Tax-deductible college funding

I have two children ages 13 and 11. I want to fund their college education with pretax dollars. I am interested in establishing a family limited partnership (FLP) to operate an equipment-leasing and/or lab business.

By Charles Blair, DDS & John McGill, MBA, CPA, JD

I have two children ages 13 and 11. I want to fund their college education with pretax dollars. I am interested in establishing a family limited partnership (FLP) to operate an equipment-leasing and/or lab business. Profit from the business would be taxed to the children in proportion to their ownership percentages in the partnership. Because my children are minors, my CPA says there would be no tax savings associated with this transaction due to the "kiddie" tax. What do you think?

Operating an equipment-leasing arrangement and/or lab business through a family limited partnership is an excellent technique for funding future college expenses on a pretax basis. However, special rules — known as the "kiddie" tax — limit the tax savings applicable to children age 13 or younger. For these children, only the first $1,500 of taxable income is taxed at their rate, with the remaining income taxed at the parent's rate.

However, for minor children age 14 or older, all income is taxed to the child at the child's rate. Under the new tax law, these rates are 10 percent on the first $6,000 of income, 15 percent on taxable income up to $27,950, and 27 percent on the remaining taxable income up to $67,700. In many cases, college-age children participating in such a program will owe absolutely no federal income taxes, since their tax liability will be offset through the application of educational tax credits (HOPE and Lifetime Learning).

Even if one or more of the child-partners is under age 14, we still recommend implementing a family limited partnership. An FLP removes assets from the doctor's estate, protects them from creditors' claims, and, most importantly, assures that the funds required to pay for college and/or professional school will be available when needed.

On each trip between my home and office, I make practice-related calls on my cell phone. Since these calls are business-related, can I deduct business-car expenses for these trips?

No. Even though you are engaged in productive work on these trips, the IRS regards the cost of commuting, whether by car or by public transportation, as nondeductible. However, you can write off the cost of the business phone calls.

Last year, I bought a practice from a retiring dentist and allocated $150,000 to a covenant-not-to-compete agreement with the seller following closing. Since the agreement was only for a five-year period, I thought that I would be able to deduct the entire cost at the rate of $30,000 a year. However, my CPA says that this cost must be amortized over 15 years at the rate of $10,000 a year. Is he correct?

Yes. Section 197 of the tax law requires that covenant-not-to-compete agreements incurred in connection with the sale or exchange of a business — along with all other intangible assets such as patient files, records, and goodwill — must be amortized over a 15-year time period, regardless of their useful life. So, even though your covenant-not-to-compete agreement expires in five years, the cost must be deducted over the 15-year period required by the tax law, just as your CPA has indicated.

Recently my financial planner recommended that I take out long-term-care health insurance and said that the premiums would be tax-deductible. Is he correct?

Yes. In 2002, up to $2,990 of premiums are deductible for doctors age 70 and older; $2,390 for doctors between the ages of 60 and 70; $900 for doctors between the ages of 50 and 60; $450 for doctors between the ages of 40 and 50; and $240 for doctors age 40 or younger. Moreover, the tax-free limit for payouts under these policies has now been increased to $210 per day.

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, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($184 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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