Today’s college costs are rising faster than inflation and most doctors do not qualify for need-based financial aid, so it’s likely you’ll be responsible for the majority of your children’s college costs. However, with proper planning, you can use new technology to qualify for tax-deductible strategies in order to save thousands on college tuition costs and lower your family’s after-tax cost considerably.
Rising college costs
According to The College Board, the average cost of college has risen to about $22,000 per year for in-state public schools and almost $50,000 annually for non-profit private schools, for an average of $36,000 annually. These averages include tuition, fees, and room and board, but do not include books, computers, supplies, or living expenses, and they’re growing at a rate much faster than inflation. Moreover, if your adjusted gross income (AGI) exceeds $200,000, it’s unlikely you’ll qualify for any need-based aid to help cover these rising costs.
Additional savings from tax-deductible funding
Most advice about college savings centers around what type of accounts to use (529 plans, Roth IRAs, Coverdell Savings Accounts, custodial accounts, etc.). Unfortunately, this advice misses the mark since no federal income tax deduction is allowed for contributions to any of these accounts.
If you’re in the combined 40% federal and state tax bracket, you have to first earn $60,000, then pay taxes of $24,000 (40%) to have the $36,000 average annual college cost amount left to pay for each year of college. Using the strategies outlined here, you can pay for college with tax-deductible dollars and save the $24,000 in federal and state income taxes for each year of college. In fact, our clients save an average of more than $70,000 per child over their four-year college career!
Technology increases potential salaries for children at his very low rates (10%–12%). Any federal income taxes owed, up to a maximum of $2,500 annually, can be offset using the American Opportunity Tax Credit (AOTC) for the first four years of college. Thereafter, the lifetime learning credit (LLC) can be used to offset up to $2,000 of federal income taxes each year.
Use tax-free capital gains and dividends
Where does the remaining 50% of the college funding come from? The first option is to take advantage of the 0% tax rate applying to dividends and capital gains realized by taxpayers in the lowest (10% and 12%) tax brackets.
Doctors who have appreciated stocks, mutual funds, and exchange-traded funds (ETFs) can give them to their college-age child who can sell them and use the proceeds to pay the balance of his college costs. Assuming a gain of $18,000, this would be completely tax-free (taxed at a 0% rate) if the kiddie tax does not apply.
Fund the balance using in-house lab profits
If additional funds are needed to cover the remaining tab, explore the growing opportunity for operating an in-house lab/records business. Your lab/records business could take diagnostic scans and records, manufacture CEREC crowns, inlays and onlays in general practices, and clear aligners, retainers, and other appliances in orthodontic offices. Establishing a separate lab business (S corporation or LLC) with your college-age (or older) children as the principal (95%) owners could shift significant amounts of income from your high tax bracket into your children’s lower bracket, if properly structured. Also, they may be eligible for other tax benefits, including the research and experimentation (R&D) tax credit.
Moreover, a lab business has the added advantage of flexibility. Lab operations can commence and increase as your children reach college age and later be scaled back or stopped altogether when their education costs have been fully funded.
A growing number of companies, such as uLab, have been innovators in the next generation of smile technology, allowing dentists to create aligner movement plans in as few as 10 minutes and print custom aligners the same day, right in their offices. Using breakthrough software with Food and Drug Administration (FDA) clearance, it offers doctors full control over treatment plans using the latest intraoral scanning and 3-D printing technologies.
While this trend is still in its infancy, the number of similar new technologies is exploding. This allows you to maintain complete control over the diagnostics, treatment plan, and direct supervision of patients so you can deliver the highest quality of care while reaping increased tax benefits.
JOHN K. McGILL JD, MBA, CPA, provides tax and business planning for dentists and specialists and publishes The McGill Advisory newsletter through John K. McGill & Company Inc., a member of The McGill & Hill Group LLC. The company is a one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit mcgillhillgroup.com.
Our primary strategy to achieve tax-deductible funding is to employ your children through your practice, beginning at age six. Your child can earn income (wages and salaries) tax-free up to $12,400 annually in exchange for his or her services. Moreover, earned income in excess of the $12,400 tax-free amount is taxed at only 10% on the first $9,875, and thereafter at only 12% up to $40,125 annually for single students. While the services that can be performed in the office may be limited, technology creates opportunities for highly valuable services such as marketing, website design, SEO, social media management, producing testimonials, and more, justifying higher salaries to be provided off-site while at college.
Avoiding the kiddie tax
The kiddie tax applies to unearned income (i.e., interest, dividends, capital gains, rents, Sub S/LLC profits, etc.) in excess of $2,100 annually. It is taxed at the parent’s rate if received by most children under the age of 19 or full-time college students aged 23 or younger. However, the kiddie tax does not apply if the child provides more than 50% of his or her support from his or her earned income. This earned income includes not only salaries and wages, but also up to 30% of the profits from a trade or business in which personal services and capital are material income-producing factors, such as a lab or records business.
In our example, if your college-age child earns more than $18,000 annually to meet his $36,000 in college costs, all of his income (both earned and unearned) will be taxed
