Prepare to Meet the Challenge of Tax Planning

When the last out was recorded in the 2003 World Series, the curtain came down on baseball for another season. There was no going back, no do-overs, and no second chances—just 1 more baseball season to add to the record books. All that was left to do was close the door, turn the page, and echo the infamous battle cry, "Wait until next year."

The major difference:

When it comes to preparing for next spring's income tax season, it's a similar scenario. As long as 1 team keeps hitting and the other fails to record the final out, the season can be lengthened. With income tax preparation, however, when the clock strikes midnight on December 31, 2003, the year officially ends and so does your chance to take advantage of any tax preparation strategy.

The good news is, there's still time. In all likelihood, more than a month remains in the 2003 tax season. And there are a number of strategies you can employ now to help you maximize your 2003 tax return next spring.

Successful Tax Planning

One of the most basic strategies for year-end tax planning is to accelerate expenses and defer income, assuming, of course, that you're not going to be in a higher income bracket next year. If you anticipate being in a higher income bracket in 2004, the reverse applies: accelerate income and defer expenses.

How can you defer income? Start by mailing patient billing statements after December 31. This guarantees that payments will not be received until 2004. If you need to accelerate income, make certain to mail those billing statements by late November, indicating that payment is due within 30 days.

When it comes to accelerating expenses, there's a lot you can do. For starters, take an inventory of all office supplies and purchase several months' worth before the end of 2003. Even if you make the purchase with a credit card, the IRS allows a deduction in the year that the charge was made, not when the bill is paid. In addition, pay all outstanding bills by the end of the year; this includes subscriptions to professional journals in your field, as well as any dues you pay as a member of a professional association.

Paper trail:

If you regularly make charitable contributions, do so by December 31. You get the deduction, and the charitable organization will appreciate receiving the contribution that much sooner. The contribution can be monetary, or it can take the form of old office furniture that you want to replace. The money used to purchase the new furniture can help you further accelerate expenses. Remember to get a receipt for any charitable contributions you make.

Major Opportunities

Tax law changes have created catchup provisions, which allow certain individuals to contribute more to their retirement accounts. For example, in 2003 you can put up to $12,000 in a 401(k) and $3500 in an IRA if you're age 50 or older and a sole proprietor. But according to Brent Chapman, director of retirement services for Metavante Wealth Management (800-236-3282), those numbers are small compared to the potential tax savings offered by a defined-benefit plan.

Chapman points out that while defined-benefit plans have been around for a while, recent tax law changes allow a much larger amount of money to be funded in 2 ways. Previously, an individual had to be at least age 50 to make a significantly higher contribution to their defined-benefit plan. Now, individuals as young as age 42 can put up to $150,000 aside pretax out of their company.

"The second issue," Chapman says, "is that in the past, previous contributions made into the retirement plan were used to offset future contributions. If your bucket was already one third full, you could only fill it up another two thirds and then you were done. Now, past contributions are not counted against future ones. That has really opened the door for individuals to make significantly greater dollar contributions."

A key point to note is that with a defined-benefit plan, contributions must also be made for staff. However, Chapman suggests that rather than considering this an added expense to the practice, think of it as a benefit. These plans usually tie in vesting schedules, thereby attaching a value to the plan and adding an incentive for employees to remain with the practice. In addition, by funding a retirement plan in lieu of an employee bonus, the practice avoids paying out a payroll tax.

"If you're talking about $30,000 or $40,000 in bonuses at 7% or 8%, that's several thousand dollars more in payroll taxes for the employer," Chapman explains. "But by funding a defined-benefit plan instead, you save that payroll tax."

If you have children or grandchildren, you can further maximize contributions by funding a 529 savings plan to help pay for their college education. Nearly every state has a plan, and most have generous maximum contribution limits, some as high as $250,000 per beneficiary. Earnings from a 529 plan are exempt from federal taxes, as are any withdrawals, provided they're used toward college costs. Some states waive state taxes for residents, while others allow deductions on contributions.

Smart Purchases

The 2003 tax act, in stark contrast to the 2002 version, didn't specifically add much that was new or take away anything. What it did do, however, was accelerate many of the tax cuts that were put in place in 2001. One of those areas is depreciation deductions related to the purchase of business equipment. For physicians considering year-end purchases of office and/or medical equipment, this is some very good news.

Increased savings:

In 2002, President Bush signed the Job Creation and Worker Assistance Act, containing a September 11 bonus depreciation rule. It stated that in addition to the $24,000 annual deductible allowance for business equipment purchases, a 30% bonus depreciation would exist on purchases made between September 11, 2001, and September 10, 2004. In 2003, the bonus depreciation is 50%.

In addition, there has been a significant change in the Section 179 rule. According to Philip Goldfarb, CPA, and partner of Weisberg, Mole, Krantz & Goldfarb LLP (www.weisbergmole.com), the previous rule regarding depreciation deductions stated that you could expense 100% of any equipment purchased as if it were completely deductible. Of course, there were limits. In 2002, you could only do that for the first $25,000 of equipment you bought. Now the limit has been increased to $100,000. So, if a physician group purchases $100,000 of medical equipment, as long as it has a profit of $100,000 or more to deduct it against, the entire amount can be deducted.

One key caveat, cautions Harvey Snider, Jr, CIMA, vice president, wealth management advisor for Merrill Lynch (www.ml.com), is not to let the tax tail wag the investment dog. Before making a large purchase, he suggests looking at the business shape of the overall practice. Is the equipment you're considering purchasing vital to the practice? Is it the right time to make a large purchase?

"These are factors that should enter into the decision," Snider says, "especially the type of purchase. One person might be looking to purchase another MRI unit, but for someone else it might just be a copy machine. Those are entirely different purchases with different returns. That's why it's important to sit down with your CPA or tax attorney and consider what the bottom-line savings of the purchase is to you."

Decreased Taxation

Today's market, while improving, is anything but stable. If you're 1 of the many investors who has unrealized losses, you can deduct up to $3000 per year in losses on your income tax. Any amount above $3000 gets carried over to the following year. That may not seem important now, but when the market improves and you experience some capital gains, you'll be able to offset those gains with the losses you carried over.

However, for those investors who are fortunate enough to have experienced gains during 2003, recent changes in the tax act might make you smile even more. The capital gains rate for tax purposes, which used to be 20%, is now 15%. And dividends, which used to be taxed at ordinary income tax rates depending on your tax bracket, are now being taxed at a rate of only 15%.

"The change is supposed to encourage people to buy stocks that were paying dividends," Goldfarb explains. "It was President Bush's way of trying to spur the economy. But dividends don't only come from a public company; they can come from any corporation." And that has created a dilemma.

Goldfarb explains that when physicians set up a corporation, they often take salary and bonuses from the profit so that at the end of the day the corporation breaks even. The physicians pay taxes on their salary, but the corporation doesn't pay tax because the income has essentially been eliminated. However, with the dividend rate reduced to 15%, is it more advantageous to take money out as salary or as dividends?

Caveat:

"If physicians take the money out as salary, they're going to pay the higher ordinary income tax rate," Goldfarb says. "If, as shareholders of the corporation, they take it out as dividends, they can pay at the lower dividend rate." If the money comes out as salary, it's a tax deduction for the corporation. If it's removed as dividends, the corporation loses the deduction.