by John K. McGill, CPA, JD, MBA
Q I need a new business automobile. I heard that the tax rules are changing at the end of this year. What’s up?
A You are correct. Pending energy legislation in Congress will alter the tax rules for depreciating business automobiles beginning next year.
Under current law, doctors purchasing a sport utility vehiclewith a Gross Vehicular Weight Rating (GVWR) of 6,000 pounds or more can write off up to the first $25,000 of the cost in the year of purchase, provided they use the automobile more than 50 percent of the time for business purposes. The remaining business portion of the automobile cost can be written off over a six-year time period. All other business automobiles purchased must be written off over an extended time period.
Under the new law - effective in 2008 - sport utility vehicles will no longer qualify for the $25,000 first-year write-off, but rather must be written off over the same time period as other business automobiles. Accordingly, doctors considering purchasing a sport utility vehicle for business purposes should act before December 31 of this year to obtain the best tax benefits.
Q I contributed to a profit-sharing plan for many years while in practice, and later terminated this plan and rolled the money over to a regular IRA account. In addition, I have also made nondeductible IRA contributions to a separate account over the past few years. Recently, I read that I could convert these accounts into tax-free Roth IRAs, regardless of my income level. How does this work?
A Recent tax-law changes allow doctors to convert their regular IRAs into tax-free Roth IRAs - regardless of their income level - beginning in 2010. Until such time, doctors may convert regular IRAs to tax-free Roth IRAs only if their modified adjusted gross income (MAGI) is less than $100,000.
In the year of conversion, the taxable portion of the IRAs being converted will be subject to immediate federal and state income taxes, so proper planning is important. Two steps can help.
First, you should consider rolling your fully taxable IRA (resulting from your former profit-sharing plan contributions and earnings) back into another qualified retirement plan before the date of conversion. This will minimize the amount of taxes that are due. In addition, you should plan to convert your remaining nondeductible IRA accounts into Roth IRAs in a year in which your income is low, such as the year following the sale of your practice. These steps will minimize federal and state income taxes incurred in converting your regular IRA accounts into Roth IRA accounts.
Q At a recent seminar, I heard that doctors would no longer be able to shift income to their children in order to pay for college expenses on a tax-deductible basis. Is this correct?
A Although the tax rules have changed, there are still methods to fund college educational costs with tax-deductible dollars.
Employing a child through your practice in 2007 is one excellent strategy. Children can earn up to $5,350 free of federal (and in most cases) state income taxes, in exchange for their services rendered to the practice. Any amounts earned in excess of $5,350 are taxed at a federal income tax rate of only 10 percent.
The Tax Court has allowed deductions for children as young as 7 years old employed in a family business. In addition, employing a child also qualifies that child for a contribution to a Roth IRA. While contributions are not deductible, the earnings grow tax-free. Wages paid to a child in exchange for actual services rendered are always taxed at the child’s rate, rather than the parents’.
That’s not the case for unearned income (interest, dividends, capital gains, rents, etc.), where the rules have recently changed. In 2007, unearned income above $1,700 (per child annually) is taxed at the parents’ rate, rather than the child’s, for children 17 and younger. Unearned income for college-age children (18 and older) is taxed at the child’s rate. Moreover, if the child uses these funds to pay for college educational costs, he or she can also qualify for lucrative educational tax credits, such as the Hope and Lifetime Learning tax credits.
Beginning in 2008, unearned income above $1,700 annually is taxed at the parents’ rate for children under the age of 19 - or under age 24 if a full-time student - unless half of the child’s support comes from earned income.
Tax-savvy doctors should consider shifting income to their college-age children this year, before the tax rules change.
Q I recently built a new office building at a cost of $600,000. My accountant tells me that the land cannot be written off at all, and that the building must be written off over a 39-year time period. A colleague of mine said that he has been able to write off some of his building at a much faster rate. How can I do this?
A Utilizing a cost segregation study, doctors can allocate a portion of the building costs to items that can be more rapidly depreciated, says Bo Elliot, a partner with the CPA firm of Elliot & Warren, CPAs (888) 333-8815. In this situation, amounts allocated to specialized lighting, plumbing, electrical, landscaping, signage, sidewalks, parking lots, etc., can be segregated out of the total building costs and written off over a much shorter (generally three to seven years) time period, says Elliot.
In addition, since these building components can qualify as personal property, the amounts allocated this way are eligible for immediate write-off under the Section 179 expensing election.
Elliot notes that the Section 179 expensing election amount has recently been increased to $125,000 beginning this year. Elliot says that doctors who have purchased or constructed a new office building since 1986 are eligible for these new rapid write-offs which can be obtained through a cost-segregation study.
Q Recently, I reviewed my 2006 corporate tax return and noticed that I had lost several thousand dollars of deductions categorized under “travel and entertainment.” Why is this?
A The tax law allows only a 50 percent deduction for “meals and entertainment expenses.” Unfortunately, your CPA may have made a mistake which many other do - that mistake is to include many items which are 100 percent deductible into an overly broad “travel and entertainment” category, and then deduct only 50 percent of the entire amount on your tax return.
Under current tax laws, all amounts spent for travel, lodging, and continuing education are 100 percent deductible and should be listed under separate accounting categories, says Bo Elliot, CPA with Elliot & Warren, CPAs (888) 333-8815. In addition, even some types of meals and entertainment expenses remain 100 percent deductible, notes Elliot. Social and recreational expenses primarily for the benefit of staff employees are 100 percent deductible. This would include Christmas and holiday outings, staff meetings and outings, and meals of staff members at continuing-education meetings, etc.
You should make sure your CPA includes items which are restricted to 50 percent deductibility in a separate category entitled “meals and entertainment.” All other expenses should be categorized separately and a 100 percent deduction taken to arrive at your taxable income to minimize your federal and state income tax liability.
John K. McGill, MBA, CPA, JD, is a tax attorney, CPA, and MBA, and the editor of “The McGill Advisory,” a monthly newsletter devoted to tax, financial planning, investment, and practice-management matters exclusively for the dental profession. The newsletter ($209 a year) and consulting information are available from John K. McGill & Company, Lake View Professional Building, 8816 Red Oak Blvd., Ste. 240, Charlotte, NC 28217. Call (704) 424-9780, toll-free (888) 249-7537, or visit the Web site at www.bmhgroup.com.