Capture capital losses

March 1, 2002

by Charles Blair, DDS John McGill, MBA, CPA, JD

I need advice on how to dissolve my professional corporation and return to sole proprietorship. I plan to retire soon and would like to know how to capture the capital losses previously generated by my corporation and transfer them to my personal account.

According to IRS regulations, a corporation can carry forward capital losses for only five years. I need to do something with my professional corporation so that I do not lose these capital losses before they expire. I am planning to dissolve my corporation sometime this year. It began in November 1981, and 20 years is long enough! Can you help me?

As a general rule, a corporation's unused capital loss carry-forwards expire upon the earlier of five years or the dissolution of the corporation. Your best bet is to generate sufficient capital gain prior to the dissolution of the corporation to fully utilize the capital losses previously carried forward.

Since you plan to sell your practice soon, simply allocate a sufficient portion of the practice sales price to assets — such as patient files and records, contracts, and goodwill — that will generate capital gain upon the sale in an amount sufficient to offset the capital losses previously carried forward. As a result, there will be no corporate tax on this gain. This will allow you to fully utilize these losses prior to the time that you liquidate your corporation.

I hope to sell my practice in five years and take early retirement at age 55. I have been funding a retirement plan for a number of years. However, since I will not be able to get to my retirement plan or IRA assets until after age 59½, I feel that I should stop funding it and begin saving on a personal basis. What do you think?

Your intended strategy is based upon a common misperception and would be a big mistake. I recommend that you continue to maximize tax-deductible retirement plan funding to generate the maximum dollars available for retirement.

In the event that you sell your practice at age 55, the retirement plan then would be terminated. After IRS approval of the plan termination, the assets would be distributed to each plan participant or transferred directly to their IRA accounts to avoid current federal and state income taxes.

Once the funds are in the IRA account, you may withdraw them in periodic monthly payments over your life expectancy immediately (at age 55) without any penalty.

However, in most cases, it is best to let retirement plan and IRA funds grow continuously on a tax-deferred basis and satisfy your personal living expense needs from the proceeds of the sale of your practice and from any personal investments or other assets you may have.

Recently, I read that retirement plan rules are changing and that in 2002 a participant can make an annual tax-deductible contribution of the lesser of 100 percent of pay or $40,000. However, I also read that the limit on employee deferrals into a 401(k) profit sharing plan is rising from $10,500 to $11,000 in 2002. Why can't contributions of up to $40,000 be made to a 401(k) profit sharing plan?

Under the new tax law, contributions equal to the lesser of 100 percent of pay or $40,000 a year can be made on behalf of an individual to a qualified retirement plan, as a general rule. However, contributions through employee deferrals to a 401(k) profit sharing plan are governed by a lower limit. Under the new law, employees can defer the lesser of 100 percent of their pay or $11,000 into a 401(k) profit sharing plan. Accordingly, an employee who receives a salary of $40,000 in 2002 cannot elect to defer 100 percent of it into a 401(k) profit sharing plan due to the more restrictive salary-deferral limits.

The information provided in this column is based upon the current Internal Revenue Code, regulations, IRS rulings, and court cases as of the date of publication. This column is not to be construed as legal or tax advice with respect to any particular situation. Contact your tax attorney or other adviser before undertaking any tax-related transaction.

Dr. Blair is a nationally known consultant and lecturer, and is a member of the American Academy of Dental Practice Administration. McGill is a tax attorney and MBA. They are the editors of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($177 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217 or call (704) 424-9780.

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