Kids Roth IRA: A good choice

July 1, 1998
I have employed my child in my practice for many years and have completely funded his college education costs. I want my child to continue to work, since he is learning a lot from working in the office. However, since I no longer need these funds for his college education, I wonder if the money could be contributed to an IRA on his behalf. If so, what kind of IRA would work best for him?

Charles Blair, DDS

John McGill, MBA, CPA, JD

I have employed my child in my practice for many years and have completely funded his college education costs. I want my child to continue to work, since he is learning a lot from working in the office. However, since I no longer need these funds for his college education, I wonder if the money could be contributed to an IRA on his behalf. If so, what kind of IRA would work best for him?

We believe that funding an IRA for your child represents an excellent strategy. Given your son`s age and income level, it is highly unlikely that he is covered under any type of qualified retirement plan. Accordingly, he would be eligible to contribute to a regular (deductible) IRA, a regular (nondeductible) IRA, or the new Roth IRA, which became effective January 1, 1998.

Given the fact that he is showing little, if any, taxable income, the benefit of deducting a regular $2,000 IRA contribution is minimal. Through taking advantage of this type of IRA, all future distributions would be fully taxable. The regular nondeductible IRA also is not the best move, since there is no deduction on the front end, and earnings are fully taxable upon distribution.

We would, however, recommend a Roth IRA. Although a Roth IRA does not allow a deduction for your contributions, earnings grow tax-deferred as with a regular IRA, and all distributions are tax-free provided that certain requirements are met. Accordingly, the ability to generate tax-free income through the Roth IRA is an opportunity that is too good to pass up. We would recommend that each doctor contribute $2,000 annually to Roth IRAs for all qualifying children.

I have been reviewing an investment that qualifies for a special tax break as a qualified small-business stock. I understand that the new tax law has added even greater benefits to such an investment, but I cannot find the details anywhere. Can you help?

As a general rule, 50 percent of the gain otherwise taxable must be included in income from the sale of a qualified small-business stock held for at least five years. The new tax law added a further benefit providing that doctors may elect to roll over the gain from the sale of such qualified small-business stock totally tax-free, provided that certain requirements are met.

The small-business stock must be held for more than six months. In addition, the total amount of the sales proceeds must be reinvested; if not, Section 1045 of the tax law requires that the portion not reinvested is subject to federal income taxes.

However, for doctors looking to invest in qualified business stock as a growth opportunity, this can dramatically increase their after-tax rate of return, since federal income taxes can be entirely avoided through prudent planning.

I attended a seminar during which the speaker indicated that unincorporated doctors now are able to deduct 100 percent of their medical insurance costs. I talked with my accountant and he said that this is not the case. What do you say?

The Taxpayer Relief Act of 1997 has increased the deduction for medical insurance costs for self-employed doctors (including those operating as sole proprietorships, Subchapter S corporations, and unincorporated partnerships). Effective for taxable years beginning in 1997, the deductible percentage is 45 percent; in years 2000 and 2001, the deduction is 50 percent; it`s 60 percent in 2002; 80 percent in years 2000 - 2005; 90 percent in 2006; and 100 percent thereafter.

Dr. Blair is a nationally known consultant and lecturer. 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 ($149 a year) and consulting information are available from Blair/McGill and Company, 4601 Charlotte Park Drive, Suite 230, Charlotte, NC 28217 or call (704) 523-5882.

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