Time and perspective: effective tax planning's most valuable factors

May 9, 2011
The overarching benefit of a proactive and comprehensive approach to financial planning and managing your tax exposure is having the luxury of time and perspective. Kevin Jack, CFP, tells you why last-minute tax reduction recommendations actually cost you in the end.
By Kevin Jack, CFP®Take time for all things: great haste makes great waste.Benjamin Franklin Let’s face it — most efforts to minimize business and personal tax exposure are reactive and last-minute. Frequently, these efforts consist of little more than the obligatory, harried phone call to your CPA as year-end looms near. The conversation likely includes some variation of the following questions: “How can I minimize my tax exposure this year?” “What can I still do before the end of the year to qualify for another deduction?” “Am I out of time?”The typical response could include ideas such as the following:
  • Buy a piece of equipment to qualify for the Section 179 deduction
  • Establish and fund a pension plan for your practice
Now, suggestions like these are often representative of valid and sound advice ... within the proper context. However, when offered as hurried solutions to your year-end plea for tax reduction options, they may offer only a temporary and often costlier fix in the long run for the larger issue at hand — an overall lack of proactive tax planning and exposure management. What do last-minute tax reduction recommendations like these truly cost you in the end? Buying expensive equipment in order to meet Section 179 deduction eligibility requirements is a little like putting the cart before the horse. Was your practice in current need of the new equipment? Was this major expense planned into your five-year operating expense budget? Without a current need or plan for this significant last-minute investment and despite the deduction opportunity, in essence, this “solution” has you spending a dollar to save 30 cents in taxes.Paying your staff the amount you would have paid to the IRS, at first glance, appears to be both an altruistic and sound investment strategy. However, creating and implementing a pension plan at the eleventh hour can easily result in an inefficient and costly product over both the short- and long-term. In the short-term, you could easily spend more on the expenses associated with plan establishment than in original taxes owed. Over the long-term, the annual expenses associated with plan management (plan administration, investment fees, and staff funding contributions) could be greater than annual taxes owed on a regular basis if thoughtful and comprehensive planning and analysis were not undertaken prior to the pension plan’s inception. Switching gears now, let’s examine how the implementation of a proactive and collaborative approach to managing tax exposure can positively impact and enhance your bottom line in both the sort- and the long-term.First and foremost, keeping up with the continual changes in tax code, not to mention the ever-increasing complexity of these changes, is a full-time job in and of itself. It is nearly impossible to maintain and grow a successful dental practice and remain current with the myriad tax changes, all the while fully understanding their intricacies and how or when it is best to apply any number of them for optimal tax benefit. Most professionals realize the value of enlisting the services of a third-party tax expert. However, it is equally important to determine whether your expectation of this expert role is that of tax preparer or tax planner and further, what level of service this expert is able to deliver. If you expect tax planning services yet receive mere tax preparation in return, your goals for optimal practice and personal success cannot be realized easily or according to plan. This disparity between service expectations (comprehensive financial planning which includes long-term tax planning) and the reality of services received (tax preparation with narrowly focused tax advice) often serves as a motivation for seeking out the services of a comprehensive wealth management firm.Now let’s revisit the tax-saving solutions mentioned earlier. When implemented within the context of a proactive plan for total wealth management (of which tax mitigation is an integral part), these options can provide true benefit and incremental value.Section 179 deductionTaking a Section 179 deduction on a new piece of practice equipment makes great business sense within some variation of the following context: As part of your multi-year business plan, you have analyzed your practice production, valuation, overhead, revenue flow, optimal hourly productivity, etc., figures and have identified a specific practice need — replacement of a fully depreciated piece of equipment within the current calendar year. You have proactively planned for this purchase over time; you have run projections that identify increased practice productivity as a result of the new device; you have comprehensively researched all depreciation scenarios and have determined that the accelerated depreciation (Section 179) deduction is the best option for your tax strategy. Because this purchase was planned, so, too, was the decision to purchase in the current calendar year, given your research findings on time-sensitive additional benefit opportunities tied to the Section 179 deduction. A necessary and planned business investment can now occur in a manner that also provides maximum tax savings.Pension plansEstablishing a pension plan for the practice can add value on numerous levels when its implementation occurs within the following context:Again, as an integrated component of your multi-year business plan (a system you have put in place allowing you to monitor your progress, growth, and needs consistently and over time), you have spent considerable time exploring the myriad options available for pension plans (i.e., defined benefit, defined contribution, SIMPLE IRA, etc.) conducting exhaustive due diligence on the funds used, the fees (hidden) assessed, the benefits of different funding levels, the administration costs, and have determined that there are a few options that appear to make sense from a tax-mitigation perspective. You then calculate out various growth scenarios and determine, with high certainty, a projection for incremental revenue this year, enabling you to fund a defined contribution plan fully ($49K) before mid-year. You have further identified that the pension plan creation will deliver the highest ROI on the funds invested, from a tax management strategy perspective, as well as from a team morale perspective.Think ahead. Don't let day-to-day operations drive out planning.Donald RumsfeldThe overarching benefit of a proactive and comprehensive approach to financial planning and managing your tax exposure is having the luxury of time and perspective. Time to plan, compare, learn, analyze, modify, respond, and course correct; perspective from which to reflect, clarify, weigh, prioritize, and choose options – all within the context of your unique vision and the distinctive parameters of your journey toward personal and professional success. Author bioKevin Jack, CFP®, is a financial advisor at Mercer Advisors Inc., an independent, fee-based comprehensive wealth management firm that helps dentists to optimize their financial lives. Contact Kevin at (800) 394-3894 or [email protected].