Taxes: Goals and Deductions

Associates, welcome back. In our last module we spoke about tax planning and the three step process to tax planning. I want to start off this module. We're going to talk about what you can run through the practice, some of the basics, some basic tax planning strategies. And I want to start it off by emphasizing again the goal of tax planning. And the goal of tax planning is an important sort of segue into this discussion of what you can and can't run through your dental practice for tax deductible purposes. But what often dentists attempt to do is completely eliminate their taxes. Wes, if I could eliminate all my taxes, I will and I want you to try to do that for me. Well, guess what? That is not the goal of tax planning. Instead, it's to eliminate all unnecessary taxes. Look, you're using public services. There are a lot of things you use and interface with in your life that are from paying taxes. So you need to pay your taxes. However, you shouldn't pay any more taxes than you are obligated to pay per the tax rules. So it's important to understand these tax rules. So you pay the amount you should pay, but don't pay anything more than that. The second goal is to pay that amount and to pay it at the right time. And we spoke about doing quarterly estimated payments versus running it through payroll. So it's important to make those on time. And the third is you want to avoid an IRS tax audit. Now I can guarantee you that throughout your career, more than once, somebody's going to come to you with some elaborate, intriguing tax idea. It might be you get some credit for doing this research in your practice. Or it might be that if you set up this entity over here and you start to pay consulting services over here, that you're going to get to get this tax benefit, these things are going to increase the possibility of you being audited by the irs. They are tax shelters. If you're not careful, tax shelters are the equivalent of tax evasion. And in the tax rule in tax 101, I remember when I was in college in my first tax class, one of the things I learned was the difference between tax avoidance and tax evasion. And tax avoidance is 100% legitimate. You can attempt to avoid paying taxes and by tax planning. Now that is different because then evasion, because in tax avoidance what you're trying to do is to avoid paying those unnecessary taxes, but you're sort of still complying and saying, I'm going to pay what I have to, but I'm going to avoid what I don't have to. Tax evasion is even what you have to pay. You're not paying it and you're trying to develop some elaborate reason or scheme to not pay what you legitimately owe to the irs. And the IRS doesn't like that. And there are big penalties, possibly even jail time for people who go too far and dip into the bucket of tax evasion. So stay a mile away from that. Be clean with your taxes and do the right thing. Now, let's talk about, though, some of those ways that you can avoid paying unnecessary taxes.

What can you deduct through the practice? Well, number one, you can deduct all legitimate business expenses. Your labor, your labs, your supplies, facility, marketing, consultants, all that, of course, probably goes without saying. Make sure to run that through your corporation. This is really important that you create a wall between you personally and your personal checking and credit card account, and your corporate checking and credit card accounts. You don't want there to be this sort of fuzzy gray between the two of them that you're running some over here and some over here and some personal here and some business and same thing over here. No, you need to treat your corporation for what it is, which it is, a separate entity than you. It has its separate tax ID and it files a separate tax return. And it's intended to give you certain tax rules and even some tax benefits if you play your cards right. But it's also for liability protection. Now, in most states, it's not going to protect you against malpractice, but it will protect you against certain other liabilities as well. Protect your personal assets to not be attached to any of those certain types of liabilities inside your corporation. But that can all be thrown out in a court of law. And if you're not treating your corporation separately from you, if it's just an alter ego of you and you're running a bunch of personal stuff through there, and you're running a bunch of business stuff over here, then it's going to just be sort of treated as if it didn't exist. So be smart about this and be a good business owner and treat the two separately. Now, if there's occasional moments where, for whatever reason, you run a business expense through your personal card, then what you need to do is notify your account or CPA so that they can do what's called a journal entry and treat that expense as if it happened within your corporation. But again, you want to keep those to a minimum. Any personal expense that happens within your corporation is going to be treated as A non deductible draw, as if you took the money out personally and then you paid it. That's how it's going to be treated. But again, try to avoid those as well. We want to keep these things simple, separate. Now, there are some areas where you get both a business benefit and a personal benefit. Now this is where we can maybe toe the line a bit. We don't want to cross the line, but we can toe the line a little bit. I know for me, I use my cell phone way more for business than I do for personal. So guess what? I'm running my cell phone cost through my corporation. Even my wife on occasion, she and I are talking about the business. It's all sort of one payment. Should I go and dissect it out? Perhaps. But there are just some areas where there's a little bit of grayness. So you just run that through the business. Meals, if used for business. Now, meals have changed in their tax deductibility and the IRS wants to know what every meal, what the business purpose was for that. But typically what doctors do is they run their mills and that relate to their business. So if they're out with their staff or maybe for lunches with another doctor, you're running that through the corporation and getting a 50% deduction on the meals. It's not 100% deduction on the meals. Entertainment is no longer deductible. It used to be if you're out golfing with the specialist that you work with or a potential prospective patient, maybe some of that entertainment, you could have really toed the line there. Iris has done away with entertainment expenses completely because of the rampant abuse there. But mills still exist at some level. Now there's this thing called a home office. Some CPAs are going to tell you that you need to avoid that because it's a red flag. Well, we've never been audited because of a home office. And a lot of our clients are claiming the home office deduction by having the corporation essentially pay rent to you as an owner of your home for allowing you to use a segment of your house that is used. And here are the keywords, regularly and exclusively for business purposes. So if you also have your weight set in there or you have your kids play stuff in there, then it's not going to qualify at all for a home office deduction. So I usually will tell you, take a picture of you in your scrubs or your doctor's outfit with maybe your computer open and some ledgers or some dental magazines there in case you're ever audited, because typically these are not, they're coming to your house. These are remote audits. And they will ask you to sort of provide evidence that you have a home office. Well, that way you've got some evidence to do that. Now one of the main benefits though of having a home office is now you have two offices. You have your principal office and you have your administrative office. We'll say the administrative office is your home office. And now any travel or commute in your car between your administrative office and your principal place of business, which is your practice now becomes tax deductible. Where normally any commute from home to work is not tax deductible. Depending on how far you live from your practice, that can really add up in terms of car repair costs and insurance and gas and tires, etc. That can add up. So if you can use say 70 to 80% of your car expenses and claim those as a business use, largely because you're traveling to and from your administrative office and your principal office, well now you get to deduct a lot more. Where if you don't have a home office, you're probably deducting next to nothing with your car. And some doctors will go wild and try to put two cars or even three cars in your corporation. Just limit that to you and your own car. We don't want to, we don't want to toe the line on that business based travel. If you're traveling for CE or conferences, you can absolutely deduct that through your corporation. Even if you go there and a portion of it is personal and a portion of it is business, you can deduct some level of that travel, including the to and from costs. Now there's more specific rules around that which we're not going to get into here. Coordinate with your CPA or with us on that. But what I wouldn't do is say, hey, I'm going to ski with my buddy and we're friends from college and I'm going to talk to him about some dentistry while I'm there and think that that suddenly becomes a business expense. Well, well, it's not. Now if you go there because there is a convention or because there is a study club that's a legit study club, then you might have more reason to deduct that. What we've had to do on occasions where it seemed a little bit more aggressive is we have the doctor send us just a description of what it was for the purpose of the travel, the purpose of the business purpose so we have it in our records in case the IRS audits. Do the right thing on that and be smart about it because remember, once on the IRS's radar, potentially always on the IRS's radar, and that's not a place that you want to be. The next one would be personal family health insurance for S corporations. As of the law 2020 is you should be running that through your corporation. There's this complicated set of rules that, that shows up as income to you on your W2 and then you could deduct that again on your 1040. Going to ignore that. Your CPA should be handling that. But bottom line is you should be running that through your corporation and getting a proper tax deduction for your, your own and your family health insurance premium. That's one of the benefits of being a self employed business owner. And self employed doesn't mean sole proprietor. Self employed means you own your own sort of small business as an S Corp shareholder of that business or even a sole proprietor. You get to deduct your health insurance 100%.

For that. That's a great benefit. Now the next one is your automobile. Now we spoke about the automobile because it related to the home office deduction. So I won't explain that anymore. But I would run your automobile costs through the corporation which include your, your insurance and your gas and your maintenance costs. And then at the end of the year your CPA should back out that portion of your automobile costs that are not business, that's not for business use, that might be a percentage, that might be some other way that your CPA has. We have a form that we use with all of our clients every year. Takes a few minutes with them to complete that and it saves thousands as they properly manage and plan for the use of their car and their home office and some of these other expenses. The next thing is kids properly on payroll. Now if you remember from our tax module about the 1040, we explained that, that there's this thing called a standard deduction that if you simply breathe the IRS will give you a deduction against a share of your income up to for single individuals, $12,400 as of 2020, double that for married filing joint. Now your kids are going to be single and I'm talking kids who are 18 and under. They're even living at home. I probably wouldn't do a three year old, but you could probably start talking about 8, 9, 10, 11 year old and, and have them do stuff in the office. And we have a list that you could provide, but have Them do stuff in the office like taking out the trash or dealing with shredding or organizing files or cleaning or taking pictures to model and put that around the office. You can have them manage your social media page, do things like that. You should have a job profile for them. Now, to the extent that doctors actually implement that with their kids, I tell them they should be that's going to be between them and their kids and you know, whatnot. But it's a great way if your kids are on payroll in that you pay them $12,400 or less or the standard deduction or less, your kids will pay zero federal income tax. In fact, they don't even have to file a federal income tax. Your child a federal income tax return because it's under the standard deduction they owe zero in taxes. And if you owe zero in taxes, you don't even have to file. So you don't even have to withhold any taxes during the year federally, if you plan that accordingly, depending on the state, you may have to pay a little bit of state taxes. But if you're at a federal and state marginal tax rate of 40 to 45%, your children are going to be in a tax rate of maybe around 15 to 18% when you add in FICA taxes because they do have to pay Social Security, Medicare and, and that's going to be 15.3%. Add on maybe a little bit for state. Some states also have state disability, that kind of thing. So you're going to end up getting though somewhere around a 30 plus or minus percent spread in tax savings. So if you have three kids and you pay them each $12,000, that's $36,000. And if you have a 30% spread on that, you just saved $12,000.

On paying your kids. Now what should you do with them when the money lands in their account? Technically, it should land in their account. Sometimes doctors set it up to land in their own account since they're paying for all of their kids living circumstances anyways. But if you decide to have that go into your kid's own account, you could use that for college education funding or funding an IRA account. Specifically a Roth IRA account because your kids are in such a low tax bracket. A Roth IRA is excellent because it goes in after tax. But remember, they're paying almost no taxes. So you don't need a tax deduction for your kids Roth IRA account because they didn't pay any taxes because their income was so low. You put that into the Roth ira. That grows when it comes Time to go to college, you can pull 100% out tax free. Or if you let it grow longer till they're 70 and it turns into $6,000, turns into $300,000, you can pull 100% of that out tax free. It's a beautiful strategy. So having your kids properly on payroll is one strategy. I don't know if I would say try that yourself at home. I would say make sure you're talking to a CFO advisor or your tax advisor about doing that and structuring that properly because you don't want to make mistakes on that. And the last big item will be contributions to your 401k plan. Now why is this one so important? Because the amounts of contribution are significant. You as a doctor could fund if you're under age 50, you could fund $57,000 into your retirement into your 401k if you have adequate cash flow. Now that's going to come with some staff costs. Of course, if you have a spouse, you put them on payroll, you, you can fund their employee portion, which is going to be somewhere around $20,000 if they're under age 50. Right now it's 19,500, but that's going to go up. So the sum of those two ends up being around 75 to $80,000, 100% tax deductible. Now you may go put in $15,000 for your staff, so you're at around $90,000, but you're going to save on that, who knows, somewhere around 30,000 to $40,000. So even though you paid your staff some, you got you rerouted 30 to $40,000 from the IRS back to you, and now it's going to grow in a tax deferred account for a very long time. Compounded, the math is amazing in its effect on your ability to become financially independent. 401ks can get somewhat complicated. So make sure you have somebody who understands dental practices and understands retirement plans as they relate to dental practice. If you have a practice that only has six, seven, eight employees, we often recommend that you do a pooled 401k as opposed to what's called a participant directed 401k. A pooled 401k is when all of the money is in one account and at the end of the year accounting is done and everybody receives the documents showing just their own balance. Participant directed 401k is everyone can log in and see their own balance at any time and choose their own investments. Those are a lot more expensive, can erode at some level. The amount of investment returns over the long run, which is why we oftentimes refer or Recommend A pooled 401k. If you have a larger practice with a lot of staff, probably better to set up a participant directed 401k even if they have extra cost practice CFO sets up a lot of both of these types of plans and we oversee them and provide education to the staff. They so that this doesn't become a burden to you and so it doesn't become an expense on the P and L because it's not properly designed and funded. It needs to be an asset builder and therefore if it's done right, becomes an asset builder and a tax saver as well. Now, what can you not run through your practice? What can you not deduct? Student loans in the student loan module. We already spoke about that. So don't even pay your student loans out of the practice. Bad move. You don't get a tax deduction and it can sort of raise some eyebrows. If the IRS were to look at your numbers. It is not tax deductible through your corporation. And if you have a low enough income, some of the interest might be deductible on your personal tax return. But for most of you, that's not going to be the case because it's a pretty low threshold of income before that phases out and you don't get that deduction on the interest. So pay your student loans personally. Also any personal travel, just pay that personally. Your personal Amazon and Costco purchase, pay that personally. What I end up seeing is a whole lot of Amazon and a whole lot of Costco running through the practice. And we as accountants don't know whether that's business or whether that's personal. And so it's just sort of on the honor code that's you. But if you're buying personal stuff at Amazon or Costco, that should be paid on a personal card. If it's business, of course that should be paid on a business card. You know, Amazon allows you to have multiple cards, etc. When you're buying things. The next thing is avoid a second car or third car. Just have one car through your corporation. And lastly, don't deduct, please, the purchase of your Cessna plane or your boat or your pool guy or, or your gardener or any of that stuff. As I have seen that and I've seen the consequences be pretty fatal. So be honest. Do the right thing. Let's avoid taxes, but let's not evade taxes. Now there's a whole lot more we could go over when it comes to tax planning. And it is a big part of the overall business planning and financial planning for doctors that we do. But for now, as associates getting ready to buy a practice or recent practice owners, I just want you to understand what are the basics of the tax planning process, what you can run through the practice and what you can't or shouldn't be running through the practice.