Business Management | February 2015 Hearing Review

A look at some available options, as well as the potential tax implications.


Mark E. Battersby is a tax and financial freelance writer and advisor formerly enrolled to practice before the IRS, and is the author of four books. His office is located in the suburban Philadelphia community of Ardmore, Pa.

In today’s current economic climate, doing it yourself or keeping financing within the family frequently produces the fastest and best results. Unfortunately, our tax laws create a number of obstacles that must be observed and overcome to avoid penalties and corresponding higher tax bills. Here are some options and a few considerations before entering into self-funding avenues.

A surprising number of principals in hearing healthcare practices depend on themselves for their financing needs. With conventional financing often difficult to obtain, it is little wonder that self-financing is the number-one form of financing used by professionals and small business owners. It’s quick, doesn’t require a lot of paper work, and is often less expensive than conventional financing.

That is not to say that self-financing is without a cost. The cost that every audiologist and hearing care professional using his or her own funds must consider is the so-called lost opportunity cost. The lost opportunity cost is the amount that could have, or might have, been earned had those funds remained in savings or invested elsewhere.

However, in today’s current topsy-turvy economic climate, doing it yourself or keeping financing within the family frequently produces the fastest and best results. Unfortunately, our tax laws create a number of obstacles that must be overcome to avoid penalties and corresponding higher tax bills. 

Reversing the Bottomless Pit

Professionals using their own money will usually discover that there is more available than they might think. Although many hearing healthcare professionals ordinarily think only of cash savings, there are other assets that can be liquidated and turned into that badly needed cash. Unfortunately, there are also many drawbacks, including the risk of running afoul of our tax laws and the Internal Revenue Service (IRS).

As a hypothetical example, when John Jones’ hearing care practice ran low on funds, things began to look grim. Repeatedly turned down by conventional lenders, even nonconventional funding sources rejected John’s overtures. John’s answer was to personally guarantee a $100,000 loan, run up expenses on his personal credit card, and defer his salary. In short, John put himself in a position where he had a lot to lose—and the only way out was to succeed and profit.

Putting yourself at risk can attract lenders or investors. Just as often, it succeeds in raising the funds needed by the practice or business. Consider a few strategies that can either put the practice at risk or provide the needed funding—or both:

  • Liquidate savings. A good option if you have it.
  • Sell a vacation home. Again, a good option if you have it.
  • Take out a home-equity loan. Remember, however, there is a limit to the amount of qualified residence interest that is tax deductible. The aggregate amount of acquisition indebtedness may not exceed $1 million, and the aggregate amount of home equity indebtedness may not exceed $100,000. Interest attributable to debt over these limits is nondeductible personal interest.
  • Get a bank loan. Usually any bank loan, if available, will require a personal guarantee—or the guarantee of friends or family members.
  • Leverage your investments. Take out a margin loan against your stock holdings.

One note of caution: Never use personal credit card debt for business purposes. It is far too costly. 

Imputed Interest

When either lending to or borrowing from the hearing business or practice, remember that, in order for it to count, it must be a legitimate interest-bearing loan. Under our tax rules, hearing care professionals borrowing from their practice can face a hefty tax bill should the IRS view the transaction as a dividend payout rather than a loan.

Often, it is below-market interest rates or the lack of evidence of an arm’s length transaction that draws the attention of the IRS. In particular, the IRS is always on the lookout for:

1) Gift loans;

2) Corporation-shareholder loans;

3) Compensation loans, between employer and employee or between independent contractor and client; and

4) Any below-market interest loan in which the interest arrangement has significant effect on either the lender’s ?or borrower’s tax liability.

If the IRS re-characterizes or re-labels a transaction, the result is an interest expense deduction when none was previously claimed by the borrower—and unexpected taxable interest income on the lender’s tax bill. The lender’s higher tax bills, often dating back several years, are usually accompanied by penalties and interest on the underpaid amounts. 

Always a Borrower Be…

For many hearing care practices, borrowing means a loan from the principal, owner, or shareholder. In some cases, the principal borrows the funds from the practice. Not so surprisingly, loans and advances between so-called “related parties” are quite common in closely held practices. Corporate loans to shareholders are probably the most commonly seen by IRS auditors, with advances from shareholders to the incorporated hearing care practice running a close second, particularly in the early years of closely held but thinly capitalized corporations.

The IRS’s interest in these transactions stems from the tremendous potential for tax avoidance, inadvertent or intentional. When an incorporated practice or business makes an interest-free (or low-interest) loan to its shareholder, in the eyes of the IRS, the shareholder is deemed to have received a nondeductible dividend equal to the amount of the foregone interest, and the corporation receives a like amount of interest income. (Fortunately, there is a $10,000 de minimis exception for compensation-related and corporate/shareholder loans that do not have tax avoidance as one of the principal purposes.)

Although this transfer of taxable income between entities may appear to be offsetting, there can be a significant tax impact, depending on the relative tax benefits of the borrower and the lender, and the deductibility of the expense deemed paid.

Downside: Stock or Loan

When IRS examiners review loans from shareholders and the common stock accounts of many hearing care practices, they frequently encounter something called thin capitalization. Thin capitalization occurs when there is little or no common stock, and there is a large loan from the shareholder. A special section of the tax law, Section 385, specifically considers whether an ownership interest in a corporation is stock or indebtedness.

The IRS’s objective when they encounter thin capitalization is to convert a portion, if not all, of the loans from the shareholders into capital stock. Naturally, this conversion requires an adjustment to the interest expense account because, at this point, the loans are considered nonexistent. The interest paid by the incorporated practice on these disallowed loans becomes a dividend at the shareholder level equal to the operation’s earnings and profits.

Recovering From the Downside of Loans Gone Bad

Under our tax laws, a business bad debt deduction is not available to shareholders who have advanced money to their incorporated practices where those advances were labeled as contributions to capital. A principal, business owner, or shareholder who incurs a loss arising from his guaranty of a loan is, however, entitled to deduct that loss—but only if the guaranty arose out of his trade or business, or in a transaction entered into for profit. If the guaranty is business-related, the resulting loss is an ordinary loss for a business bad debt.


If your business or practice is in need of an infusion of cash, but you are reluctant to invest additional money, an answer may lie with the tax benefits. Are the operation’s tax benefits being wasted because of low or non-existent profits? As a result, does the business or practice find itself in a low tax bracket?

A one-transaction-cures-all, all-purpose solution involves the sale-leaseback of the assets of your practice. Generally, the practice sells its assets, the building that houses the operation, the equipment used in that operation or even the fixtures that are an integral part of the practice. In return, the practice receives an infusion of working capital. The buyer of those assets, usually using borrowed funds, is often the hearing care professional and principal shareholder (you).

When the principal shareholders in a practice own the assets of the operation, the practice pays fully tax-deductible lease payments for the right to use those assets in its operation. An unprofitable business or practice is exchanging depreciable equipment or its building for badly needed capital and immediate deductions for the lease payments that it is required to make.

The new owner of that equipment—whether the practice’s principal, chief shareholder, or, perhaps, a trust established for the benefit of the principal’s children—receives periodic lease payments. With one transaction, the audiologist or hearing instrument specialist has found a way to get money from the practice without the double-tax bite imposed on dividends. Even more importantly, the practice has an infusion of badly needed cash.

Self-financing is the number-one form of financing used by small business owners. Among the advantages of self-financing is that control is not given to shareholders nor will there be oversight by bankers or other lenders. Disadvantages are that sufficient capital may not be available.

Self-financing is an option, and often the only option, in today’s economic climate. Drawing on assets, such as savings accounts, equity in real estate, retirement accounts, vehicles, recreational equipment, and collectibles, practice owners and other owners of small businesses are increasingly finding the funds needed to fund their enterprises.

Selling these assets for cash or using them as collateral for a loan is an option. Other self-financing options are also available and should be studied, considered, investigated, and acted upon by any hearing care professional—or practice—in need of funding.

Editor’s Note: As with any financial and tax advice, be sure to check with a tax accountant or attorney to verify that the financial topics discussed here pertain to your own particular business situation. 

Citation for this article: Battersby, M. Self-Funding 101 for Private Practice Owners. Hearing Review. 2015;21(2):34.