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Bruce Bryen is a certified public accountant with over 45 years of experience and is a part of Baratz & Associates CPAs. He specializes in deferred compensation, such as retirement planning design; income and estate tax planning; determination of the proper organizational business structure; asset protection and structuring loan packages for presentation to financial institutions. He is experienced in providing litigation support services to dentists with Valuation and Expert Witness testimony in matrimonial and partnership dispute cases. He is also a financial writer for several dental journals. You may contact him at 609-502-0691 or at Bryenb@baratzcpa.com.
Here’ what you can do to avoid any more surprises next year.
Many dentists were frustrated with their 2018 personal federal income tax bill or lesser refund than expected and their 2019 projected personal federal income tax liability as well.
Even if you have a reputable dental CPA sometimes new ideas are needed to be creative and ease the pain a little bit. The section 199A rule is part of the new tax law change regarding the ability to deduct an additional 20 percent of your qualified business income if you are reporting income within a certain range on your personal tax return. There is a list of restrictions and high-income earning dentists are one of the categories of those who have had their ability to use the additional 20 percent deduction being denied or altered.
A creative idea to overcome part of the problem with the inability to use the section 199A rule is to adopt certain qualified employer sponsored retirement plans. These can be used to substantially reduce the taxable income reported on the individual personal federal income tax return of the dentist as it passes through from his or her dental practice directly to the 1040. There is a range of income from each filing status that disallows the use of the 20 percent deduction even if the dentist’s qualified business income is acceptable for use. This is because of his or her other personal income, not part of the dental practice tax return. The following describes a method to reduce the taxable income of the dental practice.
Typical questions, answers and other responses from the dentist and the advisers not familiar with the various benefits of the design and adoption of the qualified employer sponsored retirement plans
Before delving into questions and answers, the following is a general guideline tutorial on how the use of these retirement plans will work to assist the dentist and his or her family with the tax reduction.
The retirement plan that is qualified and sponsored by the employer creates a tax deduction for the dental practice and reduces its taxable income. That income then passes through to the personal federal income tax return and ultimate personal federal income tax of the dentist. The effect is the amount that passes through from the tax return of the dental practice to the personal federal income tax return of the dentist can do so in a dramatically reduced income amount. This is when compared to not having used the qualified employer sponsored retirement plan deduction in the dental practice. The dentist’s personal federal income and federal income tax is then lessened. A common question from the dentist or his or her advisors is: “How much is allocated to the dentist and how much to the employees?” The answer to the question depends on the type of qualified employer sponsored retirement plan adopted by the dental practice. An example is a 401k/profit sharing plan allows all of those with “earned income,” meaning W-2 or self employment income to defer either $18,500 or $24,500, if age 50 or older, of his or her reportable earned income. That income does not get reported as being taxable from a federal point of view until a date far into the future. A retirement account is the vehicle in which the contributor controls where that money is invested. This is the first step in deferring the maximum amount of income not subject to personal federal income tax compared to not doing this and leaving that income to be available for taxation. Think about the personal federal income tax rate and multiply that rate times the amount of the deferral and see what will not have been paid in tax for the coming year. If the spouse or children (who are actually working) of the dentist work for the practice, create additional deductions.
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The next step in the process and the answer to how much the employees receive
The next step in the process is the determination of the type of qualified employer sponsored retirement plan to be adopted by the dental practice. The type of plan will determine how much the employer is responsible for contributing on behalf of the employees and himself or herself. This is where the cost for the employees compared to the owner is determined. A good actuary working with a good dental CPA who understands retirement plans will prepare a study to give an approximation of what the allocations will be. It would include the list of employees and the particulars of age, employment description, estimated annual compensation, number of years of employment and a few other details. A good dental CPA would describe the goals of the dentist and review the types of other retirement plans available to see how high the owner’s deduction can be with the cost of the employees included on the schedule. Determining what the tax would have been based on not contributing for the employees will result in the actual net out of pocket pre-tax cost to the dentist for the employees and what must be contributed into the retirement plan on their behalf. The subtraction of the tax from the employees’ contribution amount is the net effect.
How low or high of a deductible contribution is allowable by the IRS?
The previous discussion described the more traditional qualified employer sponsored retirement plan known as a defined contribution plan. Those amounts allowed to be contributed and deducted are set by law. The amount contributed by the employer is also designed within the plan document sent to the IRS for approval. The dental CPA and actuary should work together to understand the goals of the dentist to finalize the determination of the aims of the dentist and the amount the dentist wishes to advance to the retirement plan for himself or herself and the employees. There is another type of retirement plan known as a defined benefit plan. This kind of plan is geared more to the dentist who may be older with reasonably stable high-income levels from year to year. The deductible contribution level with the defined benefit plan can be over $125,000 per year for the dentist. Imagine how that would reduce the personal federal taxable income and tax for the dentist. Contacting the dental CPA with the knowledge to explain the intricacies of the defined benefit plan should be an important step for the dentist with high income who wants to substantially reduce his or her taxes with the use of the Section 199A ruling and the adoption of the qualified employer sponsored defined benefit plan.