide, the IRS now recognizes services, such as grooming, boarding and product vending, as non-veterinary specific, relieving practices claiming more than 5 percent in such sales from a personal service corporation label that carries a 35-percent tax rate. Until now, auditors have been known to follow previous IRS directives that blended professional and ancillary activities, pushing practices such as Kendall's, which pays a 15-percent rate, to close the tax gap.

"In 1997 the IRS wanted me to pay a difference in the rate by around $25,000 in back taxes, audited from my 1995 and 1996 returns," says Kendall, former president of the American Veterinary Medical Association (AVMA). "Since then, many veterinarians have received demands for more taxes because the government views veterinary practices like they're major corporations. What I have discovered is that you can always fight the IRS."

Inside the guide

The back-and-forth struggle between Kendall, of Sacramento, Calif., and IRS officials ended with the practitioner threatening tax court and auditors backing off his case. But not all veterinarians are as fortunate, says Owen E. McCafferty, CPA, of North Olmsted, Ohio.

"The big debate is defining income that would bounce you out of that 35-percent bracket," he says. "Not realizing any exceptions, the IRS has taxed veterinarians and other personal services corporations as if they were General Motors or Proctor and Gamble. It has caused veterinarians to pay massive taxes that they didn't have to before. It's been a horrible blow to veterinary medicine."

The distinction now appears in writing, amended in the Veterinary Audit Technique Guide, which steers IRS auditors when dealing with veterinary practices. The change reflects Kendall's work as well as the American Veterinary Medical Association's (AVMA) efforts to restructure how the IRS views the profession.

"It's taken more than a year of talk between AVMA and the IRS," says Dr. Michael Chaddock, executive director of the AVMA's Governmental Relations Division. "But the new language provides guidance to auditors that will make it less likely that veterinarians will be placed in the qualified professional services corporation status. It will save them a lot of money considering that's a category with a 35-percent tax rate."

But McCafferty stresses that Veterinary Audit Technique Guide amendments are not cause for veterinarians to relax. The guide change holds a "low level of authority" because it stems from an administrative decision rather than a revenue ruling, which can carry the force of law. "This is nothing more than an administrative interpretation that could change at any time," he says.

In addition, the guide works only to instruct on the intent of IRS code, whereas judicial interpretations and consolidated interpretations specifically stem from the law.

"On the food chain, the audit technique guide is pretty far down," McCafferty says. "The advisors of veterinarians must be careful that they don't get carried away with their interpretation of it."

At the practice level

A favorable interpretation regarding non-veterinary services relieved Dr. Lori Wyatt, owner of a five-veterinarian practice in Cary, Ill., from paying $20,000 in back taxes last year when she ended a two-year fight with the IRS.

Wyatt began researching the audit technique guide in 2003 after receiving what she describes as an IRS "delinquency notice" that asks for additional taxes based on retail product sales. After a handful of meetings with auditors, the parties failed to come to terms.

"At that point, I escalated the situation by filing in tax court," she says. "It took the case out of the auditing agent's hands and was the best decision I made."

The case reached the appeals level, where a reviewer found in favor of the veterinarian.

"All the way through, the IRS tries to get you to believe that you're wrong," she says. "I knew they would cancel my case, but I was shocked that the IRS played all these mind games in the beginning. In my opinion, the law was clear."