The Private Practice Millionaire® Tax Blueprint
Income Tax Optimization for Practice Owners
s a private practice professional, one of the greatest outlays of annual expenses will be in the form of income taxes. And of course, the more income you make, the higher your potential income tax liability will be.
In order to understand how to reduce our income tax burden, we must first understand what income tax is. Income tax is actually a surcharge on every dollar of income that you earned, from whatever source. Here’s the reality: You earned a dollar of value for risk and production. Great! Well done! Now pay a fee on that dollar for the privilege of earning it (sigh).
The best way to look at this is, for every single dollar you earn there is a surcharge—from the first dollar to the last one that came in the door this year. As a matter of practicality, view all of the income you make as belonging to the IRS (it would seem that this is their view) and through the use of the Internal Revenue Code, you can utilize certain Code sections to reclaim the right of that income and the reduction of that income tax surcharge concomitant with it.
To reduce taxes then, only two possible strategies exist: 1) make less income so no surcharge can be assessed, or 2) add levels of complexity to your income streams so that transactions can occur which are favorable to the IRS surcharge-waiving bias. This is called a “deduction” when it is an expense and is called “tax-free” when applied to income. Option one really isn’t workable since income in needed to pay for lifestyle expenses. Therefore, option two is really the only way to operate if you want to have a more tax-efficient experience, since an abundance of income is needed to fund one’s lifestyle.
Now this is quite a challenge, because the maxim of income taxes is this: “the less complex your tax return, the more you pay.” Proof of this is the 1040 EZ form. This tax reporting document assesses the highest level of income tax possible for your level of income because it prevents you from recharacterizing income and expenses to be more tax-favorable. Your goal is to arrange your affairs so you can utilize various Code sections to create tax-deductible expenses and tax-reduced or tax-free income. This will create a more complex business and financial life, but the rewards can make it well worth the effort.
In an attempt to mitigate your income tax liabilities, you tend to rely on your accountants and tax preparers to assist you with advice and implementation. However, you often fail to realize that most accountants and income tax preparation experts are simply preparers and not tax planners or tax strategists. There is a HUGE difference. When you find yourself being critical of your tax professional for not saving you money in taxes, please realize that they may not consider that as part of their services. Good tax planners will look out 2-5 years and advise on actions to take now that will improve your tax experience in the future. Only then do we have an opportunity to optimize our tax strategies as time goes on.
In order to create any tax optimization plan, it is necessary to get a very clear idea of what a “perfect” tax structure would look like. I had to get a concept of what an ideal tax strategy entailed with all of the arbitrary complexities and authoritative opinions taken into account. In order to mock this up, I had to consult several tax attorneys, accountants and experts to review the most feasible tax-reduction strategies specifically tailored to private practice professionals and their possible career paths. The result is what I call the “Private Practice Millionaire Tax Blueprint.”
The number of deductions, of course, is extensive and falls into 3 general and arbitrary categories: Rudimentary, Intermediate and Advanced. The Rudimentary deductions include all of the basic expenses for a professional practice such as payroll, supplies, office machines, rent, utilities, etc. The Intermediate group are the less-commonly-used deductions that require a little more sophistication. These are circumstantial, such as utilizing dependents, employee benefits programs, commercial real estate and leasing company structures. The Advanced level includes management corporations, owning an insurance company for your business, various trust structures, and practice sales transactions.
Once I settled on the general approach to the subject, then it became necessary to create a standard process by which we would assess and implement the appropriate strategies. In this wise, I created a “filter” of 21 income tax deduction strategies that may be utilized by a private practice owner with the help of their tax professional. These are intermediate and advanced strategies that are generally overlooked or avoided by many tax preparers. These are widely-used and conservative strategies that take some future planning to implement.
The process is simple. We take your last year’s personal and business income tax returns and run them through the 21 strategies. The tax returns are reviewed by a CPA and a “what-if” analysis is completed. In other words, tax returns are generated that show the results that would have occurred “if” you had implemented some of the strategies. While it is only an estimate, it demonstrates that there are potential tax savings under the right circumstances.
No matter how basic or advanced your income tax plan is, we have found with our pilot program that most private practice owners can save a significant amount of tax liability with just a handful of these strategies. Of course, your results can vary widely according to the strategies you and your tax professional agree to implement.
The Private Practice Millionaire Tax Blueprint is the NEW “standard” business structure with which to take advantage of the majority of available income tax mitigation strategies for private practice owners. The interaction of these various income and expense transactions, carefully choreographed within your economic life, can potentially save you a fortune in unnecessary tax expenses over your lifetime.
Stay tuned to more developments in this area as I codify the process.