Tax Planning for Dental Practice Owners
By Cecil Staton, CFP®
Tax Planning for Dental Practice Owners: Maximizing Your Savings and Minimizing Your Tax Burden
As a dental practice owner, you are a healthcare provider and a small business owner. Navigating the complexities of tax planning can be daunting, but with strategic planning, you can significantly reduce your tax liability and increase your savings. As a financial advisor for dentists at Arch Financial Planning, I’ve assisted numerous dentists in navigating this complex process. This comprehensive guide will walk you through essential tax planning strategies tailored to dental professionals.
Before taking any tax deduction from the list below, check with your financial and tax advisors to optimize your tax strategies. Your financial advisor and dental CPA firm should review your tax return with you every year to ensure you take advantage of all tax credits and do not miss a single tax deduction.
Choosing the Correct Entity Structure
One of the most critical decisions for dental practice owners is choosing the correct business entity. Many dental practices operate as an LLC (Limited Liability Company), but making an election with the IRS to be taxed as an S-Corporation can provide substantial tax benefits. This structure allows you to pay yourself a reasonable salary and take the remaining profits as distributions, which are not subject to FICA taxes, thereby reducing your overall taxable income.
If you’re paid as a 1099 contractor, you must choose between taxing yourself as a sole proprietorship or making an s corporation election.
Related Reading: How To Buy A Dental Practice
Paying Yourself a Reasonable Salary
In an S-corporation structure, it’s important to balance salary and distributions. Paying yourself a reasonable salary ensures compliance with IRS requirements, while distributions reduce your FICA tax burden. Collaborate with a tax advisor to determine the optimal salary and distribution ratio.
Related Reading: How Dentists Can Maximize Income
Employing Family Members
Employing family members, such as your children, can provide tax advantages. If your children work in your practice, you can pay them up to the standard deduction amount without incurring federal income tax. This strategy reduces your taxable income and allows your children to contribute to a Roth IRA, fostering early investment in their future.
Utilizing an Accountable Plan
Reimburse yourself for business-related travel and cell phone expenses through an accountable plan. This plan allows you to deduct these expenses without including the reimbursements in your taxable income. Keeping accurate records of these expenses is crucial for compliance and maximizing deductions.
Section 179 and Bonus Depreciation for Equipment Purchases
Investing in dental equipment, such as dental chairs and other essential tools, can provide significant tax benefits. Under Section 179 and Bonus Depreciation, you can deduct the full purchase price of qualifying equipment in the year of purchase rather than spreading the deduction over several years. This immediate expensing can substantially lower your tax bill in the current tax year. Anything depreciated, including cars, must be used for business purposes in the first year and beyond.
Related Reading: Average Dental Office Overhead
Retirement Planning
Saving for retirement is crucial for your future and offers substantial tax savings. Consider establishing a 401(k) plan combined with a Cash Balance plan. This combination allows you to contribute significant amounts pre-tax, potentially exceeding $150,000 to $300,000 annually. Although costs are associated with employee contributions and plan administration, the tax savings often outweigh these expenses. Typically, it’s recommended that practice owners consider a safe harbor 401(k) plan instead of a SEP IRA or SIMPLE IRA plan.
Related Reading: Retirement Plans for Dentists
Maximizing the Qualified Business Income (QBI) Deduction
The QBI deduction allows eligible small business owners, including dental practice owners, to deduct up to 20% of their qualified business income. This deduction has several moving parts, and working with a knowledgeable tax advisor can help ensure you maximize this benefit.
Real Estate and Office Space
You can leverage additional tax benefits if you own the real estate where your dental practice operates. Depreciating the property and deducting mortgage interest can reduce your taxable income. Furthermore, a separate entity should be created to hold the real estate, which can offer asset protection and additional tax planning opportunities. Typically, this is an LLC, and you’re taxed using Schedule E rather than filing an S-Corporation election for your real estate.
Real Estate Professional Status
A non-working spouse of a dental practice owner can become a real estate professional to unlock significant tax planning advantages. By actively managing real estate investments and meeting the IRS’s criteria for a real estate professional—spending more than 750 hours annually on real estate activities and more than half of their total working hours—the spouse can qualify for substantial tax benefits. This status allows the couple to fully deduct real estate losses against their ordinary income, reducing their overall tax liability. Additionally, the income from rental properties can be offset by depreciation and other expenses, further minimizing taxable income. This strategic move maximizes tax efficiency and diversifies the family’s income streams, contributing to long-term financial stability.
Health Savings Accounts (HSAs)
A Health Savings Account (HSA) is a powerful tool for dental practice owners to manage healthcare expenses while enjoying significant tax benefits. Contributions to an HSA are tax-deductible, and the funds grow tax-free. Withdrawals for qualified medical expenses are also tax-free, providing a triple tax advantage. Additionally, HSAs can be an attractive employee benefit, enhancing satisfaction and retention. By leveraging HSAs, dental professionals can reduce their taxable income and save for future healthcare needs. A high-deductible health plan is required under current tax law to contribute to an HSA.
Tax Purposes & Tax Strategy
While it might be tempting to incur business expenses solely to reduce taxable income, dental practice owners should prioritize expenses that genuinely contribute to the growth and efficiency of their practice. Investing in high-quality dental equipment, advanced technology, or staff training qualifies as deductible expenses and enhances the practice’s capabilities and patient satisfaction. Strategic expenditures should align with long-term business goals, improving service delivery and expanding the client base. Dental professionals can build a more robust practice by focusing on growth-oriented investments, ensuring that tax benefits are a secondary, albeit valuable, advantage rather than the primary motive of lowering gross income.
Related Reading: Selling Your Dental Practice To A DSO
Donor Advised Fund
A Donor-Advised Fund (DAF) is an excellent vehicle for dentists looking to lower their tax liability with charitable deductions while supporting charitable causes. By contributing to a DAF, dental professionals can receive an immediate tax deduction for the full value of their donation, which can be especially beneficial in high-income years. The funds in the DAF can be invested and grow tax-free, allowing for potentially larger charitable contributions. Additionally, dentists can strategically time their donations to optimize tax benefits, making DAFs a flexible and tax-efficient method for philanthropy. This approach supports important causes and helps manage and reduce taxable income effectively.
Tax Efficient Investing
Investing in Exchange-Traded Funds (ETFs) can be a tax-efficient strategy for dental practice owners looking to grow their wealth. ETFs generally incur lower capital gains taxes than mutual funds and active trading due to their unique structure and trading mechanisms, which help minimize taxable events. Additionally, ETFs offer a diversified investment portfolio, reducing risk and enhancing potential returns. Practice owners should be mindful of the timing of capital gains tax and the associated tax implications, strategically managing their investment portfolio to align with their overall financial and tax planning objectives. By leveraging the tax efficiency of ETFs, dental professionals can effectively grow their investments while maintaining a favorable tax position.
Related Reading: Investing for Dentists
Tax Planning Throughout the Year
Effective tax planning is not a one-time event but an ongoing process. Regularly review your financials, keep current financial records, and consult with a tax advisor to adjust your strategies based on changes in tax laws and your financial situation. Planning ahead for the next year can help you take advantage of new opportunities and minimize surprises during tax season.
Conclusion
Tax planning for dental practice owners requires a comprehensive understanding of the tax code and strategic implementation of various deductions and credits. By choosing the right entity structure, employing family members, maximizing equipment deductions, planning for retirement, and staying proactive throughout the year, you can significantly reduce your tax burden and enhance your financial well-being.
At Arch Financial Planning, we specialize in providing tailored financial advice to dental professionals. Our expertise in tax planning and understanding of the unique challenges faced by dental practice owners can help you navigate the complexities of tax season with confidence. Contact us today to learn more about how we can assist you in achieving your financial goals.
If you’re interested in becoming a practice owner, check out our post here: Related Reading: How To Buy A Dental Practice
For more personalized advice on managing your dental practice’s overhead, feel free to contact me at Arch Financial Planning. Together, we can achieve your financial goals and secure the future of your practice.
Arch Financial Planning is a dental-focused financial advisor that helps dental practice owners nationwide. Be sure to read our guide and hire the right team of advisors who can assist with building and selling the practice you’ve built to empower your retirement plan.
Related Reading: Tax Consequences of Selling Your Dental Practice
Author: Cecil Staton, CFP® CSLP®
I'm a fee-only financial advisor for dentists serving clients nationwide.
I left the large financial institutions to start my own RIA. I did it so people could pay for real planning and not just an agenda to sell a hidden product. As a fiduciary, Arch Financial Planning, LLC was built on that promise by delivering non-cookie-cutter plans that provide solutions to achieve their goals.
Who do I serve?
Typical: Dental practice owners
Goals: Pay off student debt, start/sell a practice, and grow their wealth
Location: Virtually anywhere in the U.S.
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