Owe Less, Save More: Last-Minute Tax Strategies for 2023
I receive numerous calls every April from dentists scrambling to lower their tax bills at the eleventh hour. While nothing can replace great planning, there are still a few strategies you should employ heading into Tax Day, and, for some, a miracle is possible. My first recommendation for every dentist who is unsure of his or her tax situation for 2022 is to extend your return. Doing so extends the corporate return due date to Sept. 15 and the individual return due date to Oct. 15. Your certified public accountant (CPA) will need to estimate any taxes due and submit payment before April 15 to avoid penalties — but extending now will buy you the benefit of time.
Roth IRAs for Everyone
The tax code doesn’t allow dentists with a modified adjusted gross income of $204,000 or more to make a full contribution to a Roth individual retirement account (IRA). However, you can still make contributions to a Roth IRA by utilizing the “backdoor Roth” strategy. To accomplish this, make a nondeductible contribution to your traditional IRA on or before April 15. For tax year 2022, this deadline is April 17 since April 15 falls on a Saturday. Contribution limits are $6,000 for 2022, plus an additional catch-up contribution of $1,000 for people who were age 50 or older before Dec. 31, 2022.
Once you’ve made the maximum nondeductible contribution into your traditional IRA, move all taxable monies from the IRA to your 401(k). It’s best to do this using a direct trustee-to-trustee transfer to avoid the limit of one IRA rollover per year. Once the taxable monies are removed from the IRA, leaving only the nondeductible contributions, you can complete a tax-free conversion to a Roth IRA. Be sure to complete this on behalf of your spouse as well. Additionally, be sure to inform your CPA of these transactions, as nondeductible contributions won’t generate tax forms for your CPA to see.
Health Savings Accounts
Dentists who have a qualifying high-deductible health savings account (HSA) can make contributions until the April 15 deadline (April 17 for 2022). The maximum contribution for a family plan is $7,300 for 2022 ($3,650 for self-only coverage). Furthermore, dentists who reached age 55 before Dec. 31 can make an additional $1,000 catch-up contribution. If both spouses have reached age 55, both can contribute an additional $1,000. To accomplish this, each spouse must have their own HSA.
For dentists without a qualifying HSA plan, I recommend obtaining quotes at your next renewal date. An HSA is commonly referred to as the “triple threat,” as contributions are deductible, earnings grow tax-free, and withdrawals are tax-free if used for qualifying health expenses. For this reason, it’s best to spend after-tax dollars on current medical expenses and invest your HSA contributions. You can withdraw these funds later for qualifying medical expenses or to reimburse yourself for previously incurred medical expenses while covered under an HSA plan. Remember to keep records of all out-of-pocket expenses incurred to reimburse yourself tax-free in the future.
Increased Retirement Plan Contributions
The most important tax and financial strategy for any dentist is to maximize their retirement plan savings. Congress passed the first SECURE Act in December 2019, which made substantial changes to retirement plans and IRAs. This law extended the deadline for companies to add new retirement plans to the tax filing deadline rather than at year-end. This allows dentists without a retirement plan to start one for the prior year. Furthermore, dentists who have an existing 401(k) profit-sharing plan can potentially add a cash balance defined benefit plan to substantially increase retirement plan contributions.
Since Dec. 31, 2022, is behind us, you can’t make 401(k) contributions (salary deferrals) for 2022, but you can implement either a standalone profit-sharing plan or a cash balance defined benefit pension plan. The maximum amount you can contribute to a profit-sharing plan is $61,000 for 2022. For a dentist in the maximum federal income tax bracket (37%), this will create savings of over $22,000. However, keep in mind you’ll also be required to make contributions on behalf of your staff members as well, so be sure to use a firm specializing in small employer retirement plans, as there are many ways to design profit-sharing plans. Having a specialized formula to calculate contributions, such as a cross-tested (e.g., age-weighted) or Social Security integration formula can save you thousands in employer contributions. Utilizing these formulas ensures nondiscriminatory compensation by comparing the amount of contributions given to participants.
For dentists age 40 or older with younger staff, consider adding a cash balance defined benefit pension plan in combination with a 401(k) profit-sharing plan. This plan can be added to an already existing 401(k) plan if certain plan criteria exist, so confer with your retirement plan administrator to confirm whether this is an option for you. Contributions for this type of plan can range from $50,000 to $250,000 or more annually, depending on the age of the dentist. Cash balance plans operate in conjunction with a 401(k) profit-sharing plan and allow you to significantly increase your retirement plan contributions while minimizing additional staff costs. In my experience, most dentists receive 85% or more of all contributions into the cash balance plan, with most cases exceeding 90% of contributions.
Funding a cash balance defined benefit plan does come with a new set of rules. While profit-sharing contributions are optional each year, cash balance contributions are not. Furthermore, investment returns don’t factor into accrued benefits, further complicating implementation. I highly recommend that you hire a seasoned professional to help you navigate these plans.
Cost Segregation Study
Every dentist should seek to own their own office space. As many dentists have discovered, the IRS allows a depreciation deduction each year based on the value of the building and improvements made. Unfortunately, this depreciation is taken over 39 years. Instead, consider having an engineer complete a cost segregation study. This study can be done on buildings purchased, renovated or constructed after 1986 and allows you to reclassify a portion of the costs as nonstructural, which allows depreciation write-offs sooner.
You can have this study completed in 2023 and applied to your 2022 tax return. Furthermore, you can elect to immediately deduct a portion of these expenses on your 2022 tax return. Since this bonus election to immediately write off expenses decreases to 80% in 2023, dentists who qualify should act immediately.
Looking Forward: Smart Steps to Decrease Taxes for 2023
The Tax Cuts and Jobs Act passed in 2017 further complicated tax planning for dentists by introducing the Section 199A Qualified Business Income Deduction. This deduction is equal to 20% of business profits for all pass-through entities (S corporations, limited liability companies [LLCs], partnerships) and sole proprietors, subject to phase-out limits. For 2023, this deduction phases out when taxable income reaches $364,200 (married filing jointly) and is completely phased out at $464,200 for specified service trade businesses. These limits are cut in half for all other filing statuses.
Since this deduction is only for business profits, not officer wages, it requires very careful planning for maximum results. Incorporated dentists need to consider officer compensation (wages), retirement plan contributions and associated payroll taxes.
To maximize this deduction, dentists need to have a calculated plan that can be executed throughout the year. The key to maximizing this additional 20% tax deduction on profits is having retirement plan contributions and salaries set to the exact amounts for your specific needs. There is no “one size fits all” with tax planning, and every dentist should seek to optimize their salary in relation to their specific retirement plan. Furthermore, you should make sure your retirement plan contribution formula is being optimized by using a cross-tested (age-weighted) or Social Security integration formula.
Spousal Employment
Every dentist should employ their spouse through the practice. Duties can include consulting, maintaining the books from home, paying the bills, etc. Your spouse’s salary should be at least $3,000 annually to qualify for tax-free fringe benefits such as fully deductible travel to continuing education and other business meetings. Furthermore, increase your spouse’s salary to accommodate retirement plan contributions as applicable. For spouses not covered by another employer-sponsored retirement plan, be sure to pay your spouse the maximum tax-deductible salary deferral of $22,500 for 2023 ($30,000 if 50 or older). To maximize salary deferrals while minimizing payroll taxes, you should pay your spouse $24,500 if under age 50 and $32,500 if over age 50.
Tax-Free Rent
Dentists should also consider renting their personal residence for any business use throughout the year — including staff retreats and trainings as well as board of directors, shareholder or retirement plan meetings that occur throughout the year. Under IRC Section 280A(g), a taxpayer can claim this rental income tax-free if their residence is rented for 14 days or less. When doing so, make sure to pay yourself the highest justifiable rent for the days rented, and be sure not to exceed 14 days, as any additional income will become taxable on day 15.
Employment of Children
Dentists should also employ their children. The standard deduction for single filers is $13,850 for 2023, meaning your children will not pay federal income taxes until their wages exceed $13,850. To legally employ your children, they must perform appropriate duties, wages must be reasonable, and they must receive their own payroll check and have their own bank account. As a bonus, qualifying children will be able to contribute up to $6,500 to a Roth IRA in 2023.
Dentists with college-aged children should consider increasing children’s salaries to take advantage of the American Opportunity Tax and Lifetime Learning credits. The American Opportunity Tax Credit is a tax credit with a maximum benefit of $2,500 for the first four years of post-secondary education. To qualify, the child must earn one-half of their support in earned income (wages). Many dentists choose to have their college-aged children manage their social media accounts to increase wages and tax savings.
Furthermore, it’s great to teach your children the benefit of hard work. Under this arrangement, a child can make up to $38,350 without paying federal income taxes. Dentists can increase tax savings even further by shifting income-producing property (office building, equipment, etc.) into a family limited partnership for children age 19 or older. This income is taxed at the children’s tax rates so long as they provide one-half of their support in earned income.
Tax Law Changes Impacting 2023
Under the Tax Cuts and Jobs Act, bonus depreciation under Section 168(k) and immediate expensing under Section 179 was increased to 100%. If Congress doesn’t extend this provision, these elections will decrease to 80% in 2023. This means any new equipment purchased is only eligible for an immediate write-off of up to 80% in 2023, reducing another 20% to a maximum of 60% in 2024.
Additionally, Congress recently passed the Consolidated Appropriations Act, which included new retirement savings rules, commonly known as the SECURE Act 2.0. One of the biggest changes was raising the age for required minimum distributions to 73 beginning in 2023 and to 75 beginning Jan. 1, 2033.
The tax credit for starting a new retirement plan has been increased from 50% of the startup cost to 100% of the cost for practices with 50 or fewer employees. Additionally, this credit is available for employer contributions made to each employee at a maximum of $1,000 per employee. This amount is 100% of the contributions in the first two years, then reduced to 50% in the third year and 25% in the fourth year.
For dentists with 529 college savings plans for their children, a portion of these accounts is eligible for a tax-free rollover into a Roth IRA. This is a tremendous benefit for dentists with overfunded 529 accounts. This strategy is only available for plans that have been in existence for 15 years or more, so don’t rush to open a new one if your children are already in college. For dentists with these accounts, a maximum of $35,000 is eligible to be rolled over into a Roth IRA tax-free. If you haven’t yet spent your children’s 529 funds, consider using alternate funds to pay for educational expenses to maximize this rollover.
The Inflation Reduction Act made changes to electric vehicle tax credits. These changes now favor purchasing electric vehicles through the dentist’s practice rather than personally. The electric vehicle tax credit is now referred to as the Clean Vehicle Credit. Beginning in 2023, this credit is only available for individuals with a modified adjusted gross income of no more than $300,000 (for joint filers), $225,000 for head-of-household filers, and $150,000 for single filers.
Fortunately for dentists, these restrictions won’t apply if the vehicle is purchased for business use. The maximum credit is $7,500 for qualifying vehicles, which must pass a complex defined North American assembly and sourcing requirement that will prevent many vehicles from qualifying. Previously, the tax credit was limited to 200,000 vehicles sold per manufacturer, which the popular brand Tesla reached back in January 2020. Under the new rules, Tesla vehicles may qualify if they can pass the sourcing and assembly requirements.
Summary
The calls I field from dentists who received unexpected tax bills from their CPAs are painful, as most could have saved tens of thousands of dollars with proper planning. The most common complaint I hear is that their CPAs aren’t proactive. Many dentists even switch CPAs every few years, hoping to fare better but with no luck. While there are a few last-ditch efforts to save money after year-end has passed, they are no substitutes for having a well-prepared and -executed game plan.
Rather than replacing your CPA, every dentist should seek a professional tax planning expert to assist with cash flow and personal/practice tax and financial planning. As business owners, dentists should expect the lines between their business, cash flow and retirement planning to be blurred. Having an expert on your side ahead of time will not only avoid headaches and stress, but it will also allow you to become financially independent as quickly as possible while paying the least amount of corporate and personal taxes legally required.
Wesley W. Lyon II, CPA, CFP, is president and CEO of McGill and Lyon Dental Advisors. For more information on his firm’s comprehensive tax and business planning services for dentists and specialists, contact Janet Blair at 877.306.9780 or email consulting@mcgillhillgroup.com. To comment on this article, email impact@agd.org.
Roth IRAs for Everyone
The tax code doesn’t allow dentists with a modified adjusted gross income of $204,000 or more to make a full contribution to a Roth individual retirement account (IRA). However, you can still make contributions to a Roth IRA by utilizing the “backdoor Roth” strategy. To accomplish this, make a nondeductible contribution to your traditional IRA on or before April 15. For tax year 2022, this deadline is April 17 since April 15 falls on a Saturday. Contribution limits are $6,000 for 2022, plus an additional catch-up contribution of $1,000 for people who were age 50 or older before Dec. 31, 2022.
Once you’ve made the maximum nondeductible contribution into your traditional IRA, move all taxable monies from the IRA to your 401(k). It’s best to do this using a direct trustee-to-trustee transfer to avoid the limit of one IRA rollover per year. Once the taxable monies are removed from the IRA, leaving only the nondeductible contributions, you can complete a tax-free conversion to a Roth IRA. Be sure to complete this on behalf of your spouse as well. Additionally, be sure to inform your CPA of these transactions, as nondeductible contributions won’t generate tax forms for your CPA to see.
Health Savings Accounts
Dentists who have a qualifying high-deductible health savings account (HSA) can make contributions until the April 15 deadline (April 17 for 2022). The maximum contribution for a family plan is $7,300 for 2022 ($3,650 for self-only coverage). Furthermore, dentists who reached age 55 before Dec. 31 can make an additional $1,000 catch-up contribution. If both spouses have reached age 55, both can contribute an additional $1,000. To accomplish this, each spouse must have their own HSA.
For dentists without a qualifying HSA plan, I recommend obtaining quotes at your next renewal date. An HSA is commonly referred to as the “triple threat,” as contributions are deductible, earnings grow tax-free, and withdrawals are tax-free if used for qualifying health expenses. For this reason, it’s best to spend after-tax dollars on current medical expenses and invest your HSA contributions. You can withdraw these funds later for qualifying medical expenses or to reimburse yourself for previously incurred medical expenses while covered under an HSA plan. Remember to keep records of all out-of-pocket expenses incurred to reimburse yourself tax-free in the future.
Increased Retirement Plan Contributions
The most important tax and financial strategy for any dentist is to maximize their retirement plan savings. Congress passed the first SECURE Act in December 2019, which made substantial changes to retirement plans and IRAs. This law extended the deadline for companies to add new retirement plans to the tax filing deadline rather than at year-end. This allows dentists without a retirement plan to start one for the prior year. Furthermore, dentists who have an existing 401(k) profit-sharing plan can potentially add a cash balance defined benefit plan to substantially increase retirement plan contributions.
Since Dec. 31, 2022, is behind us, you can’t make 401(k) contributions (salary deferrals) for 2022, but you can implement either a standalone profit-sharing plan or a cash balance defined benefit pension plan. The maximum amount you can contribute to a profit-sharing plan is $61,000 for 2022. For a dentist in the maximum federal income tax bracket (37%), this will create savings of over $22,000. However, keep in mind you’ll also be required to make contributions on behalf of your staff members as well, so be sure to use a firm specializing in small employer retirement plans, as there are many ways to design profit-sharing plans. Having a specialized formula to calculate contributions, such as a cross-tested (e.g., age-weighted) or Social Security integration formula can save you thousands in employer contributions. Utilizing these formulas ensures nondiscriminatory compensation by comparing the amount of contributions given to participants.
For dentists age 40 or older with younger staff, consider adding a cash balance defined benefit pension plan in combination with a 401(k) profit-sharing plan. This plan can be added to an already existing 401(k) plan if certain plan criteria exist, so confer with your retirement plan administrator to confirm whether this is an option for you. Contributions for this type of plan can range from $50,000 to $250,000 or more annually, depending on the age of the dentist. Cash balance plans operate in conjunction with a 401(k) profit-sharing plan and allow you to significantly increase your retirement plan contributions while minimizing additional staff costs. In my experience, most dentists receive 85% or more of all contributions into the cash balance plan, with most cases exceeding 90% of contributions.
Funding a cash balance defined benefit plan does come with a new set of rules. While profit-sharing contributions are optional each year, cash balance contributions are not. Furthermore, investment returns don’t factor into accrued benefits, further complicating implementation. I highly recommend that you hire a seasoned professional to help you navigate these plans.
Cost Segregation Study
Every dentist should seek to own their own office space. As many dentists have discovered, the IRS allows a depreciation deduction each year based on the value of the building and improvements made. Unfortunately, this depreciation is taken over 39 years. Instead, consider having an engineer complete a cost segregation study. This study can be done on buildings purchased, renovated or constructed after 1986 and allows you to reclassify a portion of the costs as nonstructural, which allows depreciation write-offs sooner.
You can have this study completed in 2023 and applied to your 2022 tax return. Furthermore, you can elect to immediately deduct a portion of these expenses on your 2022 tax return. Since this bonus election to immediately write off expenses decreases to 80% in 2023, dentists who qualify should act immediately.
Looking Forward: Smart Steps to Decrease Taxes for 2023
The Tax Cuts and Jobs Act passed in 2017 further complicated tax planning for dentists by introducing the Section 199A Qualified Business Income Deduction. This deduction is equal to 20% of business profits for all pass-through entities (S corporations, limited liability companies [LLCs], partnerships) and sole proprietors, subject to phase-out limits. For 2023, this deduction phases out when taxable income reaches $364,200 (married filing jointly) and is completely phased out at $464,200 for specified service trade businesses. These limits are cut in half for all other filing statuses.
Since this deduction is only for business profits, not officer wages, it requires very careful planning for maximum results. Incorporated dentists need to consider officer compensation (wages), retirement plan contributions and associated payroll taxes.
To maximize this deduction, dentists need to have a calculated plan that can be executed throughout the year. The key to maximizing this additional 20% tax deduction on profits is having retirement plan contributions and salaries set to the exact amounts for your specific needs. There is no “one size fits all” with tax planning, and every dentist should seek to optimize their salary in relation to their specific retirement plan. Furthermore, you should make sure your retirement plan contribution formula is being optimized by using a cross-tested (age-weighted) or Social Security integration formula.
Spousal Employment
Every dentist should employ their spouse through the practice. Duties can include consulting, maintaining the books from home, paying the bills, etc. Your spouse’s salary should be at least $3,000 annually to qualify for tax-free fringe benefits such as fully deductible travel to continuing education and other business meetings. Furthermore, increase your spouse’s salary to accommodate retirement plan contributions as applicable. For spouses not covered by another employer-sponsored retirement plan, be sure to pay your spouse the maximum tax-deductible salary deferral of $22,500 for 2023 ($30,000 if 50 or older). To maximize salary deferrals while minimizing payroll taxes, you should pay your spouse $24,500 if under age 50 and $32,500 if over age 50.
Tax-Free Rent
Dentists should also consider renting their personal residence for any business use throughout the year — including staff retreats and trainings as well as board of directors, shareholder or retirement plan meetings that occur throughout the year. Under IRC Section 280A(g), a taxpayer can claim this rental income tax-free if their residence is rented for 14 days or less. When doing so, make sure to pay yourself the highest justifiable rent for the days rented, and be sure not to exceed 14 days, as any additional income will become taxable on day 15.
Employment of Children
Dentists should also employ their children. The standard deduction for single filers is $13,850 for 2023, meaning your children will not pay federal income taxes until their wages exceed $13,850. To legally employ your children, they must perform appropriate duties, wages must be reasonable, and they must receive their own payroll check and have their own bank account. As a bonus, qualifying children will be able to contribute up to $6,500 to a Roth IRA in 2023.
Dentists with college-aged children should consider increasing children’s salaries to take advantage of the American Opportunity Tax and Lifetime Learning credits. The American Opportunity Tax Credit is a tax credit with a maximum benefit of $2,500 for the first four years of post-secondary education. To qualify, the child must earn one-half of their support in earned income (wages). Many dentists choose to have their college-aged children manage their social media accounts to increase wages and tax savings.
Furthermore, it’s great to teach your children the benefit of hard work. Under this arrangement, a child can make up to $38,350 without paying federal income taxes. Dentists can increase tax savings even further by shifting income-producing property (office building, equipment, etc.) into a family limited partnership for children age 19 or older. This income is taxed at the children’s tax rates so long as they provide one-half of their support in earned income.
Tax Law Changes Impacting 2023
Under the Tax Cuts and Jobs Act, bonus depreciation under Section 168(k) and immediate expensing under Section 179 was increased to 100%. If Congress doesn’t extend this provision, these elections will decrease to 80% in 2023. This means any new equipment purchased is only eligible for an immediate write-off of up to 80% in 2023, reducing another 20% to a maximum of 60% in 2024.
Additionally, Congress recently passed the Consolidated Appropriations Act, which included new retirement savings rules, commonly known as the SECURE Act 2.0. One of the biggest changes was raising the age for required minimum distributions to 73 beginning in 2023 and to 75 beginning Jan. 1, 2033.
The tax credit for starting a new retirement plan has been increased from 50% of the startup cost to 100% of the cost for practices with 50 or fewer employees. Additionally, this credit is available for employer contributions made to each employee at a maximum of $1,000 per employee. This amount is 100% of the contributions in the first two years, then reduced to 50% in the third year and 25% in the fourth year.
For dentists with 529 college savings plans for their children, a portion of these accounts is eligible for a tax-free rollover into a Roth IRA. This is a tremendous benefit for dentists with overfunded 529 accounts. This strategy is only available for plans that have been in existence for 15 years or more, so don’t rush to open a new one if your children are already in college. For dentists with these accounts, a maximum of $35,000 is eligible to be rolled over into a Roth IRA tax-free. If you haven’t yet spent your children’s 529 funds, consider using alternate funds to pay for educational expenses to maximize this rollover.
The Inflation Reduction Act made changes to electric vehicle tax credits. These changes now favor purchasing electric vehicles through the dentist’s practice rather than personally. The electric vehicle tax credit is now referred to as the Clean Vehicle Credit. Beginning in 2023, this credit is only available for individuals with a modified adjusted gross income of no more than $300,000 (for joint filers), $225,000 for head-of-household filers, and $150,000 for single filers.
Fortunately for dentists, these restrictions won’t apply if the vehicle is purchased for business use. The maximum credit is $7,500 for qualifying vehicles, which must pass a complex defined North American assembly and sourcing requirement that will prevent many vehicles from qualifying. Previously, the tax credit was limited to 200,000 vehicles sold per manufacturer, which the popular brand Tesla reached back in January 2020. Under the new rules, Tesla vehicles may qualify if they can pass the sourcing and assembly requirements.
Summary
The calls I field from dentists who received unexpected tax bills from their CPAs are painful, as most could have saved tens of thousands of dollars with proper planning. The most common complaint I hear is that their CPAs aren’t proactive. Many dentists even switch CPAs every few years, hoping to fare better but with no luck. While there are a few last-ditch efforts to save money after year-end has passed, they are no substitutes for having a well-prepared and -executed game plan.
Rather than replacing your CPA, every dentist should seek a professional tax planning expert to assist with cash flow and personal/practice tax and financial planning. As business owners, dentists should expect the lines between their business, cash flow and retirement planning to be blurred. Having an expert on your side ahead of time will not only avoid headaches and stress, but it will also allow you to become financially independent as quickly as possible while paying the least amount of corporate and personal taxes legally required.
Wesley W. Lyon II, CPA, CFP, is president and CEO of McGill and Lyon Dental Advisors. For more information on his firm’s comprehensive tax and business planning services for dentists and specialists, contact Janet Blair at 877.306.9780 or email consulting@mcgillhillgroup.com. To comment on this article, email impact@agd.org.