Typically, when a dentist first starts practicing, they are so focused on the practice of dentistry that little attention is paid to developing tax strategies to ensure they are maximizing their after-tax income.
As their business grows, this becomes an even bigger issue. Instead of reevaluating tax strategies that change with their business, they use a ‘one size fits all’ approach and as a result, lose thousands of dollars a year.
As a financial planner, I see this often. Many times our clients do not even realize how much they could be saving until they realize they’ve saved thousands of dollars after working with us. If you knew you were throwing that much money to taxes, you would be staying up at night trying to figure out how to save that money.
The good thing is, you don’t have to lose any sleep. At Catalyze Dental Advisors, we know exactly how to help you save thousands – thousands of dollars that could be put back into your business so that it can continue to grow. We have helped many dentists work through money saving strategies, and over and over, we see these 4 easy tax saving strategies as vital but very rarely implemented before working with Catalyze.
Few dentists are aware of these strategies, but this simple article can help save you thousands this year.
Paying More Taxes Than Legally Obligated
There’s tax evasion, which is illegal, and there’s tax reduction. Tax reduction is using the tax code to your advantage, and it’s perfectly legal. While there are a number of ways dentists frequently fail to use the tax code to their advantage, perhaps the most common is a strategy called filing an “S-Election”.
By filing an “S-Election” using form 2553, you no longer have to pay FICA taxes on the “pass through” income from your practice. Some call it a loophole. No matter what you call it, it is a legal, but an often overlooked way dentists can save on taxes.
Here’s how it works…
The IRS treats investment income (like stock dividends or rental income) differently. Unlike earned income, this money is NOT taxed at the additional 15.3%.
You see, the IRS considers the time you spend working ON your business an investment.
So, they tax any money you make during that time as a dividend.
There’s still plenty to consider before changing your company’s registration to an S-Corporation…
- You will need to pay yourself a reasonable salary
- And abide by the IRS guidelines to function as an S-Corporation,
BUT these are small hurdles for potentially significant tax savings.
Of course, making an S-Election isn’t appropriate for every dentist, and in some cases, there are other strategies that offer even greater savings, but if you haven’t even considered this as a strategy, you should.
Not using the largest piece of tax reform legislation passed in 30+ years
In December of 2017, the Tax Cuts & Jobs Act (TCJA) created a number of tax planning opportunities for dentists.
Unfortunately, the new law is quite complicated, making the task of understanding it somewhat difficult. One of the biggest planning opportunities for many dentists is the new qualified business income deduction created under IRC §199A which provides a 20% deduction on business income.
The unfortunate thing is, most dentists, and even many of their accountants, aren’t taking steps to take advantage of this newly passed tax deduction.
There are thresholds and phaseouts, but even for those dentists whose income is over the threshold, there are still ways to benefit from this deduction.
For example, income from a rental real estate business is not subject to any income-based phase-outs. So even dentists subject to the phase-out can still benefit from a 20% deduction on a portion of their income if they own the building in which they practice.
It’s also important to evaluate this in light of other tax-planning strategies you may already be using. Considering multiple tax strategies can get pretty complicated, but if you have any questions about how this might affect you and how this might impact other tax planning that you’ve done, feel free to reach out. We’d love to talk with you.
Leaving Your 401(k) on Autopilot
What I find is many dentists set up a retirement plan and simply forget about it…
Then what? Well, life and business keep marching on, and your plan continues to sit there on the shelf, unchanged, accumulating dust. You’re still contributing to it, but you haven’t evaluated if it is still the most appropriate structure. And the reality is, laws change, or you simply outgrow it. Some of your employees retire, your income increases, your goals change, but your 401(k) plan remains the same.
I’ve worked with some clients where by making a few small tweaks to their plan, they could save as much as an additional $100,000 on their annual tax bill, without any increase in cost over their current plan. And this tax savings could grow to $1,664,549 over ten years (assuming it’s invested at an 8% rate of return).
Not every plan I review has tax savings opportunities that are that large, but by helping our clients stay on top of their 401(k) and saving even just a few thousand dollars every year, this not only adds up to significant tax savings over their career, but it also means they’re better prepared for their future with less strain on their current cash flow.
Not Making High Income Roth IRA Contributions
Most dentists aren’t eligible to make deductible IRA or Roth IRA contributions, but they don’t realize they can still make contributions to a High Income Roth IRA. This goes by other names as well, but the IRS frowns on some of them, so we avoid them.
There used to be an income cap that prevented the use of High Income Roth IRAs, but the IRS rules have changed, and there is no longer an income cap for these types of contributions. With the cap removed, regardless of your income, anyone can now contribute to a High Income Roth IRA. With these contributions now in a Roth IRA, you have a source of completely tax-free income during retirement!
For example, let’s assume that Jane is a married 35-year-old dentist, and she and her husband begin contributing to a High Income Roth IRA. She repeats this process every year until she retires at 65, each year contributing the maximum amount.
If Jane can earn 8% per year, then by the time she reaches 65, she’d have contributed $373,000 to her High Income Roth IRA, and she’d have over $1.5 million of completely tax-free money in her High Income Roth IRA. This amount includes nearly $1.2 million of tax-free earnings! Had she invested those amounts in an IRA or a regular investment account, she would have accumulated substantially less due to the tax-drag.
Of course, there are a few caveats to be aware of, and it’s very important that these contributions are reported on IRS Form 8606. This is a process our team can walk you through, making it an easy way to save and plan ahead.
So What’s Next
If you’re worried over all the money you’ve lost over the years, don’t be! You did not know about these tax savings hiding right under your nose, but now you do AND you can do something about it. We’d be glad to have a conversation with you and review your tax returns to see how much you can save.