Tax Planning For Dental Practices
Tax-planning is a hot topic among dentists, and most subscriptions are focused on tax-saving strategies. The truth is, 80% of potential tax savings in a dental practice come from three important-but often poorly managed or ignored-strategies. Try concentrating on these three big points rather than determining how to deduct your next family vacation.
Proper entity planning
Is your business a C-corporation, S-corporation, partnership, or sole proprietorship? I have reviewed hundreds of tax returns for dentists over the years and found that improper management of the dentist’s business entity is one of the biggest sources of lost tax savings. Dentists cannot effectively manage C corporations, and they have the highest rate of lost tax deductions, including Section 179 in the U.S. and retirement plans, in other countries. The difference in timing refers to the difference between the outflow of cash and the deduction.
As an example, consider a dentist who borrows $50,000 in December in order to purchase large equipment. Deductions may become lost in the year of purchase unless corporate money and the deduction are painstakingly aligned. S corporations face the same issue relating to “basis.” The deduction can also be carried forward so long as the dentist does not personally contribute cash or borrows and lends the money.
You should probably elect S corporation status if you practice as a C corporation. S corporations shouldn’t spend large amounts of money on equipment or capital expenditures without careful planning. As a sole proprietor or a partnership, you should carefully consider if an S corporation will reduce payroll taxes significantly.
Pairing a 401(k) with a cash balance plan is called a paired plan. Dentistry is well suited to cash balance defined benefit plans. The current law permits dentists to participate in more than one deductible retirement plan in a dental practice. In most cases, dentists can deduct as much as $100,000-$200,000, and sometimes even more, by combining both retirement plans. Additionally, paired plans are highly effective at controlling excessive staff retirement costs, while providing large tax deductions and large retirement savings.
Throughout my career, I have struggled to figure out why so few dentists benefit from a paired-plan arrangement. The government matches 40% to 50% of a dentist’s savings in the form of tax efficiencies, so why would a dentist pass up such a benefit?
Cost segregation studies and section 179
Dentists were able to reclassify their office building costs from a 39-year useful life to five-, seven-, or 15-year useful lives thanks to the famous Hospital Corporation of America tax case. The cost of depreciating buildings can be doubled or tripled by dentists using an engineering study that separates “building costs” from “patient treatment costs.” In addition, the Section 179 rules heavily favor the capital-intensive dental field, since equipment costs can be expensed up to $500,000 under the rules. There’s no lack of knowledge about these provisions in either case-the problem is that entity problems block deductions.
To combine building deductions with practice income under cost segregation, a proper “grouping” election must be made. It is possible that a practice leasing real estate from another entity will not be able to claim large deductions to offset current income without electing to group the properties. Due to insufficient income or basis, a C corporation or an S corporation may only be able to carry forward the deductions from equipment purchased under Section 179. Planning beforehand is essential to obtaining the benefits of the deduction in both cases.
A large matched-plan arrangement, for example, could reduce an annual income tax burden by as much as 50% through careful planning of the “Big Three” strategies. Unless carefully implemented, any other tax planning is mere minor thinking.