Tax Planning: The “Big 3” Strategies
Dentists are keenly interested in strategies to reduce income taxes, and most subscribe to at least one newsletter oriented around tax-planning topics. Ironically, there are three important-but often poorly managed or ignored-strategies that account for perhaps 80% of potential tax savings in a dental practice. Rather than expending significant time and effort to determine how to deduct your next family vacation, try focusing on these three big things.
Proper entity planning
Are you practicing as a C corporation, an S corporation, a partnership, or a sole proprietor? Having reviewed hundreds of tax returns for dentists over the years, I’ve found the single largest source of lost tax savings is improper management of the dentist’s business entity. Frankly, C corporations are impossible to manage for most dentists and they result in the greatest amount of lost opportunities for Section 179 and other “timing-difference” deductions, such as retirement plans. By timing difference, I mean the difference in timing between cash outflow and the deduction.
An example would be a dentist who borrows $50,000 in December to finance a large equipment purchase. Unless corporate cash and the deduction are painstakingly aligned, the entire deduction may be lost in the year of purchase and merely carried forward. In S corporations, there is a similar issue related to “basis.” Unless the dentist personally contributes cash to buy the equipment or borrows the money personally and loans it to the S corporation, the deduction may likewise be merely carried forward.
Although dentin hypersensitivity is often thought of as a minor irritation without any significant clinical sequelae, it can have a significant effect on patients’ lives.
If you are practicing as a C corporation, you should probably elect S corporation status. If you are practicing as an S corporation, you must carefully plan any large equipment or capital expenditures. If you are practicing as a partnership or sole proprietorship, you should consider whether the S corporation form will save significant payroll taxes.
A paired-plan arrangement is a 401(k) plan paired with a cash balance plan. A cash balance plan is a specific type of defined benefit plan especially suited to dentistry. In effect, under current law, a dentist is allowed to benefit from two deductible retirement plans in a single dental practice. By combining both retirement plan types, most dentists are able to deduct as much as $100,000-$200,000, and sometimes more. Not only do paired plans result in extremely large tax deductions while providing extremely large retirement savings, they also are highly efficient at controlling excessive staff retirement plan costs.
One of the great mysteries of my career has been trying to understand why so few dentists benefit from a paired-plan arrangement. Why would a dentist forgo the benefit of a retirement arrangement where the government matches 40%-50% of the dentist’s savings through annual tax efficiencies?
Cost segregation studies and section 179
The famous Hospital Corporation of America tax case paved the way for dentists to reclassify large amounts of office construction costs from a 39-year useful life to a five-, seven-, or 15-year useful life. With an engineering study that segregates “building costs” from “patient treatment costs,” many dentists can significantly increase depreciation costs on buildings by double or triple. Likewise, the ability to expense up to $500,000 of new equipment purchased under the Section 179 rules heavily favors the capital-intensive dental profession. In both cases, the problem isn’t a lack of knowledge about the provisions-it’s preventing entity problems from killing the deductions.
With cost segregation, a proper “grouping” election must typically be made to combine the building deductions with practice income. If the building is owned in one entity and the practice leases the building from another entity, large deductions can be unavailable to offset current income without a “grouping” election. With Section 179, equipment purchased in a C corporation or an S corporation may result in deductions that are merely carried forward indefinitely, due to insufficient income or basis. In both cases, conducting detailed planning to obtain the benefits of the deduction is essential.
In summary, careful planning related to the “Big Three” strategies can substantially reduce an annual income tax burden, perhaps by as much as 50% with a large paired-plan arrangement, for instance. Any other tax planning without carefully implementing the “Big Three” is merely majoring in minors.
This commentary originally appeared October 26 on DentalEconomics.com
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