Don’t give the government more of your hard-earned cash than you have to. With tax-filing season upon us, check out our tips for understanding tax laws and avoiding common mistakes.
Last year, an emergency department physician who does his own taxes forgot to declare a sale of stock on his tax return. The IRS caught this mistake and sent him a tax bill for the entire value of the stock sale, which was about $100,000. Now the ED specialist is struggling to figure out what he paid for the shares, so that he will only have to pay the tax (plus interest and penalty) on the amount he gained on the sale.
Not keeping track of the “basis” or the original value of stocks is a common tax mistake that physicians make, notes David Schiller, the Norristown, Pa., tax attorney who is advising this physician on how to prepare his amended return. The 1099 form that brokers send stock sellers merely lists the sale price of stock, he says, not the basis. It is incumbent upon taxpayers to list the basis of each stock they sell on the Schedule D attached to their federal tax form. If they do not include that information, Schiller says, the IRS regards the basis as zero and taxes the entire amount.
This is one of several tax mistakes that can cost you big money if you’re not careful. But getting a grasp of complex tax rules - and knowing which missteps to dodge - can help you hold on to more of your hard-earned cash.
Understanding the tax implications can also help when you inherit stock, Schiller points out. If your parent gives you stock before he or she dies and you sell it later, you have to pay tax on the full difference between the basis and the sale price. But if you receive the stock after their death, and then sell it, you pay tax only on the appreciation from the time you received the shares until the date of the sale.
While we’re talking about stock, consider donating appreciated stock to charities. Not only is the gift deductible, Schiller says, but also you don’t have to pay tax on the gain on the stock. Conversely, he says, if you had a loss on stock, sell it and give the money to the charity so you can declare the loss on your tax return.
Don’t lose out on tax-deferred accounts
One of the biggest tax errors that many physicians make, Schiller says, is to not create or not fully fund tax-favored retirement plans. In his view, they should start these plans at the beginning of their careers. “When you’re in your 30s and you fund a retirement plan, that’s your most valuable money, because you have 40 years of tax-deferred compounding in front of you.”
Steven Leininger, a certified public accountant and wealth manager in Walnut Creek, Calif., agrees that too many doctors fail to take full advantage of tax-deferred retirement accounts such as 401(k) and profit-sharing plans. Between these two kinds of plans, he says, a doctor can stash away up to $49,000 a year without paying tax on it. One way to do that, he says, is to have your spouse work part time in your practice. If she puts in just 20 hours a week, he says, the amount you can add to your 401(k) doubles from $16,500 to $33,000 a year. As for profit sharing, he adds, you have to give your employees some of that, but there are ways to maximize the contribution to your own plan.
Depreciation is another area where physicians can easily go astray. For example, Leininger points out, there’s a major difference between the tax treatment of equipment and fixture purchases, which can be depreciated over five and seven years, respectively, and major tenant improvements, such as renovation or expansion of your office, which must be depreciated over 39 years. You might want to write off the latter during the period of the loan you take out for the improvement, but that would be illegal, he notes.
Schiller agrees, but says that landlords may be willing to put up all or part of the renovation cost in return for a long-term lease and a personal guarantee. Normally, the landlord will ask for a lease lasting five to 10 years and will add the cost of the improvements to the rent. But, rent is deductible, so that means, in effect, that the practice is able to write off the cost faster than it would if the physicians paid for the renovation directly.
More modest improvements can be expensed immediately. For example, you can write off the cost of painting part of your office the same year it’s done. But because carpeting has a useful life of more than a year, Schiller notes, you’re better off putting it down as a repair and expensing it. You can justify that if you carpet only part of the office and the cost is not too high.
Some office equipment qualifies for accelerated depreciation (meaning you can write it off immediately) under Section 179 of the tax code, he adds. Altogether, Schiller says, you can deduct up to $125,000 worth of equipment per year, including computers that cost you $5,000 to $10,000.
Leininger cautions that you don’t want to deduct too much in a single year, because it might lower your tax bracket for just that year, while letting you boomerang into the highest tax bracket the following year. If you “straddle” the deductions over several years, you might save more in taxes overall, he says.
Don’t trade in your car
Depreciation of automobiles used in your practice can also be a tax saver, but you have to do it correctly. First, you need to keep good records to establish the percentage of business use of the car. If it’s more than 50 percent - a fairly easy mark for a physician to reach, says Schiller - you’re able to depreciate it more quickly. Second, if you sell the car rather than trading it in when you buy a new vehicle, “you get to accelerate the depreciation that you didn’t take while you owned the vehicle,” Schiller notes. “If you trade it in, the depreciation that you haven’t taken rolls into the next vehicle.”
Leininger agrees it’s a mistake to trade in a car that you use for business. “If you have an expensive luxury car, there’s a limit on how much depreciation you can take per year. So at the end of five years, the book value of that car is much higher than what you can trade the car in for. If you trade the car in, you don’t get to recognize the loss on the sale of the car, because it’s a like-kind exchange. You have to carry the loss on the car to the next car, so if you keep trading them in you never get to take a deferred loss.”
No limits to CME
Another mistake that many practices make in the business expense area is limiting the amount of money doctors can charge to the practice for continuing medical education, Leininger says. “They should be able to take as much as they want, as long as it meets IRS rules. They might have to take a reduction in salary to offset the deduction.”
For example, if the practice has a limit of $1,000 on CME expenses, and a doctor spends $2,500 attending a CME seminar, $1,500 of that is after-tax money that is coming out of his or her own pocket. So the physician would be better off taking less in salary, which is a pretax amount, and the practice would profit by deducting the full cost of CME as an expense, Leininger explains.
Finally, remember to get some good tax advice. If a defendant who represents himself in court has a fool for a client, the same can be said for a high-income individual who does his own taxes.
Ken Terry is a New Jersey-based freelance writer and the author of the book “Rx for Health Care Reform.” He can be reached at firstname.lastname@example.org. This article originally appeared in the January 2010 issue of Physicians Practice.