“Can I depreciate my spouse?” I remember thinking: “This client isn’t smiling. Is he serious?”
“Can I deduct expenses for my pet German shepherd? He guards the dental supplies stored in my garage.” Is this doctor for real?
As a CPA, I have spent much of my life thinking like an income tax probation officer. I have tried to keep aggressive clients from landing in the pokey. But now, life is good. Via just three conservative areas of tax planning, most dentists can slash income taxes by nearly half. No more expenditures for toilet paper at home need to be hidden among office supplies at work. Here are some tips so that you can vote your own 2006 tax cut - legally.
I estimate that 70 to 80 percent of dentists nationwide still use IRA-based retirement plans. Most use SIMPLE-IRA accounts; some use SEP-IRAs. These IRA accounts have two disadvantages.The deductions are much smaller than qualified pension plans. Because of this, amounts saved typically aren’t enough to allow you to retire.
You want larger tax deductions and larger retirement savings. Big changes in pension laws have occurred in recent years. For decades, a dentist only was allowed to deduct $30,000 in a retirement plan. Until recently, 401(k) plans could not be used effectively in dentistry. Now, in most cases, they are a perfect fit. Assume that you are 50 years old in 2006 and employ a spouse. You would be allowed to deduct $15,000 in a 401(k) plan plus a $5,000 “catch up” because of your age this year. If your spouse was 50, he or she also could deduct $15,000 plus $5,000 with sufficient salary. Finally, your practice could contribute an additional $29,000 in 2006 for you, and possibly an amount for your spouse, too. In this example, the total deductible pension savings add up to $69,000 or more. Of this $69,000, the government pays approximately $25,000 through tax savings. Thus, you only pay about $44,000. Talk about a 401(k) match! You only need good advice and planning to meet these requirements, and have low and reasonable staff costs.
If you are 45 or older, consider pairing a “tiered” or other exotic defined benefit plan structure, with a 401(k) plan. Because older dentists have less time until retirement, the right structure could boost total deductions to more than $100,000. This deduction alone could eliminate the greater part of your tax liability. All that is standing in your way is getting the best possible pension advice from a professional. It is unlikely that you will receive appropriate advice from investment or insurance salespersons who do not specialize in pension law.
Your children, in some cases before age 14 and in most cases age 14 or older, are typically in a much lower tax bracket than you. So, if you have a child in college with tuition of $25,000 per year, you must earn a great deal of income to pay for nondeductible college costs. In this case, you would need to earn as much as $40,000 of pretax income to pay approximately $15,000 of federal and state income taxes. This would leave you with $25,000 to pay your child’s college tuition.
However, if your child instead of you earned the income to pay for college, taxes would be significantly reduced because of the low tax brackets and additional deductions that are available to most children. One way to accomplish this is via a children’s, or 2503(c), trust. For example, you could gift equipment that has fully depreciated to a children’s trust. Then, this trust could lease the equipment to your practice to generate tax deductible rent deductions. By doing this, you have shifted earned income to your children. They will pay a small amount of taxes due to the additional deductions children are allowed, coupled with their generally lower tax bracket.
If you own an office building - even if it was built several years ago, or if you have built-out leased space - you may be entitled to significant deductions. If you wish to build a new facility, these deductions could make the project much more affordable. A ruling in a recent tax case allows you to perform a “cost-segregation” study, and treat some components of a building as property with a five-year instead of a 39-year life. For a stand-alone building, this could mean that as much as 25 to 40 percent of the cost could be characterized as shorter-life property. This could translate into five years of additional annual depreciation deductions, adding up to as much as $50,000 to $125,000, depending on the total building costs.
These areas require advice from a qualified tax advisor. Just as you don’t perform root canals without guidance, don’t implement these ideas without professional advice. Now, about deducting that new swimming pool in your backyard ....
Brian Hufford, CPA, CFP®, is president of Hufford Financial Advisors, an independent, fee-only planning firm dedicated to helping dentists achieve financial peace of mind. Many dentists attend Hufford Financial Advisors’ Financial Breakthrough Workshops. Upcoming workshop dates and locations are listed at www.huffordfinancial.com. Contact him at (888) 470-3064, or at firstname.lastname@example.org.