Why do dentists need tax planning so badly?
Experience shows that most dentists overpay in taxes and sometimes they pay in excess of $125 for every $100 they were required to pay according to the law. While analyzing the tax returns of dentists, it becomes obvious that the reason they overpay to Uncle Sam, their state, and their local jurisdictions, is lack of proactive tax planning on their part. By not taking advantage of all the nuances of the tax law and missing tax saving opportunities, these dentists are basically handicapping their financial future. A vast majority of them appears to be unaware of the existence of proactive tax planning. They take higher taxes as a fait accompli and simply complain among themselves while paying more and more.
Proactive tax planning is the process of creating a personalized tax strategy with the ultimate goal of minimizing the tax burden and then implementing it throughout the year. Tax planning is aimed at tax management based on a thorough understanding of the tax code. The United States Supreme Court has held that tax planning to reduce ones taxes is perfectly legal. “There is nothing wrong with a strategy to avoid the payment of taxes. The Internal Revenue Code doesn’t prevent that,” former Chief Justice, William H. Rehnquist wrote.
The key here to understand is that proactive tax planning and its implementation needs to be done during the year. Once a tax year is over, there is basically not much that can be done to reduce taxes. At that point, it becomes a matter of recording history and paying the piper. Most of the accountants used by dental practices are very good at the recording history part of the process. They collect the raw data (all the income and expenses of the practice) from the practice after the year has ended. These accountants then clean up this data and put the right numbers in the right boxes on the right forms and hence complete the preparation of the tax return and file it in timely fashion. They are very efficient and knowledgeable at this and do a good job of what is called compliance work.
However, the accountants most dentists use are not focused on planning the affairs of the practice to structure them in such a way that a significant amount of tax is saved. Both the dentists and their accountants share the blame for this situation. The accountants for not getting trained in tax planning and the dentist for not seeking out the experts who are involved in the business of tax planning. The result is a huge benefit for Uncle Sam at the cost of the poor dentists.
What happens most of the time with the dentist accountant relationship is also a reason for this waste of money. Typically, when a dentist starts his practice or purchases one, he is not left with a lot of extra cash flow so he looks for the cheapest accountant he can find to do his tax returns. His goal is to find someone who will just fill out the forms and file them to keep the dentist out of trouble. Soon enough he finds this cheap, low charging accountant, who does what’s needed at a low prices. However, as the practice grows, the needs of the practice expand but our low charging accountant does not have time and resources to get trained in the latest techniques of tax planning. He charges less and hence cannot afford the training and time needed to develop individualized tax saving strategies for his clients. The end result is our dentist paying more and more dollars to IRS which he should have kept in his pocket.
Nearly 75% of all dentists own small practices. The process of them losing money to the government unnecessarily starts even before they buy their practice from a retiring dentist, or when they become associates or partners in a practice with the intention of ultimately buying it. The brokers and attorneys involved in these transactions are very good at what they do. The brokers find dental practices which need to be sold or partnered with and market them quite effectively to find suitable buyers. The lawyers draft the legal documentation quite well to ensure that the interests of their clients are well protected in these transactions. Neither the brokers, nor the lawyers are experts in tax law and hence they simply don’t know the tax implications of practice transitions. The purchase agreements are full of fatal tax mistakes. Both the buyer dentist and the seller dentist end up paying taxes which they did not have to if they had used proper tax planning techniques.
Interestingly, owning and managing one’s business is arguably the best tax shelter plan left for an average American. Since a vast majority of all dentists own and manage their practices they have a great opportunity to intelligently use this “tax shelter” to save money on taxes by using proper planning techniques like using multiple entities, structuring fringe benefits programs, and taking advantage of little used business deductions.
Albert Einstein once said “the hardest thing in the world to understand is the income tax.” His statement is more true today than it was in Einstein’s time. But it is also true that those who make it their business to understand the tax system and use it to their advantage reap huge dividends.