Brian Hufford, CPA, CFP
Dentists who made the unlikely wager that Congress would extend large Section 179 expensing in 2014 were rewarded last-minute with the Tax Increase Prevention Act, which allows expensing of up to $500,000 of qualifying dental equipment and technology. In addition, the law extended bonus depreciation with the ability to write off 50% of new equipment purchases. This knowledge certainly would have been helpful prior to the closing minutes of the year's end. The law had been scheduled to allow only $25,000 of expensing and no bonus depreciation in 2014. Without action from Congress, the same sunsetting now applies in 2015. So what are you to do for the current year?
During my college days, one of my tax professors touted "the holy trinity of taxation": farmers, teachers, and preachers, so called because each of those three professions had special tax benefits that were unavailable to other taxpayers.
In many ways, dentistry has tax advantages that are unique to the profession - the ability to rapidly deduct or expense all equipment and office buildings, and to deduct nearly all retirement savings with 401(k)/cash balance plan arrangements. Dentistry is extremely capital intensive and equipment tax rules are a very important part of tax planning. If you were lucky enough to have equipped a new office last year and to have purchased a 6,000-pound pickup truck as your business vehicle, life was good.
Because of this late Congressional action, very few dentists purchased equipment with tax planning as the primary purpose for the expenditure. Dentists who won the 2014 Section 179 lottery will likely have large unexpected refunds, and will have to wrestle with whether to apply those to 2015 income taxes or to receive a refund check.
Over the years, I have viewed large equipment expensing as a three-shells-and-a-pea game for many dentists. There are several reasons for this cynicism. First, if a dentist practices as an S corporation, typically any loan used to purchase large amounts of equipment must be made outside the corporation in order to have sufficient tax basis to benefit from Section 179. This is because of the complex basis rules in S corporations. Most incorporated dentists don't participate in this critical extra step of tax planning and simply carry forward unused expensing for an indefinite period of time, thus voiding the benefits offered by the law. Second, large tax expensing benefits remove "purchase resistance," somewhat like credit cards (or Apple Pay) remove payment resistance. Many dentists overspend on technology and equipment thinking that it is OK not to save for retirement because of their small tax bill.
Large expensing may or may not be available for 2015. We probably won't have direction from Congress until it's too late to plan. What I would like to see for your important equipment planning is somewhat the attitude of a manufacturing facility plant manager. Decisions to buy equipment need to be made with an eye toward Internal Rate of Return (IRR). IRR is all about justifying an expenditure with cash flow returns from the expenditure. An initial tax benefit from expensing is simply a form of cash flow benefit that is only part of the needed justification. It is not the whole reason for making an expenditure. Likewise, the largest financial danger dentists face is not that they won't be able to fully utilize a Section 179 benefit: it's that they won't maximize their ability to replace their working income in retirement.
In this regard, equipment expenditures are not only about reducing taxes. Any cash paid or debt incurred must be viewed as a potential saboteur of cash available to save 20% of your income each year. It's important to keep your practice current with available technology - but large expenditures for equipment require an extra planning step to avoid forfeiting a bigger future offered by wise tax, debt, and cash flow management.
Tax rates have increased dramatically for dentists in the past few years, but tax benefits still abound for the most part. It's too bad that "tax planning" is an oxymoron.
Brian Hufford, CPA, CFP, is a wealth advisor and dental practice thought leader with Buckingham Advisors, a national, independent wealth and financial advisory firm with a specialty in helping dentists achieve their most important goals. To connect with Brian and Buckingham, visit BuckinghamAdvisor.com, call (866) 545-8816, or email firstname.lastname@example.org.