This is the time of year to shop for holiday bargains. Savvy women dentists are looking at the new tax law to make wise purchases for their practices. New tax law changes now make these end-of-year purchases very attractive. The new law reduces tax rates on ordinary income, capital gains, and dividends, as well as dramatically expands write-offs for new practice investments. Here's how to maximize your tax savings under this highly complex and controversial tax law change.
- Child tax credit — The new law increases the tax credit available for each child under age 17 from $600 to $1,000 per child, but only for 2003 and 2004. Thereafter, the child credit reverts to current law levels of $700 per child for 2005 to 2008, $800 for 2009, $1,000 for 2010, and $500 per child each year thereafter.
Unfortunately, the child tax credit is phased out for higher income individuals — over $75,000 of modified adjusted gross income (AGI) for single dentists and $110,000 for married dentists — so most dentists will not qualify for this tax break.
- Eliminate marriage penalty — A "marriage tax penalty" exists when the combined tax liability for female dentists who are married is greater than the sum of the taxes owed by each spouse if they were not married and filed a single return. The new tax law eliminates this penalty for 2003 and 2004 by increasing the standard deduction amount and the size of the 15 percent regular income tax bracket for joint returns to twice that for single taxpayers. This is an important provision, because household income for married female dentists is greater than for their male counterparts.
- 10 percent rate bracket expanded — The new law increased the amount of income taxed in the 10 percent rate bracket from $6,000 to $7,000 for single dentists and from $12,000 to $14,000 for married dentists, for 2003 and 2004.
- Reduction in other tax rates — The new tax law also reduces income tax rates as follows:
These tax-rate reductions will be effective through 2010.
Strategy: Rather than giving the government an interest-free loan, women dentists should immediately act to reduce their federal income tax withholding and/or estimated tax payments to receive these tax savings now! However, make sure that your federal withholding and estimated tax payment are sufficient to avoid an underpayment penalty. You must pay in at least 90 percent of your 2003 tax liability, or 100 percent of your 2002 tax, as a general rule. However, if your 2002 AGI exceeded $150,000, you must pay in at least 90 percent of your 2003 tax liability, or 110 percent of your actual 2002 tax, to avoid the penalty.
Tax rate on dividends cut
Under the new tax law, dividends will be taxed at a maximum rate of 15 percent to most dentists, down from 38.6 percent under present law. Moreover, those in the lowest tax bracket (e.g., children age 14 or older) will pay tax at a maximum rate of 5 percent for tax years 2003 to 2007. This maximum rate for low-bracket taxpayers drops to zero for 2008, meaning that dividends will be tax-free for that year!
Stock dividends paid by both publicly traded companies as well as closely held firms (including dental practices) qualify for the favorable tax treatment. Subchapter S company dividends, if paid from prior profits accumulated while operating as a "C" corporation, qualify for this extremely favorable tax break, although the woman dentist's pass-through share of the practice's profit do not. Dividends from money market and bond mutual funds and REITs also do not qualify.
Strategy: "S" corporation dentists who previously operated as a "C" corporation should pay out a higher percentage of their profits as dividends to qualify for this 15 percent rate.
Strategy: Borrowing to buy dividend-paying stocks can pay off handsomely with dividends taxed at a 15 percent rate and the margin interest deductible against ordinary income, taxed at rates of up to 35 percent. However, the new law allows dentists to deduct margin interest only to the extent of net investment income (not counting dividends and long-term capital gains). To benefit from this strategy, dentists must have interest income, short-term capital gains, or money market or bond fund dividends to deduct the margin interest again.
Lower capital gains rates
While Congress did not raise the $3,000 annual limit on deductions of excess capital losses, it did reduce the rate on long-term capital gains received after May 6, 2003, to only 15 percent. Congress rejected the IRS' plea for a Jan. 1, 2003, effective date; unfortunately, this will lead to a paperwork nightmare for dentists with 2003 capital gains. Women dentists receiving installment sale payments after May 5, 2003 (from practice, office building, or other real estate sales) qualify for these lower tax rates, even though the actual sale occurred earlier.
Moreover, the maximum rate on long-term capital gains for taxpayers in the lowest (10 to 15 percent) income bracket (e.g., children age 14 or older) drops to only 5 percent for sales after May 5, 2003, until 2008, when the tax rate falls to zero! Thereafter, the rate springs back to 10 percent in 2009.
These changes further enhance our long-recommended strategies for funding children's educational costs with tax-deductible dollars. As a result of investment losses, many women dentists' college funds are well below the amounts required to meet their children's educational needs.
Strategy: Women dentists with appreciated stocks, bonds, or real estate, who need additional funds for college, can transfer these assets to their adult children or to a family limited partnership (FLP) or limited liability company (LLC) set up on the children's behalf. The appreciated stocks, bonds, or real estate can then be sold and the proceeds used for college, with the gain taxed to each child age 14 or older at a maximum rate of just 5 percent!
Children age 14 or older with no other income can receive up to $28,400 in long-term capital gains and dividend income this year and pay federal income taxes at a rate of only 5 percent! Moreover, the total tax of $1,420 ($28,400 x .05) can be reduced to zero for college-age children by using the educational tax credits described in our Aug. 2001 issue of the Blair/McGill Advisory newsletter.
Strategy: Women dentists should hold stocks, bonds, and real estate at least one year before selling. While long-term rates have dropped to a maximum of 15 percent, short-term gains from assets owned for less than a year continue to be taxed at rates as high as 35 percent.
Strategy: The new law places a real premium on deciding which investments to hold in retirement (retirement plan and IRA) and taxable accounts. For best results, use the following allocation:
Strategy: As a result of these lower tax rates, women dentists should avoid deferral schemes funded with after-tax dollars, such as tax-deferred annuities. In addition to the higher fees and surrender charges, all amounts withdrawn from annuities are taxed at higher ordinary income tax rates (maximum rate of 35 percent). If the same assets were held personally, all capital gains and dividends would qualify for the 15 percent maximum rate.
Increased expensing election
The new law quadruples the amount of new or used dental and office furniture and equipment (including computer software and some business automobiles as discussed below) that dentists can elect to immediately write-off (expense) each year — from $25,000 to $100,000 — in 2003 to 2005. Despite rising opposition, luxury sport utility vehicles (SUVs), and other vehicles with a Gross Vehicular Weight Rating (GVWR) of 6,000 pounds or more continue to qualify for the increased expensing amount. The new law also increases the maximum first-year tax write-offs for other business autos to $10,710.
Finally, women dentists can now file amended tax returns to increase or decrease the amount of equipment they wish to immediately expense, rather than depreciate, without IRS approval.
Bonus first-year depreciation increased
Under the new law, the amount of bonus first-year depreciation on new equipment purchases is increased from 30 percent to 50 percent, for purchases after May 5, 2003, and before Jan. 1, 2005. While most women dentists will use the $100,000 expensing election discussed above to immediately write-off the cost of new equipment purchases, the 50 percent bonus first-year depreciation is available for purchases above this amount, as well as for leasehold improvements (but not buildings or other real estate) that do not qualify for immediate expensing.
The above article, submitted by Dr. Charles Blair, was reprinted with permission from The Blair/McGill Advisory, a monthly newsletter devoted to tax, financial planning, investment, and practice-management matters exclusively for the dental profession. Dr. Blair, along with The Blair, McGill & Hill Group, offers a fee and procedure mix consultation for dentists. For more information, call (704) 424-9780 or email [email protected].
John McGill, CPA, MBA, JD Mr. McGill is chief editor of The Blair/McGill Advisory newsletter and a tax columnist for Dental Economics. He has specialized in consulting services for the dental profession for more than 20 years. You may contact Mr. McGill at (704) 424-9780 or [email protected].