Dr. Michael Kleinman knew he couldn’t do it alone. Ten years ago, when the Souderton, Penn., dentist set out to purchase a dental practice, he soon found himself swamped by an array of dizzying tasks—structuring the loan, tax planning, incorporation and more.

“I didn’t have any idea where to start,” he says. “It was overwhelming.” To negotiate this unfamiliar territory, Dr. Kleinman enlisted the help of financial consultant Bruce Bryen of The Snyder Group, LLC, Marlton, N.J. “He helped guide me through everything,” Dr. Kleinman continues. “I still work with him; he’s my accountant.”

Recognizing that complex economic issues can be challenging for anyone, this month’s cover story, by Mr. Bryen, focuses how best to manage several money concerns that top many dentists’ lists.

During my 38-year career as a dental financial consultant, I’ve found that dentists’ top five worries about money are debt, income taxes, children’s education, retirement and health care costs.

What I’ve done here is draw from my experience in working with dentists to present ideas that I have found to help resolve these problems.

Financial liabilities of a personal or business nature have high interest rates accompanied by hefty monthly payments. This can have a big impact on any dentist’s cash flow and damage his overall financial health. What can be done to overcome these problems?

If a dentist has more than one outstanding loan, it’s imperative that the first payment be made to the loan with the highest interest rate. Then any remaining money available after other loans are paid, should go to the highest-interest loan to help reduce the principal so that the interest being charged is at the lowest level of debt possible.

   Another source of relief in terms of lowering the interest rate is to try to secure the loan. A secured loan is one that’s provided against an asset like someone’s home. Get assistance in obtaining such a loan, and use the funds to pay off the loan that is unsecured. Your interest rate on the secured loan will be much lower than on the loan you are paying off.

Your term will be longer because secured debt is almost always available for a duration in excess of the unsecured debt. Most times, the secured debt is available without prepayment penalty or with insignificant penalties for early payment. If additional funds become accessible, the loan can be paid faster. Once in place, the new interest rate and payment schedule will seem like an enormous raise in pay because of the excess cash flow generated by merely adjusting the repayment schedule.

As dentists’ earnings increase, so do their income taxes. But growing tax obligations are something they frequently overlook and, as a result, they fall behind in their tax payment schedule. That situation is severe because late payments almost always present large penalties and interest charges. What can be done?

When budgeting or planning with a financial advisor, a tax allocation, taking into account the projected increases, should be planned for and adhered to. Some advisors and most dentists review the income and expenses of the practice when determining the budget. An area that is usually not addressed (and one that creates part of the problem with taxes) is that of the balance sheet.

This part of the financial statement is often ignored completely. In fact, from my experience I know that many dentists do not even know what is included on a balance sheet. The balance sheet lists the assets, liabilities and net worth of the dental practice. Every change in the components of the balance sheet has a direct impact on the profit, loss and tax impact to the dental practice and the dentist.

It is very significant because when items are paid or deposited—and they’re reflected on the balance sheet but not on the income statement—they can create income that the dentist doesn’t know about. Items like the amortization of principal on a loan are income items, yet money leaves the practice; and at the same time taxes are accruing on that principal payment.

So essentially, debt is paid, yet there is no money available to pay the tax on that debt reduction because the funds have left the practice and are allocated to a balance sheet item.  Now the dentist has a tax, no money and, to further complicate the scenario, is in arrears on income taxes.

The areas of debt and taxes are very closely related. For example, when you purchase a dental practice, which is usually done with borrowed funds, the term of the loan plays an important part in the issue of income taxes.

The allocation of the purchase price to items that would be deductible—and the speed at which they are deducted—creates the opportunity for tax benefits. A good advisor can alleviate future tax considerations with careful planning and advice prior to the purchase. For example, on the issue of taxes, an advisor would discuss the advantages of the length of the term of the loan used for the acquisition and the amortization of the principal.

 Suppose a loan was written with a five-year term. Typically, the shorter the term of the loan, the cheaper the cost in amount of interest paid. However, as the principal is being amortized over five years, the income being reported by the payment allocation to a non-deductible item (principal reduction) is also being reported over the same five-year period.

The principal

That means that taxes are due on the principal over the five years it is being paid. A common approach to allocating the sale price of a dental practice is to use a large portion of the sale price as goodwill, which is a balance sheet item recorded as an asset. Goodwill is written off over a fifteen-year term. Using an example of $500,000 allocated to goodwill and a loan of five years, $100,000 of principal would be paid per year ($500,000 loan divided by five years of amortization of the principal).

The goodwill would generate tax deductions of $33,333 per year for fifteen years ($500,000 purchase price written off over 15 years). In this example, $66,666 of taxable income would be generated over the first five years of the loan, with no funds available to pay the tax on that income since the funds generated by the dental practice were used to pay down the loan so quickly.

A solution could be to finance the acquisition over a longer term so that the principal payments would more closely match the tax deductions. Your accountant would be able to assist in the early stages of the acquisition process—and certainly before the papers were signed for the tax allocation of the purchase price. This is one example of how debt and taxes are closely related.

 To help understand this, think about the principal payments on your home mortgage, which are not deductible. A longer term on the mortgage loan costs more, overall, in interest payments. What is the interest rate you may be paying, 7 percent, 8 percent, even 10 percent?

Consider the tax rate that you pay for social security, Medicare taxes, state income tax and the federal rate. Most dentists are paying taxes at an effective rate of well over 40 percent on their taxable income, when all of the taxes—including payroll and state taxes—have been included. Compare that to the extra interest paid, and see what makes sense when determining the term of your loan. Of course, there are also allocations to shorter term write-offs that an advisor should discuss when assisting in the purchase-price allocation to help alleviate the tax burden on a transition.

Other areas of relief involving a tax burden can usually be addressed by consistent review of financial information with a professional advisor.

Another concept that relates directly to taxes is that of retirement. How best might dentists prepare for their retirement? What pitfalls might they avoid?

Many dentists segregate their personal financial affairs from those of their dental practices. As the dental practice earns money, the dentist attempts to draw as much as possible from that source of revenue, then invests those funds in his or her name.

The retirement savings are whatever can be accumulated in an “after-tax” investment. But why not merge the overall wealth of the dentist’s personal investments with that of the dental practice if it can be done without the loss of control? If this can be accomplished, the funds can be invested “pretax” so that there are more funds to invest.

Leisure activities

Many dentists look at retirement and think that it means golfing, traveling and other leisure activities. The ability to achieve this goal typically involves saving much more than is possible without some excellent financial and tax planning.

Combining retirement planning with current tax savings could be a first step toward, if not completely stopping work, at least a severe slowdown. What does one do to begin saving taxes today and using those funds tomorrow?

We are not talking of the old tax shelter investments of the 1970s, 1980s and 1990s, where the opportunity to see a return was based on a risky investment because of what the government would allow in terms of write offs.

Today’s best tax shelter is an Internal Revenue Service tax deferred qualified retirement plan that is sponsored and funded by the employer, i.e., the dental practice. With good advice, the principals of the dental practice can write off in excess of $100,000 per year.

Unlike the old days of tax shelters, this excess of $100,000 per year is available for investment in safe investments, with the opportunity for capital appreciation and current income. The income accumulates and is not taxed until withdrawn by the participant. With contributions to a qualified retirement plan on a consistent basis over a period of years, the dentist can have millions of dollars invested on a “pretax,” deferred income approach.

The ability to have a life of leisure at retirement will be more achievable when the money that was to be paid today in the form of income taxes is “written off” and accumulated in a retirement plan for years. When the earnings and the growth of those funds have also not been taxed for years, the potential for an early retirement can be readily seen.

As all of those with children know, the cost for higher education is rising so quickly that the ability to pay for college is reaching a stage where it will be unaffordable. Can something be done to lessen the blow?

For one, tuition programs, such as a 529 plan, are available. These are designed so that funds are contributed to an account for the benefit of a beneficiary’s educational costs. The income in the account is not taxable. It is an excellent planning technique to ensure that the future costs of education are at least being addressed, if not totally defrayed.

Another point: Are the children of the dentist old enough to work? As long as they are working for the dentist and performing duties just like any other employee, compensation to these children under the age of eighteen may not even be subject to social security tax. According to the amount paid, income tax may not be required of these children. This is a good way to accumulate funds so that tax deductions are achieved by the dentist, and funds are accumulated by the children that can be used for the cost of education with little or no tax effect on them.

IRAs also can be distributed to pay for the educational expenses of a child without the ten percent early withdrawal penalty. The Coverdell Education Savings Account can be used for contributions until the child has reached the age of eighteen. Also, educational loans for the parent and child are always available, as are outright grants.

Planning for the educational costs today, rather than later, will save thousands of dollars and emotional anguish over where the funds will come from to pay for the education.

What are some approaches that can be taken to reduce the cost (and fear) of increasing health care costs?

The pretax payment method for medical insurance is a critical strategy, since it will reduce the effective cost of the insurance by up to 80 percent. Currently, Congress is considering ways to stabilize the cost of health care insurance by revisions in the ability to deduct the payment before taxes are calculated.

Income tax incentives are being considered that may drastically change the method in which these insurance costs are being paid. Today, some employers use high deductibles and high co-pays to keep the overall costs down. Others use a cafeteria plan approach for the ability to have a pretax payment based on choices available to the employee.

There are flexible spending plans available for employees in which payroll is reduced by an amount sufficient to pay a portion of health care costs not paid for by insurance. The concept is to have as much in pre-tax payment as possible, so that the net cost is as low as it can be.

As dentists age, many look at long-term care insurance as a method of maintaining their assets and not having them used to pay for a lengthy illness or disability. An area of protection for the dentist is a disability policy. The owner of the policy, the beneficiary and the responsibility for payment of the premium are points that allow tax benefits to accrue if addressed properly.

Paying for health care costs after your tax has been paid will add substantial costs to each dollar for those dentists in the highest income tax bracket. There is also the ability to pay health and disability costs directly from a defined benefit pension plan. This area is also being scrutinized very carefully for the purpose of changing this loophole in the retirement plan format.

Practice growth, stability

Each of the money concerns that I’ve considered here has a solution that begins with the financial well-being of the dental practice. The more economically sound the dental practice, the better a dentist can pay taxes, eliminate debt, fund a retirement plan, take care of the children’s education and handle health care costs.

How does the dentist address the issues of practice growth and stability? What are some of the key areas of concern that will enable the practice to grow and be stable?

Checkups

Receiving regular financial checkups is key to practice growth and stability. Who does the dentist see for these visits? A certified public accountant (CPA) who knows that a dental practice is a unique business venture and is not the same as a manufacturing plant. Also, an understanding of the dentist’s personal relationship to the dental practice is a must.

   It is important to have constant communication with the CPA and to be willing to discuss all aspects of the dental practice, along with personal financial matters. The CPA should be knowledgeable in tax matters, debt structures and cash flow as it relates to the dental practice income projections.

  It would be preferable for the CPA to have extensive history in the banking world so that approaches to borrowing are easily understood. An expert in practice management and consulting should also be part of the team, to assist in the growth of the dental practice and in stabilizing its employees and office routines.

   Time is required for the growth and stability of the dental practice. If the dentist is too busy to spend the time, the office will be left without someone to help steer it. Without continual monitoring, taxes, debt retirement planning, educational expenses and health care costs can be pose problems. There will be no preventive maintenance and you can imagine what may occur: The dentist will have sleepless nights because his six biggest money worries will not have been professionally attacked.  

News you can use:

1) If a dentist has more than one outstanding loan, it’s imperative that the first payment be made to the loan with the highest interest rate.

2) Today’s best tax shelter is an Internal Revenue Service tax deferred qualified retirement plan sponsored and funded by the employer, i.e., the dental practice.

3)When budgeting, a tax allocation (taking into account the projected increases) should be planned for and adhered to.