By David B. Mandell, JD, MBA & George W. Smith IV, CPA
As a top-earning physician, do you realize that you spend 40 to 50 percent of your working hours laboring for the IRS and your state? That is a lot of time with patients, at the practice, in the hospital, on call, etc. Given this, how many tax-reducing ideas does your CPA regularly provide you? Our guess: not many.
Given these sobering facts, the purpose of this article is to show you five ways to potentially save taxes on 2007 income, and possibly motivate you to investigate these planning concepts 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 up to $1.2 million annually 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. This tool is literally “right in the tax code” and there are thousands of them presently operating successfully in 100 percent compliance with the IRS. Simply because your CPA has not implemented one before (or even heard of them for that matter) does not mean that they do not exist.
Use Non-Qualified Benefit Plans
All of you have likely heard of traditional “tax qualified” plans, as have your CPAs. 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.
Non-qualified plans have been used by most Fortune 1000 companies for more than 30 years, yet few physicians or their CPAs know how to implement them properly for medical practices. While the traditional non-qualified plan for the Fortune 1000 company typically does not involve a deductible contribution, such plans that are sponsored and administered by third parties and licensed to a medical practice may allow such a deduction. Such a plan could even tie into a non-compete between partners and potentially provide a way for retiring physicians to be “bought out” by younger physicians. Has your CPA ever suggested such a non-qualified plan for your practice?
Asset-Protect Your Practice’s Most Valuable Asset and Reduce Taxes
As a physician, you are likely very aware that malpractice liability can be a significant financial risk. What you may not realize is that a judgment against any of your partners will likely threaten all of your practice’s accounts receivable, including those you earn. 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.
Share Income with Lower-Income Family Members
Congress changed the rules on this technique in 2007, by increasing the minimum age for children involved from 14 to 18. Nonetheless, it still remains a viable option for many physician families. Essentially, this is accomplished by what is called “income sharing.” This means spreading the income created within a family limited partnership (FLP) or limited liability company (LLC) to the limited partners or members who are in lower tax brackets. Since most of our physician clients are in a 40 percent tax bracket (state and federal) and many of them have children (over age 18) who are in either a 10 percent or 15 percent tax bracket, the LLC/FLP can save significantly on income earned by LLC/FLP assets such as mutual funds, rental real estate, stocks and bonds. Typically, this is a technique recommended by many CPAs.
Use Charitable Giving To Reduce Income Taxes
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.
The information contained in this article is general in nature and should not be construed as comprehensive financial, tax, or legal advice. As with any financial or legal matter, consult your qualified securities, tax, or legal representative before taking action.
David B. Mandell, J.D., 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 (WPA) – a nationwide network of legal, accounting, and financial firms whose goal is to help clients preserve their wealth. George W. Smith IV, CPA. is a partner of George W. Smith and Company, P.C., and provides business planning to physicians around the country.