It is probable that a lot of dentists will see changes in their taxes by way of either reduced deductions, higher tax rates and surcharges on incomes above certain amounts or other adjustments that will surely raise their federal income tax bills. This will be especially difficult for those working in states with their own high state tax rates.
What should the dental profession be addressing in the way of protection against higher taxes?
One of the first material items of business may be the adoption of a qualified employer sponsored retirement plan. Prior to the expected tax increase next year, many employers thought that the cost allocated to employees based on their taxes being lower, was too expensive to institute the retirement plan. The net after tax cost to the employer didn’t seem to justify money coming from the practice and going to the employees and not to the owner or his or her family totally. Also, the expense of the implementation of the plan was an added burden to the employer on a net after tax basis with the tax rate lower.
Now that the tax rate is expected to rise, the astute dentist will be looking at his or projected tax and with advisors determining that the new tax rate, including state income tax, will be somewhere around 50% for the owner. Based on that rate, every dental owner would realize that it costs 50 cents on the dollar to contribute funds for the employees after tax and not more than that. In some situations like New York and other states with high income tax rates, the federal and state tax combined percentage of tax is closer to 55% or a little more when the double social security tax and double Medicare tax is taken into account for the owner/dentist.
Examples for illustrative purposes in understanding the cost and allocation of monies from the dental practice:
If we use a hypothetical example since each dentist’s situation is different, it can be interpolated later to determine at least an approximation of what the situation will look like comparing a qualified employer sponsored retirement plan at the dental practice and without one. The dental CPA or other financial advisor should be retained to approximate each specific situation and this example is only for illustrative purposes and should not be relied upon for the dentist’s individual practice and personal income tax situation.
After all expenses, deductions, and anything that would be construed as a write off, suppose there is $500,000 of taxable income available from the dental office as well as netting the effect of personal deductions and exemptions. Working in a state with a high income tax percentage and federal tax rate plus double social security on the increased amount of $147,000, along with the double Medicare tax on the entirety and including other charges such as the alternative minimum tax, the income tax total will be close to $250,000. For those dentists aged 50 and older, a defined benefit/cash balance plan may be the answer integrated with a 401k for certain employees depending on the circumstances. Deductible contributions can be above $150,000 per year.
The allocation is what the dental CPA who understands qualified employer sponsored retirement plans can discuss with the owner. Using an example for this hypothetical presentation, if the employee cost were to be equal to $20,000, the net after tax cost to the employer is $10,000. If participants leave the dental office’s employment, those people forfeit what is not vested and the distribution of their forfeiture is allocated among those remaining on a pro rata basis to their respective interests. That means that most of the forfeiture will go to the owner. This is because it is assumed that the owner is reporting the most income among the employees.
By making the deductible contribution of $150,000 to the retirement plan, the owner now has ($500,000-$150,000) $350,000 and a tax of $175,000. Instead of the $500,000 being reduced to $250,000 roughly after tax, the owner has ($350,000-$175,000 tax) $175,000. He or she also has some large allocation, probably around $130,000 of the $150,000 deductible contribution allocated to him or her in the retirement plan. In summary, the owner has $175,000 in hand plus $130,000 of the allocation in the retirement plan for a grand total in his or her “two separate pockets,” of $175,000 + $130,000 or $305,000 compared to the $250,000 without the deductible contribution to the retirement plan.
There are set up costs and annual administrative fees to be but there is also $55,000 per year of additional money for the owner. Try adding $55,000 plus reasonable growth for 5 years and determine what the total would be? Remember that there is no tax on the $55,000 plus earnings until it is withdrawn when the expectation is that the owner will have much lower taxes having retired with much less income.