Tax laws for business owners are ever changing and oftentimes quite complex. What may have worked to help limit your tax liabilities when you first started your practice may not be providing you the same benefits today. After 2018, for example, dentists may no longer qualify for Section 179 deductions on business upgrades or equipment purchases.
However, taking a look at your existing business structure, maximizing your retirement contributions, or opening a health savings account may be three simple, yet effective ways to help alleviate the high tax burdens dentists often face.
1) Is Your Current Business Structure Costing you Tax Dollars?
The business structure you operate under not only impacts how you are compensated, but also how your business entity pays tax. Operating under the wrong business structure is one of the main reasons dentists often overpay on their income taxes.
Three of the most popular business entities amongst dental and medical professionals are the LLC, the S-corporation, and the C-corporation, and each is governed by unique regulations and tax-paying procedures.
Limited Liability Corporation (LLCs) structures are the least complex. They require minimal setup and are most practical for small, single-owner practices that distribute the majority of the business income. Single owner LLC’s are usually taxed as Schedule C, which makes filing income taxes cost effective and relatively painless.
LLCs with multiple owners are taxed as partnerships. Unlike partners in an S-corp, though, LLC partnerships have a higher level of flexibility on how they (a) allocate income and losses and (b) handle distributions. For example, partner-owners in a partnership don’t always have to carry the burdens of losses or gains equally.
S-corporations are considered pass-through entities, which means the corporation itself is not subject to federal income tax. Instead, profits from the entity are passed on to the shareholders and taxed at the individual level.
One of the major benefits an S-corp is that business owners don’t have to pay the 15.3% self-employment tax on their portion of the profits. While this is a nice perk, it certainly doesn’t provide the shareholder a free pass. Per the stipulations of the S-corp, any employee must first pay himself what the IRS deems a “reasonable salary.” This reasonable salary is, in fact, subject to the employee’s half of the self-employment tax. “The employer,” aka the corporation, pays the other half.
Of course, deductions are another way to mitigate tax liabilities. As of 2018, S-corp shareholders can claim a deduction equal to 20% of their S-corp’s profit. But, since a number of limitations apply, including maximum income thresholds, not all dentists may qualify.
For tax purposes, a C-corporation is regarded as its own entity and, therefore, incurs its own corporate income taxes. However, shareholders are still required to pay taxes on their dividends, which is why some refer to C-corp owners as being “doubly taxed” and tend to shy away from this corporate structure.
A number of dentist with larger practices, though, find operating their business under multiple entities and employing income-shifting strategies can help to alleviate annual tax burdens. Consult with your financial advisor and/or tax specialist to see if your business could save on taxes from a corporate restructuring.
2) Reduce Taxable Income with Contributions to a Health Savings Account (HSA)
Over the past few years, Health Savings Plans (HSAs) have become increasingly popular savings vehicles since they allow investors a means to (a) make contributions that reduce taxable income, (b) increase savings for retirement, and (c) sidestep taxes on qualifying medical expenses. However, these government-regulated accounts are only available to policyholders of a High Deductible Health Plans (HDHP), so you’ll need to check the IRS stipulations to ensure you qualify. If you do, you could shelter as much as $3,500 as an individual or $7,000 as a family from taxation every year.
3) Increase Retirement Contributions with Cash Balance Pension Plans
So many dentists spend years and years re-investing in the growth of their practice, that few have managed to save enough for retirement. Luckily, putting away more for retirement can also help reduce annual tax liabilities.
Cash benefit pension plans (CBPPs) are a popular choice for dentists who are nearing retirement age and feel they are falling behind in retirement savings. The 2019 total 401(k) contribution limit with profit sharing for a person of age 50 is only $62, 000 versus a possible $158,000 with a cash balance pension plan. Since CBPP contributions reduce adjusted growth income, dentists save on both net investment income and payroll.
If you are a dentist and fear that you are paying too much in taxes, the financial professionals at Harbor West will be happy to help you evaluate your opportunities to save. We specialize in helping dental professional navigate their unique financial needs. Contact Us today to discuss how we can help you reach your short and long-term financial goals.
This information is provided for general purposes and is subject to change without notice. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Before acting on any of the information, please consult your Financial Advisor for individual financial advice based on your personal circumstances. Neither Harbor West nor Geneos Wealth Management, Inc. provide tax or legal advice.
Harbor West is a division of NorthEast Community Bank. Securities and Advisory Services offered through Geneos Wealth Management, Inc. FINRA/SIPC Investment Advisory and Financial Planning Services offered through Geneos Wealth Management, Inc. Investments are not FDIC Insured. Investments are not deposits of the financial institution and are not guaranteed by the financial institution. Investments are subject to risks including loss of principal.