By David B. Mandell, J.D., MBA
As a physician, you work too hard and trained too long 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 and your state. Still, if you’re like most physicians, you doneven dedicate one day per month to see how you could reduce your tax liability. The purpose of this article is to show you five ways to save taxes on income, and possibly motivate you to spend that day on planning now, before the end of the year. Let’s examine them now.
Get Deductions for Risk Management and Asset Protection Planning. Closely Held Insurance Companies (CICs) are great for medical practices looking to make annual tax-deductible contributions of $80,000 to $175,000 for asset protection and risk management programs. The CICs we are discussing here are very small insurance companies that primarily will insure your practice. These companies enjoy extremely beneficial tax treatment (made even better by a 2004 law signed by President Bush), allowing the physician owners an opportunity to build tax-favored wealth, as opposed to giving profits up to insurance companies. You can use a CIC to insure all, or portions of, your practice’s significant risks, such as medical malpractice liability protection, medical malpractice “defense only” policies, sexual harassment, wrongful termination, HCFA audits, worker’s compensation, etc.
Asset-Protect Your Practice’s Most Valuable Asset and Reduce Taxes. As a physician, 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 judgment 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) may 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 practice’s options in this area.
Use Non-Qualified & Non-Traditional Benefit Plans (NQBPs & NTBPs). Most of you have likely heard of traditional “tax qualified” plans. They go by the names of “pension,” profit-sharing plan,” “Keogh,” or “401(k)” and tens of millions of people participate in such plans each year. Because they are tax-qualified, these plans are generally 100 percent deductible and have strict rules as to how much you can put in, which employees must be able to participate, and when you can get the money out.
On the other hand, NQBPs and NTBPs have fewer restrictions on how much can be contributed, who can participate, and have no penalties for early or late withdrawal. Unlike qualified plans, very few people participate in NQBPs and NTBPs because they do not know their employer offers them or they have not created one for their own practice. This is a terrible wasted opportunity, as NQBPs and NTBPs can provide tremendous tax and retirement benefits, while allowing maximal flexibility, as well.
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 of our clients are in a 40 percent tax bracket (state and federal) and many of them have children (over age 14) who are in either a 10 percent or 15 percent tax bracket, the FLLC/FLP can save significantly 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 (CRT). 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.
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.
David B. Mandell, JD, MBA is an attorney, lecturer and author of the books The Doctor’s Wealth Protection Guide and Wealth Protection, M.D.. He is also a co-founder of The Wealth Protection Alliance.