Financial Mistakes - Tax Planning Gaps

Foreign. Welcome back, my beloved listeners, to the Dental Boardroom podcast. It's Wes Reed, your host, coming at you. It is today, January 12th, and I've been very out of pocket over the past couple months as you if any of you are subscribing to the show. I've got to send my sincere apologies for not issuing any new releases lately. The last couple months of the year just get remarkably busy here at Practice CFO as we go through all of our clients in in a very detailed way to help them stick the landing with their cash flow and tax planning going into December 31st. Because once December 31st comes and goes, there is only so much you can do to fight that tax bill. And we aggressively fight the tax bill for our clients here at Practice cfo. And on that note, I'm carrying on my series on financial mistakes that dentists make as dental practice owners. And just a quick recap from probably what was five or six weeks ago on the last episode on this subject, which was on cash flow and spending discipline or the lack thereof, spending more than they earn something that is so I'll just say humans are so complicit in that problem. Dentists are not an exception to that rule. And I think when you have a flow through entity like an S corporation or a dental partnership or even a sole proprietor in a way, even though a sole proprietor is not technically a flow through entity because it doesn't file its own tax return separately from the 1040 in all these cases, it's very complicated to be running your own business. And a dental practice is just that, it's a business. And with that come a lot of complexities that dentists weren't necessarily trained up on in school. And a consequence of that sometimes is just a very loose oversight or control of cash flows in the practice. And sort of extracting the cash flow out of the practice into the personal checking account often leads to spending more than perhaps a dentist should. And this is one of the primary reasons why dentists are not able to retire or be financially independent, as I prefer to call it, earlier in life than I think they should be able to. It is simply because holes in that financial boat are leaking because of excess spending and a lack of discipline around that. Excess distributions was another topic from our last episode. That is when you distribute more out of your practice checking account to your personal account than the IRS would have you do that, and then they penalize you with a penalty tax called excess distributions tax. The third one we talked about was the really it was an Extension of the first one around spending, but a lot more in the personal life consumption to income ratio, which is one of my favorite KPIs when it comes to personal finance is how much are you consuming relative to your income. And when I say consumption, I don't talk about necessarily buying a house. I talk about buying all the stuff that goes down in value. You buy it, boom, it's not worth anything. And I put a car in that category. Even though it doesn't turn into nothing overnight, give it a little bit of time and that car down, that car sort of winds down to being worth virtually nothing. And that is therefore a consumer product. The opposite is an asset. An asset is when you buy something that actually goes up in value over time as a designated purpose of that thing. So buying real estate, buying a stock, buying a bond, buying your house, starting or buying a dental practice. If done right. There's a lot of different types of asset categories. We call them asset classes in the investment world. And I don't put assets in the consumption to income ratio. In fact, it's quite the opposite. That is your savings ratio. So the consumption income ratio all too often in our lives is just too high. We consume too much relative to our income. And I always tell doctors I want you to be able to spend a million dollars a year, $5 million a year, I don't care. I just want it to be in proportion to what your income tolerates. Because if you don't do that, you are funding your life today at the expense of your life in the future. There are two you's, you now and you in the future. And it's important that you consider that you in the future, which is a lot of our job here at practice CFO is to give context and to service both of you now and you in the future through, through a good disciplined plan around the finances. Alright, the last one was just not automating savings. I mean this one is just a no brainer. It is a no brainer. I'll tell you what there was when I was maybe 15, 20 years ago, I just started dripping in a hundred bucks a month into a 529 education savings account back when my I had two kids, one of them wasn't even born yet. And I just started dropping that in a little bit now over time I bumped that up to 250 per month. But now I look at what I have in there and I'm like so thankful. I'm so thankful because I have a son who is going to UC Santa Barbara I have a daughter who's going to a local junior college and then she's trying to transfer to UC Davis where she wants to study become a vet as well. And these colleges cost some money and a living cost some money. And I am so grateful that the former Wes decided to to just drip a little bit of money Are you looking to buy or sell a dental practice? If you're a seller, how do you find a strong list of potential buyers? There's no MLS or Zillow for dental practice sales. In such a fragmented market, many dentists selling their practice feel discouraged. That's why I built practiceOrbit.com practice orbit is modernizing how dental practices are bought and sold. It's a platform technology. Y' all know them Zillow, Airbnb, Uber, and OpenTable, just to name a few. These technologies do two things. First, they help match buyers and sellers by centralizing the marketplace. Second, once the match between buyer and seller is made, these technologies help them navigate the sale to a successful close.

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Additionally and optionally, you can use the platform tools such as a built in NDA, a customizable loi, and a workflow tool to navigate the sale from LOI to closing. In fact, you can manage all your listings on the system from listing the practice to NDA to loi, and finally to closing the deal. Create your free account today at www.practiceorbit.com. Every month into these 529 accounts because I'm finding that to be extremely helpful. Now, same thing when it comes to a 401k or funding your IRA or funding a savings account for the purchase of a new home, whatever that is that you're going to need in the future. If you simply set up an automated way of funding these little buckets and then you sort of live on what's left. Now you've got to do a little bit of a balancing act there, but if you do that well and intentionally and then you stay disciplined, it is a beautiful thing to see what happens. And if you don't get too emotional on your investments that are in at least the stock market, not, not to say like a savings account, that's not an emotional thing. The stock market can be very emotional. And if you maintain discipline, you don't try to time that market then and you just, you just let it do its thing. It's amazing what'll happen over a 10, 15, 20, 30 year period. It is a beautiful thing. Like Einstein said, interest, or better said, compound interest, is one of the great wonders of the universe. And that is very true. One of the stats I show where I say about this is our man Warren Buffett. He is worth a tremendous amount. I don't know what it is these days, Probably, I don't know, 150 billion, I don't know, but. But it's a lot. But I do know that about 90% of that was accumulated after he turned 60 years old. Why? Because that's what compound does. When it eventually starts to get big, it becomes really big, really fast. Because if you're sitting on, let's say, $10 million and you get 10%, you just added a million dollars in a single year. It may have taken you 40 years to get to that $10 million mark. Now, this is a large number, but I'm just accentuating my point. It takes a long time to get to that large amount. But once you get to that large amount, it is remarkable how it turns into an extremely large amount from the large amount. But you don't get there unless you start early. Time is like fertilizer. It makes things grow when it comes to finance. So cash flow and spending discipline was the first topic in the series of financial mistakes dentists make that prevent them from becoming financially independent. The one I'm going to talk about today is tax planning gaps, as I'm calling them. These are the gaps between what you are paying in taxes and probably what you should be, which is probably less than what you are paying in taxes. Whenever I get new prospective clients, I look at their tax return, we look at their P and L and, and we scan it pretty thoroughly, and we can in almost every case, find missing tax deductions. It's like leaving money on the table. Let's say you go to a restaurant and the order is 50 bucks and you pull out money and you accidentally leave an extra $40 on accident. That's what's happening here. We're just leaving money on the table for no reason at all. Maybe you look at the government as a charity and you want to give the government more money because we all know national debt is completely out of control. And you're like, I just want to help the government, so I'm going to pay more in taxes. Well, great. If that's how you feel about your relationship with the irs, all the more power to you. The government sure could use it, that's for sure. But for me and for my clients, I don't want to pay a penny more then you are legally required to to pay. And if I try to go below that, I'm probably going to get into tax evasion, which could land you in jail. So I got a dual mandate when it comes to taxes. Keep it as low as possible. And to avoid an IRS audit. Those are my two mandates. We have to balance those very carefully here at practice CFO for our roughly 400 dental clients. All right, let's go through a few comments here. So just an example to kick us off here. We got two dentists. One dentist keeps an extra $50,000 every year. Everything else about the practice is exactly the same. What's the difference? It's not necessarily hustle, it's not necessarily luck. It is strategy, and in this case, tax strategy. And most dentists think that tax planning is something that the CPA does for them, and they do it once a year. Real tax planning is something that is ongoing. It's ongoing, done throughout the year. It doesn't mean every day you got to go home and, like, work up your tax planning strategies for that day. I don't mean that. What I mean is that throughout the year, you're making decisions around your payroll structure, around who you put on payroll, around your car, around the things that you can run through the practice and label it as a business expense, around depreciation and travel, around when to buy new equipment and to do build outs. And of course, there's areas of the tax code as well, like the pte, which we're going to talk about. That's just it's. Just money that's just left there if you're not addressing these things. And so the way I always talk about tax planning is that tax planning is a subset of cash flow planning. Tax planning is a subset of cash flow planning. It's not an independent strategy on its own. It's all about managing the way your dollar plinkos in from patients and from insurance companies into your business checking account and plink goes through your P and L, through your labor, your labs, your supplies, your marketing, your admin expenses, all of that plink goes through. And then you got taxes, then you got debt, then you got everything for you as the owner. You got your payroll, maybe there's some kids on the payroll. What's the right retirement plan if we are ready for one in the practice, like a 401 safe harbor profit share plan? And how much do you take out of the practice? And do you take it out as a W2 or do you take it out as a K1? There's all these. Those are just a few of all of the sort of oversight and the decision making around effective cash flow planning. And inside of that embedded is good cash flow planning. So for example, for example, let me give you an example what I mean to decouple these things a little bit or more better to emphasize that they're sort of one in the same cash flow planning and tax planning. If at the end of the year you believe you're going to owe more taxes than you would like to pay and your supplier from Henry Schein comes to you and says if you buy this new CAD Cam, you're going to save $40,000 in taxes. Okay? So that's a tax strategy. Okay. On December 31st, I'm going to buy and have in service my new CAD Cam and I'm going to save $40,000. Great. However, the next year you're going to be paying for that CAD Cam and you are going to be taking deductions in the year that you got it. Because you got in December 31, you can, you know, take a large depreciation deduction in that year. But then the next year you have money going out to pay the loan, assuming you didn't pay for it in cash and you're paying the loan and now you're not going to get a tax plan for it. And so the doctor looks great in the year that they bought that CAD Cam or a cone beam or a build out, anything. It doesn't have to be a CAD Cam, but anything. They look great that first year, the next year, not only are the taxes are going to go up because we don't have that $100,000 deduction or whatever that cost is. Not only are your taxes going to go up, but now you have less cash available because you've been paying on the loan for that, for that purchase. And so the strategy of buying that machine in order to get the tax deduction, that is the tax planning strategy. If you don't look at that in the cash flows, not only in that moment that you bought it and the taxes you're going to save for that year, but in the next five years as you're paying off the loan, if you don't look at it in that spectrum, you're going to end up making cash decisions that put you in a precarious place. That's why I say, yes, we can maybe buy that CAD CAM or equipment near the end of the year. But it's not just a yes or no answer. You have to look at it. And what's your cash balance today? How much are you going to save? What is your projected tax next year? Because if your projected taxes next year are going to be higher because your income is going to go up by 30 or 40% for whatever reason, you may want to extend the tax deduction into next year and not take it all this year when you're in a lower tax bracket. And all of this is affecting your cash flows as you go throughout the year. Bottom line, tax planning is a function of good cash flow planning. That's why if you're a client of practice cfo. Every time we meet, we do a cash flow forecast and we plan the movement like traffic controlling the dollar as it plink goes through that P and L and your balance sheet to stick the landing every year. Now let's talk about your S corporation. So this is what I want to kick off with here. Your S corporation and what that means. A lot of people think that they're automatically saving taxes because they're an S corporation. The truth is, you may or may not be saving taxes as an S corporation. And also keep in mind that S corporations have more extensive accounting and tax requirements because now you have to keep a balance sheet which is your assets and your liabilities, not just a P and L which is your income and expenses. Pretty much every dentist gets a P and L at some point because they have to, they have to report that P and L to the irs. And if you're a sole proprietor, meaning you don't have a corporation or you don't have a partnership set up. You're by default a sole proprietor. You actually don't have to remit a balance sheet to the irs. That's an important distinction between being a sole proprietor and being an S corporation or a partnership. Is a sole proprietor has what's called a schedule E, page one, which is simply an addendum to the 1040 personal tax return, like your atomized deductions, which are Schedule A, Schedule B, interest and dividends. Schedule C. Interesting. Is a sole proprietor. A minute ago I may have said Schedule E. That's wrong. Schedule E is rental real estate income and it's passed through K1 from S corporations and partnerships. It's Schedule C, which is on the 1040, which is where you report your income and expenses of your dental practice. If you are a sole proprietor. And if you are an S corporation or a partnership, you get a K1 and that goes on Schedule E. But there's a separate tax return for the corporation or the partnership that is prepared and filed, which then dishes out a K1 that then goes on the 1040. But if you're just a sole proprietor, there's no separate tax return. It's just right there on your 1040 tax return. Schedule C. And so it is more costly, more administrative costs to administer an S corporation because it's separate from you and it files a separate tax return. And a lot of states require corporate minutes and there's other costs to maintain that corporation. So the benefit, the tax benefits and other benefits of having a corporation should outweigh the benefits of being a simple sole proprietor. And in most cases they do. If your net income from sort of take home all said and done, taxable income is north of 180 to 200,000, I generally say it's better to be an S corporation. If you're under, say 150,000. Easy decision. Don't even set up an S corporation. It's going to be too administratively costly to do that. However, once you get up to 180, 200 plus, and especially once you start getting 3, 4, 5, $600,000 of net income in your dental practice before paying you or paying off your debt, that is an absolute indicator that you should be an S corporation. So I want to talk about this. Just because you're an S corporation, which most of you are, if you don't have a partner and you are owning a dental practice, that is you're not an associate, then most of you are going to be S corporations. Now, depending on how tuned in you are to your tax situation. Some states don't require you to organize yourself at the state level as an S corp. As a corporation, you can organize yourself as an LLC in some states, and some states allow a pa. But at the federal level with the irs, there's no such thing as an LLC tax return or a PA tax return. Instead, you have to choose. Are you going to file as a sole proprietor or are you going to file as an S corporation? And virtually everyone's going to file as an S corporation. Other states, like California, you're not allowed to set up as an llc, which is simpler because it doesn't require corporate minutes every year and a few other administrative things that are simpler with an llc. But in some states, like California, you have to set yourself up as a corporation. In California, it's called a professional corporation. And so at the end of the day, my main point here, if you didn't follow that, My main point is that if you're a practice owner, you don't have a partner and you're. You're doing, let's say, 800,000 in collections or more, you probably need to be set up as an S corporation. And if you are, great. However, that doesn't mean that you're automatically saving in taxes. It doesn't. So let's talk about this. What are the differences between being an S corporation and a sole proprietor? Well, the distinction is this. As a corporation, you are an employee of your corporation. As a sole proprietor, you are not separate from your dental practice. You are one and the same. And so you are not an employee of your sole proprietorship. So again, you set up a corporation, you are an employee, and you have to pay yourself a wage. And here's why. W2 wages are subject to payroll taxes. That's FICA, which is Social Security and Medicare. And I've mentioned this many times on the podcast. Apologize if I'm repeating myself on this, but this is a critical thing to understand as an S Corp business owner, that W2 wages are subject to 15.3% of FICA taxes. That's 7.65% Social Security employee, 7.65 employer, and then it is 1.45 of Medicare employee and 1.45% of employer. So 2.9%. So that's 12.3 plus 2.9. It ends up being 12.4. My math may be a little bit off there, but you add that all up and it's 15.3%. It's 15.3% before you even get to income tax. And if You're a sole proprietor. Guess what? 100% of your income is subject to FICA taxes. They just call it something different. They call it self employment tax, but it's the same thing.

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As an S corporation, you only pay that tax on your W2. You do not pay that on your distributions. So what does that mean? That means that as a corporation owner, you have to make a decision of when you pay yourself. Meaning you transfer money outside of your dental practice to your personal checking account. You can do it in one of two ways. You can just transfer it out through an online transfer outside of payroll. And that is called a distribution. Your corporation is literally distributing out money to you personally. Now for S Corps, it's not called a dividend. Some people call that a dividend. It's not a dividend. Dividends really are payments for C corporations like the big ones on the stock exchanges like Apple and Amazon. S corporations are flow through. So we don't call them dividends, we call those distributions. And that is one way. The second way is through your payroll company. You pay yourself as an employee. And who determines what you pay yourself as an employee of your own corporation? Nobody does. But you. You get to make that choice. Now, a lot of times people will pay themselves whatever their payroll company suggested or maybe The CPA gave them some generic advice on how much to pay themselves. And sometimes they forget and don't pay themselves at all. Or they pay themselves way too little or way too much. So this is the first key principle around tax planning from an S corporation is to get the relationship or the allocation of your income before paying you. The allocation of your income after all your overhead to you in one of two forms, W2 distributions. It's a teeter totter. And the more that you pay yourself a W2 as an expense to your corporation, what happens to your net income, your bottom line profit? Make sure you follow me on this. This is simple math. You can do this. Let's say you make a million bucks. Your labor, lab supplies, facility, marketing and admin, that's all. Your overhead, let's say, is $600,000. You're left with $400,000, you're left with $400,000. Now you, you're probably paying some debt. And let's say you're paying $100,000 in debt. Now you're left with $300,000 of cash flow. Of cash flow. And yet actually may have more cash flow than that because in arriving at that 400,000, we may have take that back. I was going to get into depreciation. I don't want to cloud this. So 400,000 is your cash flow after all of your overhead. 300,000 is your cash flow after paying off your debt. Now, most of your debt payments, or a lot of it, is not tax deductible because you're paying back principal. And you don't get a tax deduction when you're paying back the bank for money that it gave you since you didn't recognize the loan proceeds as taxable income. So when you pay it back, you do not get a tax deduction for that. The interest is tax deductible. So let's go that 400,000 before paying yourself of debt. For the purposes of this conversation, I want to leave out the debt payment. It's actually irrelevant to this conversation. It's really how much of that 400,000 should you be paying as a W2 wage to yourself? And how much should you be paying as a distribution? So let's think for a second and let's say that you decided to pay yourself 240,000 as a W2, and that is $10,000 a pay period. If you're paid twice a month. So $20,000 a month. $20,000 a month times 12 months, that's 240,000. The other 160,000 therefore is you could pull that out and just transfer it on your phone or on the computer. Assuming you you have your app set up to be able to transfer money like that, you could do old school and write yourself a check from your business to you personally as well. But who does that these days? It's just a transfer. Now what is subject to that 15.3%? It's the 240,000 W2. Only the K1 of 160,000 is not subject to that FICA tax. This is it. This is why one of the key benefits from a tax standpoint of your S corporation is that you can avoid paying full self employment tax on 100% of your earnings of $400,000. You only have to pay it on the $240,000 in that example. So two additional comments out of that. Number one is I simplify that a little bit because once you hit in 2026 $184,500 in W2 wages, then you're only subject at that point to the 2.9% Medicare tax. Up to the 184,500, you're subject to the full 15.3% Social Security and Medicare tax. But Social Security, which is the bigger one, which is 7.65%, that ends 7.65% times two, that ends. Hold on, 7.65%. No, that, that's the combined. That's the combined Social Security and Medicare. It's 1.45% is Medicare. And what is the. The Social Security portion is 15. It is 12.4%. That's it. I know this off the top of my head. I can't believe I forgot Social Security is 6.2%. So in the beginning of this podcast, if I said it was 7.33%, that was wrong. It is 6.2% Social Security and it is 1.5% Medicare. And the sum of those two together and is 7.65% employee times two because the employer pays the same amount. That's 15.3%. But that that Social Security portion is only subject on the on the W2 wages up to 184,500. Now you can make a billion dollars a year and you're still going to pay that full 2.9% Medicare portion of it. So that's why if you can get your W2 down below 184,500, that's where you make a big dent in how much you're saving. Because if you can, if you can lower theoretically from 184,000 down to 84,000. That's a hundred thousand dollar reduction at 12 point. What was that? That was 15.3 divided by that was 6.2%. 12.4%. That's 12.4% that you would be saving in Social Security. It's 15.3% you'd be saving in Social Security and Medicare. So $100,000 times 15.3%, that's $15,300 that would be saved if you went from paying yourself 184,500 W2 down to 84,500 W2. Now the question then becomes though, is 84,500 too low of W2 wages to satisfy the IRS requirements of what they call reasonable compensation? So I needed to stratify a little bit. Your W2 income between anything above 184,500 in 2026 is only subject to to the 2.9%. And everything below that is subject to the full 15.3%. Now, how much you pay yourself as a W2 doesn't only affect your FICA tax, it also affects how much you can fund into a retirement plan like a 401k safe harbor plan or a profit share plan or, or a defined benefit plan. These are the key plans you will find in a dental practice. And how much you can fund as the owner into those is very much tethered to your W2 compensation. The higher your W2, the more you can fund into those and the more income tax deduction you get. And let's distinguish between FICA tax, which is what we've been talking about, an income tax which is entirely separate. And that is what we normally think of when we think of taxes on our 1040 tax return. That's income tax. And so I am willing to bump up my W2, which I personally do here at practice CFO well past the 184,500 in order to be able to fund more into the 401 retirement plan, thereby getting a much larger deduction. Since my marginal tax rate is 47%, every dollar I put into that gets me a 47% tax deduction. So I care more about income tax than I do FICA tax. But if I don't have a 401k plan or a defined benefit plan in my practice, then I'm going to get my W2 as low as possible. How low can I go? And so let's talk about that for a second. Because being either too aggressive or being way too conservative gets it wrong when you're deciding the right amount of W2. And so we need to adjust our compensation on the W2 not to be emotional about it. Sometimes you want to say you have a high W2 or whatever. It doesn't matter. This is all a tax planning thing. Reasonable compensation isn't about avoiding taxes. It's about paying the right amount, but only paying it once. So the IRS does not declare definitively what is reasonable compensation. They will apply reasonableness measures in the event of an audit. Here's a couple viewpoints they may use. Number one is, if you truly were an employee of your corporation, what would you be paid? If you weren't the owner but you were an employee, what would you be paid? Well, they'd probably be paid 30% of your production. If you're a specialist, it's going to be more. If you're brand new out of school, it could possibly be less than that, et cetera. Other ways of viewing it are what is your W2 relationship to your K1? So if you took that total income before paying yourself anything. If we go back to our example of 400,000 is your profit after your overhead 400,000. If you paid yourself $20,000 W2 and you took a $380,000 distribution and that ends up on your K1, well, the IRS is going to say that's pretty lopsided. And so from multiple rationale standpoints, they could disallow the FICA tax savings and reclass 100% of your W2 and your distributions as being subject to FICA. That would be bad because then the full 400,000 would be subject to it. And that's typically what they do. If they deem your W2 as unreasonably low, they will just. They don't try to calculate what would be reasonable. They just take your whole income and they will, they will apply the FICA taxes to it. So you don't want to get caught in that crosshair from the IRS. Some CPAs will say at least 50% of your of that 400,000 should be an S. Corporation should be a W2. So there are different opinions on this then. There's kind of anecdotal data that I have found working at practice CFO and doing thousands of tax returns over the years that if a doctor pays themself at least 6 figures W2, the chances of them being audited are extremely low. So let's take a fairly extreme example, and this isn't entirely extreme. I have many clients who fit in this category. But after your overhead, you're left with a million dollars before paying yourself. If you took $100,000 as W2 and $900,000 as a distribution, I bet you probably wouldn't be audited. I think the chances are pretty low. However, I do think if you were audited, the IRS is going to reclass that 900,000 as wages and you're going to pay a whole lot of FICA taxes on that. So if in that example, I'm probably going to pay you 200,000, and the reality is, once you hit that 184,500, which is the cap at which Social Security, which is the larger amount, stops, when that stops, 12.4% goes away. You're only left with 2.9%. At that point, you're only left with 2.9 percent. The IRS doesn't care as much about that 2.9%, especially given the fact that the employer portion of 1.45 is tax deductible. So the actual amount that the IRS is going to recover by coming and recategorizing all of your distributions as wages ends up only being about 2% of whatever that amount is, which isn't that much. And so if you ever pay yourself more than 184,000, honestly, it should only be if you have a 401k or a defined benefit plan or profit share plan and you're trying to max those plans. That's the only reason why you would ever really pay yourself above 184, 4500. And if you want to play it really safe, you could go up a little bit to 200,000. You are not going to get audited if your W2 is 200,000, because that could be considered a reasonable wage. 200,000. And the differential to the IRS is just in the Medicare, which isn't that much. So that's pretty safe. However, if you have a retirement plan like a 401 or a defined benefit plan, now we don't care about FICA taxes, just pay your FICA taxes because the reality is to go from 150,000 up to 360,000, the amount that you're going to pay in an extra FICA tax might only be five or six thousand dollars. Do I want you to pay that? No. But if I can save you $80,000 in income tax by paying 5 or 6,000 in FICA tax, I'm going to do that all day long. Now, let me go back to my original premise. Good tax planning is embedded in good cash flow planning. And so whether or not you can fund a 401 safe harbor profit share plan and fund later in life. If you have all your debt paid off, you're a little bit older than your staff, you're really cranking it and you start funding a cash balance defined benefit plan, then do you have enough money to be putting 150 to 350,000 a year into that defined benefit plan? This all needs to be done in the context of cash flow planning. This is why I will say to be very careful if you're running your dental practice and let's say you're a few years in, five years in, even 10 years in and somebody comes from a mutual fund company or 401k company tries to set you up in one of their default cookie cutter off the shelf 401k plans, maybe ADP comes to you or Paychex and says use our plan because it's integrated into payroll and it's going to make your life easy. And all this stuff, nonsense, they create incredible amounts of complexity. That integration they're talking about is plugging you into a cookie cutter 401k plan that ends up just being expense on the P and L because you don't properly fund it. It doesn't follow the rules, it doesn't comply with testing because nobody is there helping you embed that or see it inside of your broader cash flow planning, which it has to be inside of that. Yes, you're going to get tax deductions, but yes you're going to pay costs for it. And yes you're going to have to fund your staff for it. And yes you need to be able to fund a certain amount for yourself for it even to make sense. And so it needs to be seen within the context of everything else in your ecosystem of cash flows. You got a lot of things demanding for your dollar, a lot of them. And you got to make sure that you have efficiently addressed those demands to create surplus to then fund these and see it in relationship to the tax consequence of doing so. So let's let me dwell on this just a little bit more. If you have a 401k and you're just trying to fund your elective deferrals, you can still keep it pretty low. Elected deferrals is how much you're putting in as an employee of your corporation, which you can, you can do, it's going to be Anywhere from in 20, 26, 24,500 all the way up to the low 30,000 depending on your age for catch up contributions. However the big kicker, the big turning point is when you can start putting away $100,000 to $400,000 a year. Now, you can do some incredible things with knocking off massive chunks of your income taxes through these well designed 401k plans. But if you try to do that prematurely, it's only going to end up being this administrative nightmare that takes up your time and your money and doesn't get funded the right way. So that's why when we're doing our tax planning, we need to look at the, the full universe of your cash flows to decide what can we do to mitigate our taxes. If you're in a low tax bracket, I'm probably not terribly concerned about setting up a 401k yet, because if you're in a low tax bracket, you probably are just trying to make ends meet at this point. If you're in a really high tax bracket, then you should have surplus spare cash flow. If you don't, it's probably because you're spending too much money on a personal level. And so that's where the personal financial planning needs to kick in and exercise some restraint. Create surplus, use that surplus to fund into a tax deductible type of retirement plan and then reduce your taxes and creating this beautiful compounding effect where you save more taxes, which allows you to put more into the plan, which saves more taxes, which allows you to put more into the plan. And it's the, it's a beautiful thing when you start using the tax code to spiral up your own savings into these retirement plans. Okay? And so the max you would ever want to Pay yourself is $360,000 in 2026. Last year was $350,000 in 2025. So this max compensation that you would ever want to pay yourself as a W2 is going to go somewhere up about $10,000 a year. But in 2026, that is $360,000. And if you do that, you're allowing yourself to maximize your 401 safe harbor profit share defined benefit plan, or whatever level of those that you have. They're like steps you can elect to add on the next step, which if you have a 401k save Arbor, that's the first step. The second step is going to be the profit share. The third step is going to be the cash balance defined benefit plan. So wherever you are in those steps depends on your cash flow situation. And you would never want to go above360.360 allows you to maximize that. And the benefit of doing that is the following. The more you pay yourself as a W2, the more you create a spread between your W2 and the average W2 of your of your team, and the more of a spread you can create between your W2 and the average W2 of your team, the lower the cost you have to pay to your team. Not that you don't want to pay them. I've emphasized this a lot on the podcast. Not that you don't want to pay them or help provide for some of their retirement. It's not that you're trying to be stingy. The problem is, is if too much of the money out of your pocket goes to paying your staff in their 401k is an employer contribution, the more you're not going to be able to do it in the first place. And so you have to strike this balance where you have to fund them at some level in order to satisfy what are the testing requirements on these erisa plans like 401s, they're tested every year by a third party administrator. They have what's called the ADP test, the ACP test, they test whether it's top heavy, a number of tests that they do every year. And that's why you pay a couple thousand dollars or so to a TPA to do that testing. And so if you can pay yourself a lot more than your staff, it helps you satisfy those tests without having to come out of pocket so much to pay for your team and make the whole thing unworkable. So that's why good tax planning again has to be seen in all of your cash flow. How much of your cash is earmarked for your overhead, how much is earmarked for debt, how much is earmarked to pay yourself and live on today, and then how much can you save in the future? And, and then we start to see what can we do in molding these tax strategies inside of that spectrum. Okay, so in terms of reasonable compensation being the number one issue, the number one issue here in tax planning gaps, we need to get that right. So the first question is, are you a corporation? Assuming you are, then you have to pay yourself a wage. If so, what is the low? And if you don't have a 401k, what is the lowest amount you can get away with? Typically, unless your corporation is really running a loss and you'd be making more money at In N Out Burger, assuming you have a modestly run dental practice with a modest amount of cash flow, you should probably be paying yourself at least $100,000 in W2, you're very safe in that scenario. When your K1 or your profits, I should say in the corporation start to go up and up and up and you start to hit 4, 5, 6, $700,000 of profit. Not collections, but profit, then you should probably start to move your way up to 150 to 200,000. I mean to 184,500. At the point in time when you get a retirement plan in place and you start to fund the profit share portion and potentially a cash balance defined benefit plan. Now you start to ramp up your W2 all the way up, but no more than $360,000. That is good strategy around the amount of compensation you pay yourself as a W2. Okay, we are going to end off on that one. I have more bullet points on the tax planning gap which I will get to in my next episodes. We're going to talk a little bit more about the PTE and and just missing low hanging tax deduction. We're going to talk about kids, spouse and payroll, home office, cars, meals, travel, etc. What can you run through the corporation and what should you not run through the corporation? We're going to talk about the misuse of depreciation. I'm going to extend my conversation on that a little bit from the beginning of this podcast episode. And lastly, what are the costs of not meeting with your CPA during the year and how should you or can you engage your CPA to maximize your tax planning and deductions if you are a client of Practice cfo? You know, every time we meet it's a routine. We do a cash flow projection. We go up and down your P and L, we look at all the strategies we can employ. We look at the right type of design around a 401k and a retirement plan. We look at the whole continuum within the context of your cash flows. By doing that, doing it throughout the year and then doing a year end analysis to make sure we're hitting everything right, that all the levers are are lined up exactly where we want them to be. That's how you consistently save in that anywhere from low end, 10,000, high end, hundreds of thousands of dollars in taxes. But safe to say, I think a good dentist earning one 1.2 million in collections or more every year, I think they should be saving somewhere around 30 to $50,000 a year through good tax planning if it's done right. And that is the aim, one of the aims of us here at Practice cfo. Our primary aim is financial independence or earlier in life to give you freedom to pursue the life you want. Tax planning being the biggest friction of your personal payments, your personal expenses is what you pay the irs. So we need to address that issue, that roadblock, if we're going to get you financially independent, financially free, and breathing easier earlier in life. Until our next episode. Farewell, everybody.