Prepare for the Future Through Tax, Retirement, and Estate Planning
Medical Economics Feature -- April 2000
By Johanna Franke
Ah, springtime. The birds are singing. The flowers are blooming. The Internal Revenue Service (IRS) is knocking at your door.
Keeping up with the financial burdens of your practice is tough enough, but adding personal finance planning to the mix can make you feel -- don't groan -- overtaxed. Even though this year's IRS deadline is just days away, experts say it's never too soon to start preparing for next year -- and the rest of your life.
If you haven't thought about filing your 1999 income tax return yet, run, don't walk, to your nearest accountant and ask for an extension.
"At this stage of the game, tax preparers are up to their eyeballs, but a preparer will still respond by helping physicians file a Form 4868 to give them an extension until August 15, 2000," said David Hunt, practice management consultant and owner of Doctors Management Services in Waco.
This extension applies only to the filing of the form -- not payment of a balance due, Mr Hunt says. "What this does is give you time to pull together the paperwork properly. If you believe you're going to owe on your return, you need to get that paid at the time the extension is filed on April 17. If you pay too much, you'll receive a refund and, if, in spite of your best efforts, you didn't pay enough, you'll have to pay whatever balance is due in August, as well as a penalty for missing the April 17 deadline."
And how will you pay this balance and penalty? Try your plastic.
The IRS now accepts payment of taxes by credit cards, though Mr Hunt doesn't advise this. "Most likely, your credit card interest rate is going to be higher than the IRS's," he said. "So if you intend to pay your balance out over a long period of time, you really should go with the IRS's Installment Agreement Request."
You can arrange your installments by filing Form 9465 and paying a $43 user fee as well as interest and penalty charges on unpaid balances.
To minimize your balance due, the November 8, 1999, issue of Medical Economics offers these reminders:
- Count all your dependents. You know you can claim a personal exemption -- $2,750 for 1999 -- for each dependent child along with one each for you and your spouse. But you can get another $2,750 exemption if you provide more than half the support of a parent or someone else who qualifies as a relative and whose gross income for tax purposes is less than $2,750.
- Look to your home. Certainly you can deduct your home mortgage interest, but you also can deduct points the lender charged up front for a mortgage to help you buy your main home.
- Deduct miscellaneous expenses. To effectively deduct for miscellaneous expenses, they must be more than 2% of your adjusted gross income. If you need a push to get over that barrier for next year, consider paying your 2001 expenses for personal tax assistance and subscriptions to investment publications and medical journals this year. If you use a home computer to help with investments or taxes, you can depreciate part of its cost.
- Study your portfolio. Though it's a financial no-no, letting taxes influence your investment decisions may not be a bad thing. Check your portfolio for stocks you can sell to offset gains or losses you have taken already. You may do better using losses to offset ordinary income instead of capital gains.
Another way to make sure the IRS receives less is to give more, and the gift that keeps on giving is appreciated stock, Mr Hunt says.
Say you bought stock a couple of years ago for $5,000, and it has appreciated to $15,000. You haven't paid taxes yet on that increase in value. "If you transfer that $15,000 over to your church's brokerage account, you get to deduct $15,000 -- not just the $5,000 cost basis that you paid for the stock," Mr Hunt said. But if you sell the stock for $15,000 and give the money to the church, you would get to deduct that $15,000, but you also would have to pay capital gains tax on the $10,000 you earned, Mr Hunt cautions.
The qualified appreciated stock tax provision that allows this was scheduled to expire on July 1, 1998, but an amendment to the Tax Relief Extension Act of 1998 extended it permanently. Trying to apply this tax provision to gifts other than stock won't work, Mr Hunt says. "If you give a van to the church, and even if it somehow appreciates in value, what you would write off would be just the cost of the van." Usually automobiles go down in value, and, in that case, your deduction would not be the cost basis but rather the fair market value of the vehicle at the time you donated it, Mr Hunt adds.
Some physicians have taken charitable deductions a bit too far. One physician group wanted Mr Hunt to write off the group's copier because the doctors had given it to a church office. Mr Hunt explained to the physicians that they already had deducted the copier as a business expense when they purchased it.
Nice try, though.
Covering your assets
The key to financial planning is asset allocation and protection, says Dale Cooper, a certified public accountant at Cooper Graci & Company in Austin.
Lately, physicians have been using family limited partnerships to protect their assets as well as transfer wealth to their children while still controlling the assets.
For example, say you own real estate and you decide to give your children some part of it each year. If you make direct gifts to them, you'll need to file deeds every time you make a transfer, and you'll wind up with several owners of undivided interests. This can be very cumbersome when it's time to sell the property, Mr Cooper says.
"With a family limited partnership, you transfer the property to the entity up front," he said. "You usually receive a 1% general partnership interest and a 99% limited partnership interest."
Then you give each child $10,000 worth of the limited partnership interest each year, gradually increasing their ownership. As general partner, you retain control over all decisions while you're moving your assets to your children, who are most likely in a lower tax bracket.
Another advantage of family limited partnerships is the ability to discount the value for gift and estate tax purposes. This allows you to transfer a larger percentage each year, Mr Cooper says.
"The family limited partnership is an easy way to give to the kids and, at the same time, keep those assets a little more protected from creditors just in case something goes wrong with a malpractice issue," Mr Cooper said.
Retirement plans offer protection for your assets as well. The advantage to most retirement plans is the ability to make contributions after year's end and still get the tax deduction in the current year, Mr Cooper says. Though you can choose from a vast array of plans, you may be drawn to those that include the word "simple" in their titles.
Mr Hunt recommends a simplified employee pension individual retirement account, or SEP IRA, which is extremely popular among small business owners and sole proprietors. If you own your practice, you may contribute up to 15% of the salary you pay yourself, but your maximum annual contribution is limited to $24,000. Remember that if you establish an SEP plan for yourself, you must offer a similar plan to your employees and fund their plans with contributions of your own. For example, if you contribute 10% of your salary to your own plan, you must also contribute 10% of each worker's salary to his or her individual plan.
"The reason it's so simple is there's no plan adoption agreement," Mr Hunt said. "To set up an SEP IRA, all you have to do is fill out a one-page form from your bank or brokerage firm. There's no annual reporting form or 5500 forms to be filed."
A second option is the Savings Incentive Match Plan for Employees (SIMPLE), a new tax-favored retirement plan that allows employees of small (100 or fewer employees) businesses and self-employed individuals to make salary-reduction contributions to an IRA. SIMPLE contributions cannot exceed $6,000 per year, and the contributions must be a percentage of the participant's earnings that is specified by the participant.
Another way to protect your assets is simply to invest in what you know, Mr Cooper says . "Most physicians probably know more about MRIs than real estate, so they should invest accordingly."
The state of your estate
Though estate planning may not be a priority for you now, you might start considering it or risk turning in your grave for all eternity if your money ends up in the wrong hands.
"Estate planning is something that everybody puts off," said David MacCulloch, JD, manager of the new estate planning program at Mercer Global Advisors in Santa Barbara, Calif. Mercer is endorsed by the Texas Medical Association to provide financial planning and investment services to TMA members.
"You're talking about death, money, and family. These are very personal topics, and people generally are not comfortable discussing them," Mr MacCulloch said. "But estate planning is an important piece of your financial planning puzzle."
Often the issue of child responsibility comes up. "Our clients will tell us, 'We want to make sure that whatever we leave to our kids becomes an incentive, not a disincentive for them,'" Mr MacCulloch said.
Mercer uses a value-based approach to estate planning by studying their clients' values, goals, and objectives for their money through interviews and a questionnaire. "Is maximizing the amount of wealth you leave to your children the utmost priority? Is it more important to eliminate estate taxes, even at the expense of making less wealth available to your heirs? How important is it to leave a legacy to charities? Everyone's estate planning goals are unique to them. There is no one perfect estate plan out there. The perfect plan is the one that reflects the client's objectives regarding the distribution of their wealth," Mr MacCulloch said.
Most estate plans focus on maintaining control of your wealth now and in the future as well as eliminating your estate tax exposure. "The problem," he said, "is there isn't a positive correlation between these two objectives."
Basically, when the IRS calculates your estate tax, it looks only to those assets that you own, Mr MacCulloch says. "The trick is to strike a balance the client is happy with and help him understand that more control means more estate tax and less control means less estate tax. The simplest way to release ownership of assets is to begin a gifting strategy by making tax-free gifts of $10,000 or less to family members and friends on an annual basis."
Proceeds of life insurance policies, while not subject to income tax, are included in the value of your estate and are subject to estate tax upon your death. For this reason, many physicians use irrevocable life insurance trusts to be the owners of the life insurance policies and keep the benefits free of estate taxes, Mr MacCulloch says.
"Most physicians, by the time they retire, do not need life insurance for the original reason they purchased it -- to replace income lost due to premature death," Mr MacCulloch said. "Instead, they now use it as a wealth replacement tool to replace those assets lost to estate taxes."
Charitable remainder trusts also are a popular strategy with physicians, Mr MacCulloch says.
"Charitable trusts are a great way to move high appreciated, low-cost assests out of your estate, thereby eliminating any capital gains taxes, reducing estate tax exposure, and receiving an income tax deduction," Mr MacCulloch said. "They also provide a stream of income to you or your heirs for the term of the trusts and provide a charitable legacy to your favorite organization, such as the TMA Foundation."
Trusting advisors with your trusts
When selecting your business advisors, look for honesty, knowledge of financial matters, command of the tax laws, and expertise in the medical profession, Mr Cooper says.
"This can be hard to judge," he said. "If I prepare your tax return, and it comes out looking like a nice, neat package, and you don't get any notices from the IRS, you don't know whether I did my very best job or my very worst job."
Asking questions and checking references, whether you're working with an accounting firm or a law firm, will help you determine which firm is right for you.
Mr Cooper suggests you interview a potential business advisor in the same manner an informed patient might question a physician. "You might ask, 'Have you had specialized training in this area?' and 'How many times have you performed this procedure and what were the outcomes?'"
Mr MacCulloch says if you employ multiple advisors, be aware that you may receive conflicting advice on particular matters. To avoid this, you may want to employ one advisor to serve as the "coach" or "quarterback" of your consultant team, he adds. "This quarterback should be a fee-only advisor, like Mercer -- one who does not earn any commission on transactions or sells products."
As a physician, your practice finances and personal finances often become intertwined, so find a firm with medical industry expertise that also can handle your personal planning, Mr Cooper advises. Your colleagues and county medical societies can help you find advisors in your area.
TMA Advantage: Financial planning for the 21st century
While you're celebrating Memorial Day Weekend at TexMed 2000 in San Antonio next month, attend the investment seminar "21st Century Financial Strategies for Physicians," from 2 to 3:30 pm on Friday, May 26.
Experts from Mercer Global Advisors will teach you the keys to building wealth, reducing taxes, retiring well, and crafting an effective estate plan. You also will learn the four biggest mistakes investors make and how to avoid them.
Mercer financial consultants also will be conducting free 30-minute, no-obligation consultations with TMA members on retirement planning, college funding, life insurance, practice transitions, and estate planning.
For registration and location information, call Mercer directly at (800) 462-1580.
Online tax resources
The February 7, 2000, issue of Medical Economics (www.memag.com) lists the following as "the best Web sites for taxpayers." Check them out!
Family Press Tax Guide for Investors
Internal Revenue Service
Small Business Taxes & Management
The Tax Prophet
Uncle Fed's Tax Board
AMA financial sourcebook
For advice on investments, risk management, and retirement tools, look to the Physician's Financial Sourcebook, offered by the American Medical Association. The $30 book also covers topics such as debt management, estate planning, and selling your practice. To order, call AMA Subscription Services at (800) 262-2350.
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