Running your own dental practice can mean high income, but this also means high tax liabilities. Luckily, dentists can benefit from a large variety of tax deductions if implemented properly. In this article, we have outlined six of our favorite, easy to implement tax tips for dentists.
1. Increase your retirement contributions
Investing back into your business is always a good idea, but with any leftover funds, consider increasing the amount you are putting away into your retirement plan.
Currently, as a general rule, every citizen can put up to $20,500 into their employee deferral 401k, 403b, or 457 b retirement plan every year (or up to $27k if you are over 50). The more you pay into your retirement, the less taxes you’ll need to pay now. If possible, consider maxing out your pension plan.
As a dental professional, there are many different retirement plans to consider:
- (Business Plan) – 401(k) – If you are hired as a W-2 employee, then the 401(k) is likely your best option, which is a defined contribution plan. You can contribute up to $20,500 as an employee deferral in 2022 and then your employer may or may not provide a match. If your employer offers a profit sharing plan paired with your 401(k), you or your employer may be able to contribute an additional $40,500 for a total of $61,000 when combined with your employee deferral. The 401(k) can also be implemented if you are self employed (often referred to as a Solo 401(k)).
- (Individual Plan) IRAs and Roth IRAs could also be a great option for a dentist on a slightly lower salary (keep in mind you can’t contribute if you make more than $144,000 per year). Take a look at our article about Roth IRAs.
- (Business Plan) If you have your own practice, it may be more beneficial to open an IRA account. There are two options here;
- SEP IRA (Self Employed Pension Individual Retirement Account), where you can contribute up to 25% of your income every year with a cap at $61,000 (2022)
- SIMPLE IRA (Savings Incentive Match Plan for Employees), where you can contribute up to $14,000 per year (2022).
- (Business Plan) -Defined Benefit Plans – DBPs are complicated and more costly than other retirement plans but they offer the most advantages in terms of contribution amounts over any other plan.
The type of retirement account you choose will all depend on your financial goals, speak to us here at Cerebral taxes if you are unsure about what would work best for you and your family.
2. Hire your kids
Many people dream of running a family business, and if you have children over the age of 7, you could fulfill this dream and save money on your taxes, a win-win.
If you have a sole proprietorship or a partnership, under IRS rules, children under the age of 21 don’t have to pay unemployment taxes or FICA taxes. Children under the age of 18 also don’t have to pay payroll taxes, Social Security, or Medicare taxes. If you have an S-corporation or C-corporation, you will be required to pay Social Security and Medicare taxes.
Generally, your children will be of a lower income bracket than you. This allows you to shift their salary from your higher tax bracket to their lower tax bracket thus transferring wealth, help your kids save up for college or their retirement, and create a deduction for your business!
There are a couple of rules you must follow:
- The compensation must be shown as an ordinary and necessary expense connected with the practice.
- The pay must be reasonable, defined as the amount normally paid for similar services.
- The services must actually be provided. Not sure what your child should do? Check out our article on common child responsibilities in your practice.
- The compensation must be paid.
Essentially, you need to treat your child just like any employee. Keep in mind, your child could save directly to a Roth IRA enabling them to get a headstart in their retirement savings.
3. Take advantage of your new equipment purchases (Sec. 179)
Tax deductions for dentists almost always include equipment purchases, though not everyone takes advantage of the Section 179 Tax Deduction. Prior to this deduction being available, businesses had to treat all purchases equally and depreciate them over time.
Section 179 essentially enables you to deduct 100% of the equipment purchased within the financial year, though there are a couple of rules. The equipment or new technology must be :
- Bought by 31 December.
- Used for business purposes at least 50% of the time.
- Put into service that year.
The maximum you can claim is $1,080,000 in 2022. Note, the equipment does not have to be brand new, in fact many pre-owned pieces of equipment qualify. Some of the qualifying expenses include:
- Dental practice equipment, like chairs and X-ray machines
- Software and technology, such as servers, computers, accounting, and dental software
- Office furniture
- Heating/AC systems
- Air ventilation systems
- Security systems
4. Choose the right business structure
Depending on your situation, you may be in the position to choose your corporate structure. If so, don’t take this decision lightly! For your dental practice, there are four different ways you can set it up:
- Sole Proprietorship – 100% of profit is subject to ordinary income tax and self employment tax
- Partnership – 100% of profit is subject to ordinary income tax and self employment tax
- S-Corporation (S-Corp) – 100% of W-2 wages and distributions are subject to ordinary income tax but only the W-2 wages are subject to Social Security and Medicare tax
- C-Corporation (C-Corp) – 100% of profit is taxed at the entity level
Each type of entity is taxed differently or offers different deductions. What you choose depends on the amount of income you make, how many employees you have, if you have partners, which state(s) you are in, etc – just to name a few variables.
Whilst there are many variables to consider, generally speaking an S Corp is the most common choice for those who own their own practices. Although S-corps are popular, you shouldn’t automatically jump on the S-corp bandwagon until you consider your state laws. A qualified tax advisor will be able to guide you in the right direction. If you want to learn more about S-corps, check out our blog post about the basics of S-Corps.
5. Prepay expenses
If you are in the cashflow to do so, prepaying some bigger expenses before the year end will allow tax write offs sooner rather than later. If you are thinking of buying some equipment or significant amounts of supplies, consider putting it on your business credit card to enable a write off without a hefty cash deposit, though make sure you pay your credit card each month so you avoid unnecessary interest
Remember, even if this pushes you into a loss, this loss won’t be “wasted.” You can roll this loss over next year if you are a C-corporation, you can carryback the loss if you are a C-corporation, or you can deduct the loss on your personal tax return if you are an S-corporation, Partnership or sole proprietorship. Especially during the current economic environment, this may really help out some of your suppliers and promote your relationship with them.
However, note that if you pay an expense this year, you will not be able to expense the same item next year, meaning you may end up with a higher tax bill the following financial year if you are not careful. Look at your forecasts and budgets, sit with a professional, and see what works best for you and your company.
All that said, if your position allows you to, consider prepaying some or all of your expenses in the current financial year to benefit from a decreased tax liability.
6. Donate to charity
Provided the charity you donate to is listed in the 501(c)3, all money you donate to them is tax deductible. If you have the ability to, you may donate up to 50% of your gross income. Whilst of course this isn’t an investment into your company, it may make sense if you are already donating personally and choose to move this donation from your personal name into your business name to help optimize your taxes. If your company is a C-corporation, you are able to deduct the charitable contributions from business income. Any other type of entity, the charitable deduction is passed through to you as the individual to deduct as an itemized deduction on your personal tax return. Of course, it will also help a good cause.
Although there are tons of other tax reduction strategies for dentists, this preliminary list will help you start thinking about ways to improve your practice or personal finances. If you have any questions or concerns and would like to speak to a Cerebral Team Member, contact us at Cerebral Tax Advisors. We are here to educate and provide you solutions!