By Charles Blair, DDS
John McGill, MBA, CPA, JD
Recently, I read that it may be possible to fully deduct medical insurance costs for my entire family by having my spouse employed in my unincorporated dental practice and covering her as the named employee under a family policy. My accountant says that this will not work, but I have read otherwise. Who is correct?
Recently, the IRS applied Revenue Ruling 71-588, 1971-2 C.B. 91, to find that a self-employed individual who employs his or her spouse and provides employer-paid medical insurance to the spouse as a fringe benefit can deduct the cost as a business expense under Section 162 of the tax law. This rule applies even if the employer employing the taxpayer is also covered under the family policy.
However, the IRS ruled this result will occur only if the spouse is a "bona fide employee" of the business and actually provides services. (See Coordinated Issue, All Industries, Health Insurance Deductibility for Self-Employed Individuals, UIL 162.35-02.)
For several years I have operated a horse-breeding activity, which continues to show losses, in addition to my dental practice. Can I deduct these losses against my other income?
The deductibility of losses from a part-time business is governed by Section 183 of the tax law. You must prove a profit motive to deduct these losses.
A profit motive is presumed in horse-breeding activities as long as you show a profit at least two years out of every seven. Even without meeting this test, losses still can be deductible if you can prove that you intended to operate the venture with a profit motive. Regulations under Section 183 outline all of the facts and circumstances that are taken into account in determining whether an individual has a true profit motive.
In a recent case, a dentist engaged in Arabian horse breeding and sales was allowed to deduct his losses. (See Morely vs. Com missioner, T.C. Memo 1998-312.) While the court looked at a number of factors, they were most im pressed with what the doctor's wife said. She told them she resented the amount of time Dr. Morely spent on horse-breeding activities and that she was unhappy that her husband came home every night "dirty and smelling." The court concluded that Dr. Morely would not subject himself to such rigors "solely for recreation or pleasure," and allowed him to deduct the losses!
Some time ago, I borrowed $100,000 from my retirement plans to invest in real estate. The real estate has turned out to be a good investment, and it has appreciated rapidly.
While the real estate holdings are growing, I am "cash poor" and do not have the funds necessary to repay the loan when it comes due. I have thought about transferring part of the real estate back to the retirement plan to repay the debt. Is this a good idea?
The transfer of real estate in exchange for the satisfaction of a debt will constitute a "sale or exchange" that will give rise to a taxable gain on the real estate, just the same as if it had been sold to a third party. Moreover, if you serve as Trustee of the plan, this sale or exchange with the retirement plan will constitute a prohibited transaction under Section 4975 of the tax law, resulting in additional penalties as well as a possible plan disqualification.
We recommend that you sell the real estate personally and use the proceeds to repay the loan and all accrued interest as quickly as possible.
The information provided in this column is based upon the current Internal Revenue Code, regulations, IRS rulings, and court cases as of the date of publication. This column is not to be construed as legal or tax advice with respect to any particular situation.
Contact your tax attorney or other adviser before undertaking any tax-related transaction.
Dr. Blair is a nationally known consultant and lecturer, and is a member of the American Academy of Dental Practice Administration.
John 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.