By Adam Cmejla, CFP®
Feb. 20, 2019
Tax-paying season is upon us, but there are still measures you can take to lessen your tax burden from the previous year.
I emphasize to the practice owners I work with that for nearly every aspect of financial planning, it’s much more effective and efficient to be proactive than reactive to your strategies. Tax planning is no exception. Even though most tax reduction strategies must be implemented before year-end, there are still a few “arrows in the quiver” that can be used post-12/31 to help you write checks payable to yourself instead of “U.S. Treasury.” The key is that the strategies discussed here will either directly or indirectly reduce your AGI (Adjusted Gross Income) on your personal return.
Important note: The IRS recently raised the limits and dollar amounts on most planning strategies. Keep in mind that all strategies referenced below need to be done using 2018 numbers. In addition, make sure you consult with your own advising team to determine whether the strategies mentioned below are applicable to your own circumstances.
Fund your HSA. The HSA (Health Savings Account) is one of the most under-utilized planning vehicles available to practice owners and others. This is unfortunate because it can be one of the most impactful planning tools to use in short- and long-term planning.
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The HSA is only able to be used if you are on a HDHP (high deductible health plan), which means that your deductible must be at least $1,350 (single) or $2,700 (family). The max that you can contribute to the HSA (for 2018) is $3,450 (single) and $6,900 (family). If you are over age 55, there is an extra catch-up contribution of $1,000 that’s allowed.
Why do I like the HSA so much? It has a “triple tax benefit.” You (1) get a deduction on your contributions, (2) if you invest the contributions, the earnings grow tax deferred, and (3) distributions for qualified expenses come out tax free! No other type of account has these rules.
When compared to other planning strategies, there are additional benefits to the HSA. There are no income caps on whether you can deduct or contribute to the account. This means that whether you make $100,000, or $1,000,000, you will be able to contribute and deduct the contribution. In addition, once you are over the age of 65, distributions from an HSA that are not used for health-care expenses are not assessed an additional 20 percent tax (though you will pay ordinary income taxes on them, much like distributions from your Traditional 401(k) or IRA). Distributions can also be used to pay for Medicare premiums in retirement, but keep in mind that once you are on Medicare, you can no longer make contributions to the HSA.
Contribute to SEP IRAs. Contributions to SEP IRAs can be made up until the time that you file your taxes, plus extensions. SEP IRAs are a favorite among self-employed ODs that are in a 1099 relationship, and do not have any employees, because of the relatively high contribution limits and flexibility in funding amounts. Generally speaking, you can contribute as much as 25 percent of your net earnings from self-employment income for the year. SEP IRA contributions cannot exceed $55,000 for 2018.
Contribute to Traditional IRAs. If you have a retirement plan in your practice (like a 401(k) profit sharing plan), the ability to contribute and deduct your Traditional IRA contribution will be subjected to IRS limits. More times than not, if you have a qualifying retirement plan set up in your practice, such as a 401(k), SIMPLE IRA, etc., most ODs will not be able to deduct the contribution, though you are still eligible to make a non-deductible contribution. There are additional rules if you are not covered by a retirement plan in your practice, but your spouse is covered by a plan, so make sure to work with your team of advisors to understand your deductibility options. The maximum contribution amount for 2018 is $5,500 per individual, with an extra $1,000 catch-up amount for those age 50 and older.
Make Profit Sharing Contributions. Assuming that you already had a profit-sharing plan established in 2018, this strategy is generally one that is discussed and decided earlier in the calendar year (post 12/31, but pre-tax filing) as there are a number of related planning timelines that affect the decision of if/how much to fund.
First, your Third Party Administrator (TPA) is likely going to be asking you in mid-January to complete your plan’s compliance packet, which will aid them in the annual testing of your plan to ensure it is within IRS and Department of Labor rules while also giving them the information necessary to complete (and file) your Form 5500.
Meanwhile, your CPA (should) be giving you some estimated numbers for your corporate tax return, as S-corporation and Partnership tax returns are due March 15 instead of April 15, which is a month earlier than personal returns.
Remember that it doesn’t matter whether funds are sitting in your personal or business checking account: as the practice owner (and assuming your practice is set up as anything other than a C-corporation), you’ll personally pay taxes on what your corporate tax return says is your net profit, minus additional adjustments that are accounted for on your Schedule K-1.
If your practice has matured and there is a decent delta between net profits (after owner’s compensation) of the practice and what you need to take home annually to fund your personal lifestyle, making profit-sharing contributions can prove to be helpful. Not only are you putting away money for your retirement, but you get an immediate tax deduction on your corporate return on contributions that you make to the plan.
If you have employees, it’s important to understand how much of the profits you’ll have to share (hence why it’s called a profit-sharing contribution) with your team, but we’ll dive deeper into the nuances of calculating your “break even amount” in a future article, and the intangible benefits of “sharing the wealth.”
As mentioned, it’s much better to prepare than it is to repair a failed tax planning strategy. As you’re figuring out which strategies can help you keep more of your hard-earned dollars, use this time to proactively prepare for 2019.
Adam Cmejla, CFP® is a CERTIFIED FINANCIAL PLANNERTM Practitioner and Founder of Integrated Planning & Wealth Management, LLC, an independent financial planning & investment management firm focused on working with optometrists to help them reach their full potential and achieve clarity and confidence in all aspects of life. For a free copy of his “Top Five Tips to Financial Freedom” visit https://bit.ly/2Mo3NV8 and check out “The Dose Podcast” wherever you find your favorite podcasts to get more tips on making smart, informed financial and business decisions.