5 hidden tax opportunities for dental professionals
Ninety-five percent of dental professionals pay taxes in excess of what is required by law because they do not take advantage of all of the opportunities provided by the U.S. tax code. That can change, and here's how.
As a specialist in reducing the tax burden of dentists through legal means, I’ve had the privilege of working with a variety of dental professionals over the years. I have determined that nearly 95% of them pay taxes in excess of what is required by law because they do not take advantage of all of the opportunities provided by the U.S. tax code.
Simply put, if you pay more than 30% in combined federal, state, and self-employment taxes, you’re overpaying. Missed opportunities for legally lowering taxes costs many dentists tens of thousands of dollars. When you add all these overpayments together, over the years some doctors incur “damages” exceeding the million-dollar mark.
Fortunately, tax overpayment is curable. If you’re like most dentists, you pay a lot in taxes every year. What you may not realize is that some of it can be saved legally. Each of the following strategies is within the letter of the law, statutes, and IRS codes, provided you follow specific protocols and treatment plans.
1. Choose the right business structure
The main reason dentists pay taxes they don’t have to pay is because they operate their practices under the wrong type of entity. Choosing the best business entity is important and complex. When I analyze dentists’ tax returns, I almost always notice that they’re conducting their business under one entity, and it’s the wrong type of entity.
Most successful practices need to be managed under more than one entity. This adds to the complexity of the situation, but the potential benefits, including tax savings, almost always outweigh any difficulties involved. One benefit of corporate structures is income shifting, a strategy that can legally lower taxes by reducing taxable business income. For example, your business could form two corporate entities with different year-ends (e.g., an “S” Corporation with a December 31 year end, and a “C” Corporation with a June 30 year end).
Under this strategy, the “S” Corporation would be your core business and receive all gross business income. Your “C” Corporation would receive money from the “S” Corporation to pay for advertising, marketing, and management expenses. In this scenario, the core business earning $100,000 in gross income could reduce taxable income in the “S” Corporation.
Income shifting enables you to deduct much of the income from the “C” Corporation by using the tax code deductions guide. Accordingly, income shifting can help a dental professional save up to 15.3% in taxes over a sole proprietorship or partnership in which all income is subject to self-employment taxes.
2. Maximize medical benefits
Medical benefits constitute one of the most overlooked and underappreciated areas with regard to smart tax strategy. By not using pre-tax dollars to pay for medical expenses, you risk a larger tax bill, and you lower business profits by not maximizing deductible business expenses. Sole proprietorships offer fewer options than corporate structures to most effectively integrate medical benefits into your tax plan. For example, Medical Expense Reimbursement Plans are available to businesses with employees, and they let you write off medical bills as business expenses. If you operate as a sole proprietor, you can’t establish a plan.
If your business is taxed as a corporation, you qualify as your own employee, whereby you can legally enjoy medical benefits and tax savings not available to sole proprietors or partnerships. Under this scenario, you should be qualified as your own employee so you can maximize the medical benefits.
3. Choose the right retirement plan
Dentists are often unable to save enough for retirement these days. I know this firsthand because many dentists I meet have negligible savings earmarked for their golden years. Retirement plans are vehicles for building financial security and maintaining lifelong living standards. Choosing the most effective retirement plan starts with a budget. How much would you like to contribute annually? If you have employees, what is the total budget for the plan? How much of that contribution is for you, the business owner?
Given the number of retirement plans—401(k), profit sharing, defined benefit, SEP, and SIMPLE IRA, to name a few—how do you determine which plan is best for you? Dental professionals should consider profit sharing plans that provide more flexibility in annual contributions. For example, if you have no employees, a profit sharing plan that includes a 401(k) provision allows your contribution in any year to be from zero up to $56,500, if you’re age 50 or over. That’s about as flexible as it can get!
How do you maintain a minimum amount of taxable income, yet maximize the retirement plan contribution? With a defined benefit plan, you don’t face the $51,000 or $56,500 contribution limits. Instead, you face a limit only on the funding of the monthly retirement income you can provide to yourself when you start receiving your retirement benefits.
4. Hire family members
Taking advantage of the IRS-sanctioned tax strategy of employing your children can provide payroll tax deductions for hiring family members, while helping your children earn money for college or other expenses. Under IRS rules, children under age 21 are not required to pay unemployment taxes, and children under 18 don’t pay payroll taxes, Social Security, Medicare, or unemployment taxes. Your kids also do not pay FICA or Medicare taxes on their wages.
You can benefit from this rule if you operate as an LLC or sole proprietorship. For example, if you pay your child $8,000, you can save $3,042, depending on your tax bracket and other factors. If you operate as an “S” Corporation or a “C” Corporation, you can create tax savings by hiring your child, just not nearly as much. For wages paid to a spouse or parent, you don’t pay unemployment taxes. However, the wages are subject to FICA and Medicare taxes.
LLCs can take advantage of family tax breaks, just as if you were a sole proprietor. If you operate a husband- and wife-owned LLC and both spouses have membership in the LLC, you likely have a partnership. You can still take advantage of the tax break for hiring family members. The only limitation is that the family relationship has to apply to all partners.
5. Plan ahead
Saving on taxes starts with a forward-looking tax strategy. Unlike tax preparation (which organizes what’s already taken place), tax planning helps you take strategic actions in active tax years. There are provisions in the laws that allow dentists to structure their financial affairs in such a way that their tax liability is minimized.
Meet with your tax advisor no later than 90 days after filing to review your previous year’s tax return and plan for the current year. Review side businesses, property rentals, charitable contributions, and business asset depreciation. By examining these key areas, you can identify potential problems and solutions and proactively implement tax saving strategies and maximize opportunities.
Lubna Channo is a Michigan-based tax and accounting CPA who helps dental professionals boost profits and maximize tax savings through intelligent tax planning. Ms. Channo has helped hundreds of business owners develop and implement a forward-looking tax strategy to pay the least taxes and build a more profitable practice. Learn more at lchannocpa.com.