by Brian Hufford, CPA, CFP
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You can slash your taxes with a simple four-step implementation strategy designed to halve overall income tax burden. Dentistry is uniquely positioned to benefit from small business income tax provisions. Tax planning in the 21st century is about implementation under an extremely complex tax environment. Knowledge of favorable provisions is simply not enough to achieve favorable outcomes. Dentists need a tax advisor who can act as a coach to assure that the tax outcomes are fully realized through comprehensive planning and implementation. This column will focus on four action plan steps to assure desired outcomes.
Step 1 – Implement the best retirement plan for your practice
Recently passed pension laws allow you to deduct as much as you can afford to save. Dentists who are 50 and older can likely deduct as much as $150,000 or more in a paired-plan arrangement by pairing 401(k) and cash balance plans with low staff costs. To properly implement this strategy, you need a custom study performed for your practice that takes into account possible employment of a spouse, along with the demographics of your staff. We have rarely seen a dentist age 40 or older who cannot achieve a great result from implementing this strategy. For younger dentists, employing a spouse with a cross-tested profit-sharing plan can achieve deductions in the $70,000 range. If your advisors are unable to assist you with a custom study for your practice for a paired-plan arrangement, contact my company for assistance.
Step 2 – Manage deductions in your practice entity
Most dentists believe that corporations are favorable entities for achieving tax benefits. In most cases, C corporations and S corporations are a significant hindrance in achieving favorable tax outcomes. If you practice as either a C or S corporation, I can almost guarantee that you are paying significantly higher taxes than you should be paying. In both cases, most dentists lose the ability to fully utilize Section 179 expensing, which offered $250,000 of equipment expensing in 2008. The reason for these lost deductions is the complicated entity rules for corporations. I wrote a column last year entitled “The S Corporation Trap.” This column generated more outrage among dentists than anything I have ever written. They became aware of lost deductions when they questioned their accountants. My purpose was not to generate outrage, but merely to make readers aware of the complicated corporation rules related to equipment expensing. Likewise, dentists who employ children in their practices pay nearly 20% more in payroll taxes for children than dentists in sole proprietorships. You may need to have a thorough entity analysis to see if you are paying more taxes due to your entity selection.
Step 3 – Manage deductions for capital expenditures
Benefits for Section 179 equipment expensing will likely remain large for the foreseeable future to boost the sagging economy. If you have major expenditures planned, you must attempt to maximize the tax outcomes by having your accountant determine the effects of your income tax brackets and the aforementioned corporate issues prior to purchasing the equipment. It could be that you would benefit from spreading the deductions over two tax years. You may need to conduct complicated planning if you are incorporated. If you own your office building, consider having a cost segregation study performed to achieve larger depreciation deductions if you acquired the building in the last 10 years. You would be able to benefit from changing the depreciable life on a significant part of your building costs from 39 years to only five years.
Step 4 – Fully utilize family income splitting
The Kiddie Tax has been extended from 13 years of age to 18, and to age 23 for full-time students. This has limited the ability to fully utilize children's lower income tax brackets to pay for college and other expensive dependent costs. But with sophisticated tax planning, it is still possible to “deduct'' college and other major dependent costs. Many dentists split income with family limited partnerships or other arrangements to rent equipment for their practices and shift income to dependents to reduce overall tax burdens. By employing a spouse in the practice, it is now possible to achieve an additional 401(k) deduction.
These simple four steps, when properly implemented, can result in significantly lower income taxes annually.
Brian Hufford, CPA, CFP®, is CEO of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. Contact Hufford at (888) 470-3064, or at [email protected].