Aggressive Strategies To Convert Non-Deductible Expenses Into Legitimate Business Tax Deductions Under The New Law
June 2018Tax General/Other
With IRS audit rates declining, now’s the time to be more aggressive in taking every legal tax deduction. Through proper planning, you can convert everyday non-deductible personal living expenses into legitimate practice tax deductions. Below are our top strategies to slash your taxes using this technique.
Years of steep budget cuts have hit the IRS hard, resulting in a loss of nearly one-third of its enforcement (audit) staff since 2010. This has resulted in a decline in business and individual tax audits for six straight years, with current audit rates at the lowest level since 2002. Given this lower audit risk, you should be more aggressive in transforming non-deductible personal expenses into legitimate business tax deductions, using the following strategies.
- Children’s Private School, College, Graduate, and Professional School Costs – The average doctor is spending $1,056 monthly* from their personal non-deductible funds for education costs. In order to fund these costs with tax-deductible dollars, employ your children in the practice and pay them the highest reasonable compensation in exchange for their services. Under the new law, each child can receive up to $12,000 annually, free from federal income taxes. Our online-only article this month discusses the increasingly sophisticated job duties that can merit this higher tax-favored pay. The proceeds from their employment can then be used to pay for private school, college, graduate, and professional school costs.
If this income is insufficient to cover all educational costs, additional income can be shifted to college-age children by transferring your office building and/or dental and office furniture and equipment into a limited liability company (LLC), gifting the vast majority (95%) of the ownership interests to your children, and then leasing this property back to your practice at the highest reasonable rental rate. Alternatively, you can operate a lab and/or records business through your LLC to shift additional income on a tax-favored basis. Paying for educational costs with tax-deductible dollars can save the average doctor over $5,000, based on a 40% combined federal and state tax rate.
- Property Taxes – The average doctor is paying $932 a month in real estate and personal property taxes from personal funds. Unfortunately, the new tax law caps itemized deductions for state and local income taxes and property taxes at a combined total of $10,000 annually. Since most doctors’ state income and property tax payments are well above this limit, the new law’s cap will cause them to lose thousands in deductions. Here are three strategies to help.
First, unincorporated doctors should deduct all property taxes on their office building and equipment on their practice tax return (Schedule C) rather than on Schedule A (itemized deductions) where they will be subject to the cap. Other doctors who own their building and lease it to their practice should deduct the building property taxes on Schedule E (rental income and expenses) of their individual return, to escape the impact of the cap.
Second, you can rent a portion of your personal residence to the practice each year to use for storage and/or a home office, and deduct a portion of the real estate taxes on your home to offset the rental income on Schedule E. Alternatively, aggressive doctors could have their practice pay the property tax on their personal residence in lieu of rent to justify a full deduction, for tax savings of up to $4,000 annually.
Third, if you own a second home, consider converting it to a rental property and offsetting the rental income received by deducting the property taxes on your Schedule E in order to avoid the cap.
- Vacation Expenses – The average doctor spends $829 a month on non-deductible personal travel and vacations. Using three strategies, you can convert these costs into fully deductible business expenses. The first is to coordinate planned family vacations around continuing education meetings. When this is not possible, you should contact a dental colleague in your desired travel locale to arrange a practice visit. In order to properly document this, send a letter confirming your appointment, spend at least four hours one day making the visit, and then follow up with a thank you letter outlining what you learned from the experience. The third strategy, available only to incorporated doctors, is to conduct a board of directors meeting at the desired locale. In order to properly document this, you should have a written agenda, spend at least four hours one day in business discussions between the directors (usually the doctor and spouse) and thereafter document the meeting with corporate minutes reflecting the items discussed and actions taken. Converting personal vacation expenses into tax-deductible travel can save the average doctor over $3,900 in federal and state income taxes annually.
- Meals and Entertainment – The average doctor spends $594 monthly on non-deductible meals and entertainment personally. Through quarterly board of director meetings, shareholder meetings, retirement plan committee meetings, meetings with dental colleagues, and meetings with referring doctors and patients, you can still convert some of these meal expenses into tax-deductible (50%) status, even under the new law, for tax savings of up to $1,400 annually. In order to remain deductible under the new law, you must document the business purpose of the meal, including the topics discussed and individuals present, in order to avoid having this re-classified as non-deductible entertainment in the event of an IRS audit.
Furthermore, under a little-known exception surviving under the new law, entertainment expenses for theater and sporting event tickets, as well as health club membership expenses, can be 100% deductible if primarily for the benefit of the staff. Through distributing more of these tickets and benefits to the staff, rather than to you, you can take the position that these expenses are primarily for their benefit and not for yours. In order to avoid unwanted IRS scrutiny, categorize these expenses for full (100%) deductibility under a separate accounting category such as "office expense" or "employee benefits," rather than as "entertainment."
- Clothing Expenses – The average doctor spends $489 a month on non-deductible clothing. You can purchase uniforms for staff members (including your spouse) on a basis which is tax-deductible to the practice and a tax-free fringe benefit to the employees. In order to qualify, the uniform must be required as a condition of employment, and must not be adaptable for general use. Furthermore, aggressive doctors can purchase uniforms for themselves with the practice name and logo imprinted on them and deduct these items as "advertising and promotion." Converting these expenses into tax-deductible status will allow doctors to save up to $2,300 annually in federal and state income taxes.
- Home Repairs and Maintenance – The average doctor spends $481 a month here. Tax-savvy doctors can schedule home and office building construction, renovation, and other repairs concurrently. After negotiating an overall price for both, allocate the highest reasonable value to the practice building cost, with the minimum reasonable value allocated to the non-deductible personal project. Through utilizing this strategy, you can save up to $2,200 annually in federal and state income taxes.
- Family Medical Insurance – Some doctors continue to pay medical insurance premiums for themselves and their family personally, losing valuable tax deductions. Regardless of the business form in which you practice, medical insurance premiums for you and your family (including Medicare premiums) are fully deductible if paid through the practice, for thousands of dollars in federal and state income tax savings annually.
- Debt Service on Personal Automobiles – Doctors are spending an average of $279 monthly on debt service to purchase personal automobiles with non-deductible (after-tax dollars). While most doctors are deducting some business car usage, some are not. The reality is that virtually every doctor qualifies for at least some deductible automobile expenses on at least one business car (and two for doctors employing their spouse). Accordingly, you can sell one or more of your existing personal automobiles to gain tax-free cash and then have the practice purchase a business automobile to take advantage of the accelerated business car depreciation deductions available under the new law.
- Personal Auto Expenses – Likewise, pay all operating expenses (gas, oil, maintenance, repairs, taxes, tags, insurance, etc.) on your car, and that of the spouse (if employed in the practice) through the practice and deduct the business use percentage on your practice tax return. Be sure to keep a mileage log on a three-month basis in order to document your business use percentage. Since the average doctor is spending $291 monthly on auto expenses personally, converting these into tax-deductible business expenses can save up to $1,500 annually.
- Gifts – Doctors average spending $361 monthly on gifts for birthdays, graduations, weddings, holidays, etc. Tax-savvy doctors have the practice deduct the cost of gifts to patients or prospective patients as “advertising and promotion," for tax savings of up to $1,400 annually.
- Second Home Expenses – If not otherwise rented out, rent your personal residence and vacation home to your corporation to use for board of director meetings, shareholder meetings, staff retreats, staff training, and any other business meetings. The rental paid by the practice is tax-deductible, while up to 14 days of rental income can be received tax-free pursuant to Section 280A(g).
- Out-Of-Pocket Medical Expenses – The average doctor is spending $293 monthly on non-deductible medical expenses. Doctors who have a Health Savings Account (HSA) can receive tax-free reimbursements from their account. Those who don’t can be reimbursed under their practice’s Health Reimbursement Arrangement (HRA) if they do not provide staff health insurance coverage, and through a Medical Expense Reimbursement Plan (MERP) if they do provide coverage. Converting these out-of-pocket medical expenses into tax-deductible status can provide tax savings of up to $1,400 annually, in addition to the tax savings derived from the tax-deductible HSA contributions.
- Artwork, Office Furniture, and Antiques - Doctors are spending $223 a month on non-deductible furniture and artwork. Convert these purchases into fully deductible status by purchasing all new artwork through your practice and displaying it in your office. When new artwork is purchased, store the "old" artwork in your climate-controlled home, at no charge to your practice!
Furthermore, all furniture, office equipment, and supplies purchased for your home office use (typically where your spouse works from) should also be paid for by the practice on a tax-deductible basis. Finally, you should deduct the cost of antiques (clocks, rugs, cabinets, desks, bookcase, conference table, etc.) purchased and used in your practice and/or home office, in order to convert these expenses into tax-deductible status.
- Cleaning, Lawn, and Landscaping Expenses – Doctors are spending an average of $544 a month personally on expenses related to the cleaning and upkeep of their personal residence, which are not deductible. You should use the same vendor for both personal and practice services and have that vendor charge the maximum reasonable price for the practice services (fully deductible), and the minimum reasonable price for the personal services (non-deductible), to maximize your tax savings.
- Personal Trainer and Athletic Club Expenses – Tax-savvy doctors can convert these expenses, averaging $90 a month, into tax-deductible status through implementing a corporate wellness plan. One doctor employed a personal trainer to come into her office to provide regular counseling sessions to the doctor and staff on proper nutrition and exercise programs to improve practice productivity, reduce stress, and lower employee medical costs. As part of this program, the trainer gave regular personal training advice to the doctor and staff who requested such. The cost of all services were bundled and billed directly to their practice, which fully deducted them as a tax-free employee benefit.
- Nanny/Child Care Expenses – Doctors routinely spend thousands of non-deductible dollars annually employing a nanny or child care assistant. However, you can find part-time job duties within the practice for that individual as an administrative assistant and pay them the highest reasonable rate for their practice-related services (fully deductible), while paying the minimum reasonable rate for their personal child care duties (non-deductible). Ideally, the personal non-deductible salary would not exceed the maximum allowed for purpose of the child care tax credit ($3,000 a year for one child; $6,000 for two or more children) in order to generate the maximum child tax credit on your federal income tax return ($600 for one child; $1,200 annually for two or more children), while minimizing payroll taxes.
- Personal Legal and Accounting – While the cost of your personal tax planning and preparation is non- deductible under the new law, the cost of practice tax and business planning and preparation of related returns remains fully deductible. Accordingly, have your CPA bill the maximum reasonable amount for the fully deductible business-related services and the minimal reasonable amount for the non-deductible personal services.
- Personal Cell/Cable/Internet Expenses – The average doctor is spending $216 for these non-deductible expenses personally. Since you (and possibly other family members) are required to be available for emergency coverage, these expenses should be deductible. Likewise for cable and internet costs, since you (and your employed spouse) need remote access to office computers to work from home, and to monitor cable TV to review your advertising and that of your competitors. Also, monthly security system costs should be deducted by the practice in order to secure the home office and related contents. Converting these expenses can provide tax savings of about $1,000 annually.
- Dues and Subscriptions – The average doctor spends $253 a month on non-deductible dues and subscriptions. Tax-savvy doctors have all subscriptions ordered, paid by, and delivered to the practice for full deductibility. Likewise, all dues for professional and civic organizations should be paid by the practice for full deductibility. While dues to country clubs, athletic, and social clubs are non-deductible, aggressive doctors who use these facilities as part of their corporate wellness plan may achieve some tax deductibility.
The McGill Advisory content is provided for informational purposes only and does not constitute legal, accounting, or other professional advice.
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