"Abusive trusts"

Jan. 1, 2002

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

Recently, another doctor told me about some new types of trusts through which I could completely eliminate my federal and state income tax liability by moving my funds offshore. The assets would also be out of my creditors' reach. My CPA advised against using these trusts. What do you think?

Run, do not walk, away from your colleague's advice! The IRS recently placed these "abusive trusts" on its audit "hit list." Two dentists who have used these types of trusts recently received nationwide publicity when the IRS successfully prosecuted them. We recommend that dentists avoid tax-evasion schemes such as these.

Last year, I cashed in a whole-life insurance policy that I had owned for several years. How do I determine whether I owe any tax on the money that I received?

Any proceeds that you received from cashing in a whole-life-type policy that exceeds your original investment in the contract must be considered as taxable income. In general, your investment in the contract equals the total premiums paid, less any rebates, reinvested dividends, or policy loans that have not been repaid. Normally, the insurance company will send you a Form 1099R showing the total proceeds and portion thereof that is subject to federal income taxes. These amounts then must be reported on Lines 16a and 16b of Form 1040.

Recently my practice's tax return was selected for an IRS audit. The agent involved is disallowing certain advertising and employee training costs, saying that these must be capitalized and deducted over a longer time period, since they will provide benefits for years to come. My accountant disagrees with the IRS assessment. Who is correct?

Your accountant. The IRS has become more aggressive recently in trying to force doctors and other small businesses into deducting expenses such as these over a longer time period. However, the Courts have universally agreed that while some advertising and employee training costs may provide a benefit period beyond the current year, nevertheless all amounts paid for these expenses are fully deductible in the year paid.

I plan to sell my dental office building, but retain my practice in another location. If this building is paid off and fully depreciated, would the entire sales price be treated as long-term capital gains and subject to federal income taxes at a maximum rate of 20 percent?

No. The gain realized from this transaction should be somewhat less than the total sales proceeds received for two reasons: First, the tax law allows all expenses of the sale — including, but not limited to, sales commissions, closing costs, and fix-up expenses — to be deducted from the sales price before determining the amount of gain recognized on the transaction. Furthermore, even though the building may well have been fully depreciated, the original cost for the land was not depreciated, and, therefore, this amount remains as the basis for the property, which reduces the gain at the time of the sale.

Once the amount of gain has been properly calculated, an amount equal to the original depreciation taken on the building (depreciation recapture) is subject to tax at a rate of 25 percent, while the remaining gain, measured by the appreciation of the property above its original purchase price, is subject to tax at a maximum rate of 20 percent.

By transferring the property to a family limited partnership (FLP) or family limited liability company (LLC) prior to the sale, you can realize significant tax savings. Alternatively, through structuring a tax-free exchange for other like-kind real estate, the gain from the sale can be deferred or eliminated altogether.

For details on how to minimize or eliminate federal and state income taxes on the sale of a dental office building, send an SASE (55 cents) to "Office Building Tax Savings Strategies," Blair/McGill & Co., Inc., 2810 Coliseum Centre Dr., Ste. 360, Charlotte, NC 28217.

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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