By David B. Mandell, JD, MBA & Christopher R. Jarvis, MBA
As a physician, you work too hard not to consider tax planning a priority. That is, of course, unless you like spending 40 to 50 percent of your time working for the IRS. Still, if you’re like most physicians, you don’t even dedicate one day per month to see how you could reduce your tax liability. The purpose of this article is to show you six ways to save taxes on 2003 income, and possibly motivate you to spend that day on planning now, before the end of the year.
Get deductions for risk management and asset protection planning. Closely Held Insurance Companies (CICs) are great for physicians looking to make annual tax-deductible contributions of $80,000 to $175,000 for asset protection and risk management programs. The CIC we are discussing here is a legitimate insurance company, registered with the IRS for domestic tax treatment, typically based in an offshore jurisdiction, such as Bermuda or the British Virgin Islands. Most CICs are established in these countries because of their favorable insurance laws and local tax treatment, although the funds in the CIC can be maintained and managed in the United States. The CIC must always be established with a real insurance purpose, that is, as a facility for transferring risk and protecting assets. You can use a CIC to insure all, or portions of your practice’s significant risks such as medical malpractice, sexual harassment, wrongful termination, discrimination, worker’s compensation, Medicare fraud, and even health insurance. If structured properly, these companies can be tax-exempt and the assets inside the companies grow tax-free.
Asset-protect your practice’s most valuable asset and reduce taxes. As a specialist, you are likely very aware of the malpractice liability crisis presently surrounding the practice of medicine. What you may not realize is that a large judgement against any of your partners will likely threaten all of your practice’s accounts receivable. Typically, this is a medical practice’s most valuable asset.
For this reason, many physicians have implemented a strategy for asset-protecting their receivables. While the details of the options go beyond the scope of this article, it should be mentioned here that at least two of these strategies (financing and enhanced factoring) allow the practice to reduce its income tax burden as well, because of deductions generated by the strategy. Thus, if asset protection is a concern of yours, in addition to tax reduction, we recommend that you investigate your practiceoptions in this area.
Share income with lower-income family members. Family Limited Liability Companies (FLLCs) and Family Limited Partnerships (FLPs) are used primarily for asset protection. However, FLLCs and FLPs can save you thousands of dollars each year in income taxes. This is accomplished by what is called “income sharing.” This means spreading the income created by the FLLC or FLP to the limited partners or members who are in lower tax brackets. Since most physicians are in a 40 percent tax bracket and many of them have children (must be over age 14) who are in either a 15 percent or 28 percent tax bracket, the FLLC/FLP can save 12 percent to 25 percent on income earned by FLLC/FLP assets such as mutual funds, rental real estate, stocks and bonds.
Gain tax-deferral, asset protection and risk reduction for your investment portfolio. There are two types of annuities: fixed annuities (which pay you a fixed return over a period of time) and variable annuities (which have an underlying stock market investment). If you have assets that you do not intend to use until retirement, there is no reason not to utilize an annuity to defer income taxes. Under realistic assumptions, a $500,000 stock portfolio may generate an annual tax liability of $10,000 to $25,000. An annuity will let you invest funds that would otherwise go to the government and defer taxes on the earnings until you retire, when you may be in a lower tax bracket. Additionally, some states protect annuities from creditor claims. In the states that do exempt them, annuities are an ideal tool to safeguard wealth.
Use charitable giving to reduce income taxes: the Charitable Remainder Trust. As a society, Americans cherish the right to give to the charitable institutions of their choice. The problem, many times, is that we do not know how to give, or that we assume that our family will suffer as a result of our giving. There are many ways you can make charitable gifts while benefiting your family as well. The most common tool for achieving this “win-win” is the Charitable Remainder Trust (CRT). A CRT is an irrevocable trust that makes annual or more frequent payments to you (or to you and a family member), typically, until you die. What remains in the trust then passes to a qualified charity of your choice. A number of advantages may flow from the CRT.
First, you will obtain a current income tax deduction for the value of the charity’s interest in the trust. The deduction is permitted when the trust is created, even though the charity may have to wait until your death to receive anything. Second, the CRT is a vehicle that can enhance your investment return. Because the CRT pays no income taxes, the CRT can generally sell an appreciated asset without recognizing any gain. This enables the trustee to reinvest the full amount of the proceeds from a sale and generate larger payments to you for your life. Finally, the trust will be eligible for an estate tax deduction if it passes to one or more qualified charities at your death.
Eliminate the hidden 80 percent to 90 percent tax trap of retirement plans. If you die with money in your pension, your family will have to pay income taxes between 40 percent and 45 percent. Then, they will be forced to pay estate taxes of 50 percent on those assets. This can eat up 80 percent or more of your pension or IRA!
The Capital Transformation Strategy (CTS) helps reduce these taxes and increases the net estate to your heirs without sacrificing your quality of life during retirement. The CTS is the most powerful strategy for handling this tax trap. However, because it is very complex, you must find an advisor who is adept with all areas of the tax, ERISA, and Department Of Labor rules and is an expert in insurance. Only this type of advisor can deftly implement such a strategy. If you have more than $1 million in a pension plan, you are worth $3 million or more, and don’t wish to leave 80 percent to 90 percent of your estate to the government, you should seriously consider the CTS.
Judge Learned Hand said: “There is no reason to pay more taxes than the law would provide – there isn’t even a patriotic duty to do so.” This article gives you a few ideas for how to save taxes for 2004.
David B. Mandell, J.D., MBA and Christopher Jarvis, MBA are with the firm, Jarvis & Mandell, LLC, in New York City.