Planning For A Bigger Tax Bite
Summer has a way of making the stress of last tax season seem like nothing more than a bad dream, not to be relived for many months. But it’s no time to slack off. Rate increases scheduled for the 2011 tax year will affect practice owners, which means acting now to make the most out of the 2010 season.
Small-business owners can expect to see a tax hike of $11 billion over the next 10 years, says Mark McGaunn, CPA/PFS, CFP, the managing member of the accounting firm McGaunn & Schwadron of Needham Heights, Mass. Rate and tax law changes will be substantial enough to be noticeable, he says.
If a veterinarian’s practice generates a $156,800 profit and she withdraws $106,800 via payroll as salary and pays the remaining $50,000 in profit as a distribution of the profits from the S Corporation, a new law will assess an additional 15.3 percent self-employment tax on that distribution. That’s an extra $7,650 going to the government in 2010.
“The tax increase was included in the American Jobs and Closing Tax Loopholes Act of 2010, a mix of extensions of expired tax breaks, spending and physicians’ reimbursement formulas,” McGaunn says. “The Democratic-based Senate version of the bill includes the same tax on small business, leading most to believe there won’t be much of a change.”
The bill, HR 4213, is working its way through Congress.
CPAs say 2011 rate increases will hit those the government believes have wealth and need heftier taxing. The targeted group, some say, comprises those earning $200,000 a year and couples earning $250,000 and filing jointly. The same bracket could face more tax increases in 2013, they say.
“One of my veterinary clients is looking at paying about $8,000 more in 2010 Alternative Minimum Tax (AMT) with virtually the same income as 2009,” McGaunn says. “Most people are only concerned with the regular income tax because that’s what they understand, but these additional layers of 2010 tax law changes don’t see much press. I think veterinarians are in for a surprise.
“This client’s income was at the $350,000 gross income range, but most of my dental, physician and veterinary clients already paying the AMT for 2009 are finding additional bills of $4,000 to $8,000 for 2010 when we are doing tax projections,” McGaunn says. “One veterinarian with a $460,000 gross income is paying $17,000 in AMT, which is $7,000 greater than she paid in 2009.”
One constant tax that high-earning veterinarians experience is the AMT, which citizens either have to pay annually or are exempt from. The exemption rollbacks for 2009 were $46,700 for individual taxpayers, $70,950 for married taxpayers filing jointly and $35,475 if married and filing separately. For 2010, the exemption amounts will drop to $33,750 for single taxpayers, $45,000 for married taxpayers filing jointly or qualifying widower(s) and $22,500 if married and filing separately. That means a lot more people will be writing checks to the U.S. Treasury.
“The new exemption rate is expected to affect one in five taxpayers,” McGaunn says. “For years, becoming a corporation was a way to get away scot-free, so to speak. Now it will be time to pay for that past freedom.”
In 2010, the rules governing who can invest in a Roth IRA are changing. The change is part of the Tax Increase Prevention and Reconciliation Act of 2005, which allows anyone with an existing traditional IRA to convert to a Roth IRA regardless of income, says Carol L. Amernick, CPA, P.C., of Richmond, Va.
“The younger the individual is when they make the conversion the better,” Amernick says.
While regular IRA rules remain the same, the conversion tax will be paid over two years.
“The tax for the conversion for traditional IRAs to Roth will be paid in 2011 and 2012,” says Raymond Bald, CPA, a principal with Cummings, Lamont & McNamee, P.A. in New Hampshire. “This, along with the other changes, makes 2010 an unusual year for tax planning. There haven’t been this many rate increases and tax law changes since Bill Clinton was in office.”
The 3.8 percent investment tax, combined with the expected Jan. 1, 2011, expiration of the Bush tax cuts for high-income taxpayers, would produce a 2013 federal income tax rate of 23.8 percent on long-term capital gains from the sale of securities, up from the current 15 percent.
“Sell appreciated stock later this year to benefit from the 15 percent rate,” Bald says. “This will help you reduce tax liability in 2011. If you sell stocks in 2010, you won’t have to pay the additional tax percentage.”
The Social Security tax is 12.4 percent of the first $106,800 in wages, with half paid by the employer and half by the employee. Those who are self-employed pay the entire 12.4 percent. The Medicare tax is 2.9 percent with no cap on the amount paid. This is split between the employer and employee, with the self-employed paying 2.9 percent.
One way that S Corporation shareholders limited their Social Security (FICA) and Medicare tax hit over the years has been to take a salary, given sufficient income, close to the FICA limit of $106,800 and report the rest of the practice’s profits as pass-through income on their personal tax return rather than as salary and not pay payroll taxes on that profit, McGaunn says.
“As long as they and their CPA determined their practice salary was ‘reasonable,’ to comply with Internal Revenue Service mandates, this was acceptable,” he says. “It has become more difficult for the IRS to determine, and veterinarians to substantiate, what is reasonable compensation and what is unacceptable. There is no magic formula.
“Now with HR 4213, all S Corporation pass-though income would be assessed with a payroll tax, similar to partnership or LLC taxation. And those payroll taxes would be levied regardless of whether the profit was actually distributed to the shareholders.”
Taxpayers can still use laws to their advantage, which is why using a certified public accountant not only can help with compliance but also save money.
“Every time the government changes the law, we find a new way to maximize opportunities,” says Gary I. Glassman, CPA, with Burzenski and Co., P.C., in East Haven, Conn. “Rates might increase, but there are ways to get the most out of qualifying deductions.”
Hire the Unemployed
If an employer hires a worker who was unemployed, the employer is eligible for a tax credit, Bald says. A CPA can determine eligibility for the credit.
“If the employer keeps the person on staff for 52 weeks, they can get $1,000 or 6.2 percent of the employee’s wage deducted from taxes.”
Section 179 of the U.S. Internal Revenue Code details expense deductions. For 2010, the maximum amount of equipment placed into service that businesses can expense was expected to drop to $135,000, down nearly half from the 2009 limit of $250,000, but a last-minute reprieve was granted. The $250,000 limit remains for 2010, with limitations, but is again expected to be reduced in 2011.
Keep Good Records
CPAs say veterinarians need to be organized and have a basic understanding of business tax laws. Keeping organized receipts is a starting point, but software like QuickBooks should include everything veterinarians need to maintain a digital record.
“Too much tax talk tends to make people’s eyes gloss over,” Bald says. “I try to tell my clients to create a system that meets requirements but is simple. Decide if the practice owner or a manager is in charge of the record keeping. If [you are] audited and errors are found, any unsupported deductions will be disallowed.”
Go on a Treasure Hunt
Not being organized is one of the worst tax errors, tax advisers say. Considering that CPAs are typically paid by the hour, being disorganized hits your wallet in more ways than one.
“The more difficult it is to find information, the more the CPA is being paid,” says Tom A. McFerson, CPA, ABV, a partner with Gatto McFerson Certified Public Accountants in Santa Monica, Calif. “Not being able to back tax claims with receipts is a gamble with the potential of an audit.
“Being audited is no fun. The faster you can provide the information they’re looking for, the sooner they get out of your office and stop distracting you from your practice.”
On average, the expense of hiring a CPA is outweighed by his expertise in finding deductions and for audit protection.
If the IRS Shows Up
Staying in communication with a practice’s CPA throughout the year means learning about tax law changes and fewer surprises.
“I send letters to all my clients alerting them to tax law changes that would affect them,” Amernick says. “There are a lot of assumptions as to what is and what isn’t tax deductible. Also, the sooner veterinarians begin preparing for what they might owe in taxes, the less shocking their return will be.”
The IRS website — www.IRS.gov — posts the Veterinary Audit Technique Guide, which outlines some of veterinarians’ main areas of exposure, Glassman says.
“I’d recommend that every veterinarian look at the guide,” Glassman says. “It helps veterinarians understand the areas the IRS looks at in a veterinary practice.”
Amernick says she can’t help clients keep good records or write off a deduction when there’s no evidence.
“I can shield clients from some tax burden by mitigating the tax effect,” Amernick says. “We don’t worry about taxes until we make money, then we try to shelter it. Having a strong knowledge of the living, breathing tax law means the best protection.”
Continuing education is part of many careers, but for CPAs the rules historically change at least every two years.
“The trick is to not let the tax tail wag the dog,” McGaunn says. “Stay ahead of the game and plan. All you can do is prepare. After that, it’s out of your hands.”
This article first appeared in the August 2010 issue of Veterinary Practice News. Click here to become a subscriber.