Running the Numbers Some Year-end Tax-planning Tips for the Private Practice

It’s that time of year again. In the midst of holiday cheer, the business of preparing for year-end taxes looms overhead.

Tax planning for doctors who are owners of their medical or dental practice takes place at both the entity level and the individual level. Regardless of the type of entity the practice operates as, planning is important because it impacts what the doctor is ultimately going to owe in taxes at the individual level. This article is intended as a reminder of some basic year-end planning strategies focusing on cash-basis entities that should be coordinated between the doctors and their accountants — and should begin soon enough to allow plenty of time to effectively execute whatever plan is devised.

Staff Bonuses. Now is the time to show your appreciation to your employees. This is an obvious tax-planning measure at the practice level. It is also the most direct way to reward hard work and motivate future efforts. Your employees will be grateful well into the new year.

Deferral of Income. Generally, good business practices mandate efficient, concerted efforts on collecting patient receivables and keeping days outstanding to a minimum. However, the last month of the fiscal year may be a good time to slow down those efforts and loosen up the process for practices on the cash/income tax basis of accounting. Slow end-of-year collections effectively defer recognition of income until the following tax year.

Acceleration of Expenses. Typically, the acceleration of expenses is the objective at year-end. Get current on all outstanding bills. Don’t leave any hanging over to next year, and consider the acceleration of some. Examples are malpractice insurance premiums, rent, medical and office supplies, and interest on debt service. Many of these are expenditures that are due the first of the following month anyway and therefore should not negatively impact cash flow. Consider using your credit card — charged expenses are deductible in the year charged even if the credit card bill is not yet paid.

Maximize Retirement Plan Contribu-tions. Probably the single most valuable and economically sound tax-planning vehicle today is the use of retirement plans. Not only do contributions result in tax deductions, but you are building for your future. The current individual funding limited for a typical defined contribution plan is $45,000 for 2007. If you have attained age 50 or older in 2007, you can add an additional $5,000 to this limit for a total of $50,000. This is the combined amount of individual income deferral and entity-level contributions. The individual elective deferral portion of this is $15,500 or, if you are age 50 or older, $20,500.

This vehicle not only reduces current taxes at the practice level, but defers taxes at the individual level until retirement and possibly beyond. It makes good business sense as well as tax sense because employees have an increasing awareness of the importance and value of this benefit. It also provides financial security for doctors and staff alike.

A unique feature of practice retirement plans is that, unlike most cash-basis business expenses which must be paid prior to year-end, practices can deduct the entire amount in the current year but have until the due date of the practice tax returns, including extensions, to pay the liability.

Purchase of Medical and Office Equipment. The decision to purchase equipment should always be based on business need; however, related tax deductions can help ease the cost. Internal Revenue Code Section 179 allows a 100{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} expense deduction for equipment purchased each year, regardless of the month in which the purchase is made. This amount is limited to the first $125,000 in 2007.

Be careful not to make equipment purchases in excess of $500,000 in 2007, if possible, because the Section 179 deduction phases out as the additions exceed this. If your annual purchases exceed the Section 179 limit, you should carefully choose which ones you elect to treat under Section 179. Generally, you want to expense those with the longer depreciable life and those purchased in the last quarter of the year to maximize the overall writeoff to the practice.

If cash is a problem, you can purchase the equipment by loan or credit card advance and still elect to take the tax deduction as long as the equipment has been placed in service before the end of the year.

Pay Attention to Non-deductible Items. Don’t forget that the tax-planning process involves identifying expenditures that may not be deductible and therefore have to be added back to ‘book income’ to arrive at taxable income. These can be significant individually or in the aggregate. Examples are key person life insurance payments, disability buyout insurance, disability income insurance, charitable contributions, penalties, a portion of meals and entertainment, and some country club dues. The treatment of these may vary depending on whether the practice is organized as a sole proprietorship, partnership, S corporation, limited liability company (LLC), limited liability partnership (LLP), or professional corporation (PC).

W-2 Add-ons, 1099 Information, and Sales and Use Tax. As part of your year-end tax planning you should be assembling information that your accountant and/or payroll service will need to have in preparing your W-2 wage, withholding, and reporting statements. These include the taxable portion of certain business perks such as personal use of business-owned or -leased vehicles, disability insurance premiums paid at the corporate level, which you elect to have reported in after-tax dollars, and self-employed health insurance premiums paid at the corporate level. Employee copies of W-2s are due by Jan. 31.

You are required to issue 1099s for payments in excess of $600 made to unincorporated independent outside vendors for services rendered such as transcription, maintenance, bookkeeping, etc. Also, rent payments and payments to lawyers for legal services need to be reported as well as interest paid to owners for loans made to the practice. Recipient copies of 1099s are due by Jan. 31.

If you are an annual sales and use tax filer, your payment for calendar year 2007 is due by Jan. 20, 2008. Throughout the year you should have been tracking all purchases from out of state vendors on which no sales tax was charged. Many online vendors do not charge a sales tax, and it is therefore your responsibility to remit 5{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of these purchases to the Commonwealth of Massachusetts. Some frequent items include computer, office and medical equipment purchases, computer supplies, office supplies, medical supplies, books, and journals, including reference materials. If you have not been filing sales and use tax returns, you should check with your accountant as to your filing obligation. Failure to file and pay taxes due could result in substantial penalties

Specific to Professional Corporations: Professional corporations, or PCs, are subject to federal income tax at the rate of 35{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} on taxable income unless the corporation has elected to be taxed as an S corporation.Because of this, most small to medium-sized medical and dental practices are on the cash/income tax basis of accounting and bonus out all or most of the practice’s income before Dec. 31 (or the tax year-end).

The downside to this is that it drains the practice of cash, which may be needed to meet payroll and other practice expenses in the following month.

To deal with the cash-flow problem, the business manager or administrator should compile a list of expenses, including payroll, that need to be paid in the first two weeks of the following year, as well as a conservative estimate of cash collections for the same period. To the extent that you do not have enough cash to cover this, you can borrow on your line of credit. Every practice should have an established line of credit with a bank to meet short-term cash deficits during the year.

Don’t wait until you need to borrow to go to the bank — it may be too late to get the loan processed. Another option is to have the doctors loan back to the practice their net bonus checks. Of course, these are loans that need to be repaid. They effectively use collected revenue of future periods to pay bonuses of the current year.

Specific to Partnerships, S Corpora-tions, Sole Practitioners, Most LLCs, and LLPs: Taxable income of S corporations, general partnerships, sole proprietorships, limited liability companies (LLCs), and limited liability partnerships (LLPs) generally are passed through to and taxed to the individual owners on their individual income tax returns. For these practices, you should be looking at projected revenue of the practice and its impact on the practitioners’ individual tax returns. Tax planning should encompass having your accountant run a projection of your current year liability and compare that to prior-year taxes, review estimated tax payments made, and approximate April 15 liability or refund. Any planning strategies at the individual level should be considered also.

The most effective tax planning balances the financial needs of the practice with that of the individual doctors. It also involves giving consideration to business decision-making throughout the year, which may impact current as well as future tax years.

Avoid Underpayment Penalties. If you don’t pay the IRS enough during the year, through withholding or timely quarterly estimated tax payments, you could owe a penalty on the amount underpaid, which could be substantial. Generally, the underpayment penalty can be avoided by (a) timely payment of 90{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of the tax shown on the current year return, or (b) timely payment of 100{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of the tax shown on the prior year’s return. If your adjusted income in the prior year was in excess of $150,000 ($75,000 for a married person filing separately), the requirement to pay 100{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of the prior year’s tax changes to 110{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}.

In conclusion, tax planning is an integral part of running a medical or dental practice. Therefore, decisions should be made not only with tax implications in mind, but also considering cash flow and the many other business needs of the practice.

Remember, in the long run, you don’t want to make a bad business decision just to save a few tax dollars. Your tax advisor should be an integral part of your planning process.

Lisa A. Patenaude is senior manager of the Health Care Services Division of Meyers Brothers Kalicka, P.C. in Holyoke, certified public accountants and business consultants; (413) 536-8510.