You may be wondering what you can do now to save on taxes in April 2016. The fourth quarter of this year and the first quarter of 2016 are the best times to focus on tax reduction. Federal income and capital gains taxes are higher than they have been in more than 20 years. Depending on your circumstances, the ideas in this article could save you tens of thousands of dollars on your 2015 income tax bill.
STRATEGIES TO REDUCE TAXES
No. 1. Maximize the tax benefits of your qualified retirement plan
Most physicians have some type of qualified retirement plan (QRP) in place, which includes 401(k) plans, profit-sharing plans, money purchase plans, defined benefit plans, simplified employee pension plans, or simple individual retirement arrangements (IRAs). Most of these are not maximized for deductions for the business/practice owner(s). Many owners may be using an outdated plan and foregoing further contributions and deductions permitted under the most recent rule changes of the Pension Protection Act of 2006. By maximizing your QRP under the new rules, you could increase your deductions significantly for 2015 and reduce your taxes.
No. 2. Implement a nonqualified plan
Unfortunately, most physicians begin and end their retirement planning with QRPs. Many have not analyzed, let alone implemented, other types of benefit plans. Have you explored nonqualified plans in the past 2 years? The unfortunate truth is that many doctors are unaware of plans that enjoy favorable short- and long-term tax treatment. If you have not yet analyzed all the options, we highly encourage you to do so. Several of these plans can reduce your taxable income for years as part of a tax diversification strategy.
No. 3. Consider a captive insurance company
Captive insurance companies (CICs) are used by many Fortune 1,000 businesses for strategic reasons. For a medical practice, a CIC can be equally beneficial. Practice owners can create their own properly licensed insurance company to insure all types of risks to the practice, many of which have little coverage from insurance companies. Such risks can be economic (that revenues drop), business (that electronic records are destroyed), or litigious (coverage for defense of harassment claims or wrongful termination). CICs can also be used for surgery centers and real estate. If created and maintained properly, the CIC can enjoy tremendous income tax benefits that can translate into hundreds of thousands of dollars in tax savings annually.
No. 4. Prepay 2016 expenses in 2015
As the year winds down, we typically counsel cash-basis clients to prepay some of the following year’s expenses. As long as the economic benefit of the prepayment lasts 12 months or less, prepaying can be done. Since the highest marginal 2016 tax rates will likely be the same as those in 2015, prepaying makes sense because of the benefit of the early deduction.
STRATEGIES TO REDUCE TAXES ON INVESTMENTS
No. 1. Plan for the 3.8% Medicare surtax
Beginning in 2013, the tax law imposed a 3.8% surtax on certain passive investment income of individuals, trusts, and estates (Table). For individuals, the amount subject to the tax is the lesser of either (1) the net investment income (NII) or (2) the excess of a taxpayer’s modified adjusted gross income (MAGI) over an applicable threshold amount.
NII includes dividends, rents, interest, passive activity income, capital gains, annuities, and royalties. Specifically excluded from the definition of net investment income are self-employment income, income from an active trade or business, gain on the sale of an active interest in a partnership or S corporation, IRAs, or qualified plan distributions and income from charitable remainder trusts. MAGI is generally the amount reported on the last line of page 1 of Form 1040 adjusted by the aforementioned nonincludible items.
Here is a simple example of how the tax is calculated. Al and Barb, married taxpayers filing separately, have $300,000 of salary income and $100,000 of NII. The amount subject to the surtax is the lesser of (1) NII ($100,000) or (2) the excess of their MAGI ($400,000) over the threshold amount ($400,000-$250,000 = $150,000). Because NII is the smaller amount, it is the base on which the tax is calculated. Thus, the amount subject to the tax is $100,000, and the surtax payable is $3,800 (.038 x $100,000).
Fortunately, there are many effective strategies that can be used to reduce MAGI and/or NII as well as the base on which the surtax is paid. These include (1) Roth IRA conversions, (2) tax-exempt bonds, (3) tax-deferred annuities, (4) life insurance, (5) oil and gas investments, (6) timing estate and trust distributions, (7) charitable remainder trusts, (8) installment sales and (9) maximizing above-the-line deductions.
No. 2. Use charitable giving for capital gains tax planning
There are many ways you can make tax-beneficial charitable gifts and help your family as well. Charitable remainder trusts, charitable lead trusts, and private foundations can be used, within the rules established by the Internal Revenue Service, to benefit charitable causes, reduce taxes, and retain some benefits for families. If you have considered any of these tools in the past, implementing them in a year of high income might be a good idea.
CONCLUSION
Exploring these ideas for you or your practice could reduce taxes on 2015 income and beyond. The key is to take the time to evaluate which of these concepts may work for you. n
Carole C. Foos, CPA, is a principal and lead tax consultant for the OJM Group in Cincinnati, Ohio. Ms. Foos may be reached at (877) 656-4362; mandell@ojmgroup.com.
David B. Mandell, JD, MBA, is a former attorney and author of 10 books for doctors, including For Doctors Only: a Guide to Working Less & Building More, as well a number of state books. He is the principal of the financial consulting firm OJM Group in Cincinnati, Ohio. Mr. Mandell may be reached at (877) 656-4362; mandell@ojmgroup.com.
