Creating a Strategy Tax Planning Tips for the Practice and Individual Practitioner — Part II

Most people consider tax planning as an exercise that is usually done near the end of the tax year, and this can be very important to short-term tax savings. However, individuals who also do what I’ll refer to as “strategic tax planning” reap much more savings over a span of years. Strategic tax planning results in actual tax savings as well as tax deferral, which, when compounded over time, can have a significant impact on one’s lifetime wealth accumulation.

What follows are some long-term strategies and related tax law changes that can reap big rewards to taxpayers with foresight.

Retirement Plan Strategies

The Pension Protection Act of 2006 made permanent certain scheduled increases in amounts individuals could contribute to tax-favored retirement plans and IRAs. Without this, these provisions would have expired after 2010 and reverted back to pre-2001 limits. (See the ‘Part I’ tax-planning article in the November issue for contribution limits.) Most practitioners have adjusted gross income that exceeds the limit allowing them to contribute to a Roth IRA, so making the maximum contribution allowed every year to your practice-retirement plan and also maximizing your annual contribution to a nondeductible IRA can make a big difference in your retirement savings over time, and the compounded value of tax deferrals will add to this. Remember, every year that you don’t contribute the maximum is lost forever and can’t be made up for later.

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), which was made law in 2006, increased the Alternative Minimum Tax (AMT) exemption, but most practitioners may still be subject to this. You should check with your accountant to see if you will be subject to the AMT and what strategies you can employ to reduce this, such as maximizing retirement plan contributions, timing charitable contributions, and timing deductible tax payments. If you cannot make the maximum retirement plan contribution due to other plan limitations, consider opening and funding a SEP if you have outside income from consulting, speaking fees, or research.

Conversion to Roth IRA

Currently, practitioners whose modified adjusted gross income exceeds $100,000 are barred from converting a traditional IRA to a Roth IRA. TIPRA eliminates this ceiling for tax years after 2009. Taxpayers who convert in 2010 can elect to recognize the conversion income in 2010 or average it over the following two years. Why is this beneficial to high-income taxpayers? First, like traditional nondeductible IRAs, Roth IRA contributions are in after-tax dollars, but the earnings on Roth IRAs are also nontaxable, so the entire pay out is tax-free.

Second, if you believe that future individual tax rates will be higher than they currently are, it may make sense to pay the tax now on the accumulated earnings of your traditional IRA in exchange for a tax-free payout on all future earnings down the road. Note, under current tax law, the present low federal income tax rates expire in 2011, so the timing of a 2010 conversion could be critical. Third, Roth IRAs, unlike other IRAs and retirement plans, have no required minimum distribution at age 70 1/2, so you can defer payment indefinitely and use this for estate planning. The strategic planning would include:

  • Maximizing traditional IRA contributions over the next four years to build up the amount subject to conversion;
  • Having your accountant run some financial scenarios to determine the tax cost; and
  • Planning to have outside funds available to fund the taxes because having to use the funds within the IRA could be very costly, as they will be taxed and subject to an early withdrawal penalty when you draw them out.

Investment Strategies

Recent developments in the economy and stock market and the current favorable 15{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} tax on stock dividends has convinced many investors to switch more of their investment portfolio from aggressive growth-oriented stocks to high-dividend-paying blue chip stocks. The combined yield from income and growth on many of these is outpacing the straight growth stocks, and the move is less risky. Under previous tax legislation, the favorable dividend and capital gains tax rates were set to expire at the end of 2008. TIPRA extends these rates through 2010, making it more favorable to investment planning.

Capital Asset and Improvement Strategy

Under current law, practitioners can acquire $108,000 (in 2006) in furniture, medical equipment, and other qualifying business assets and can expense this amount in the year acquired and placed in use, as long as the total amount of such purchases does not exceed $430,000 (in 2006). These limitations are indexed for inflation annually through 2007. After that, they would drop back to $25,000 and $200,000, respectively. This has now been extended two more years through 2009, thereby enabling practitioners to extend and plan out their financial commitment without losing this tax benefit and enabling them to make an even larger investment over the next three years.

Kiddie Tax and College Funding

The kiddie tax rules require a child’s unearned income, such as dividends and interest, to be taxed at the parents’ tax rate, which is usually substantially higher. Under previous law, the kiddie tax applies if the child is under age 14, the child has unearned income of more than $1,700, and the parent can claim the child as a dependent. The TIPRA raises the age limit to under 18, effective immediately for all of 2006. Parents would do well to channel any college savings from custodial accounts into a qualified tuition program sponsored by a state or educational institution, referred to as a 529 plan. Many of these offer a wide range of investment options that you can change annually. Plan earnings are tax-free if the money is used for qualified education costs.


While current-year tax planning can lower your tax bill, taking advantage of longer-range planning can multiply the savings. You should contact your accountant to guide you through this process.

James B. Calnan, CPA, is partner-in-charge of the Health Care Services Division of Meyers Brothers Kalicka, P.C., Holyoke, Certified Public Accountants and Business Consultants; (413) 536-8510.

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