Doctors and surgeons are among the highest-paying professionals. And the passage of the Tax Cuts and Jobs Act into law late December has opened up a virtual tax bonanza for self-employed, high net worth clients.
First of all, professionals like attorneys, accountants, and doctors used to be treated as a Professional Service Corporation (PSC) that, if elected to be taxed as a C Corporation, had to pay a flat 35 percent in taxes. This would force extremely intensive entity structuring to be done. Today, under the new tax law, the PSC rule has been eliminated, and C Corporations are taxed at a flat 21 percent.
The downside to operating as a C Corporation has always been double taxation. However, in this article, I am going to show you where double taxation will never come into play, and you can put tons of money into your self-employed, high net worth client’s pocket tax free.
What you do for yourself with retirement plans you also have to do for your employees with certain exclusions, which I will outline.
For 2017 an employer can pay himself compensation of up to $270,000 and put up to $215,000 into the defined benefit plan (DBP). (A DBP works like a pension plan that your parents or grandparents may have had. The actual benefit allowed is based on factors such as age and the benefit that will be paid in the future).
You can combine this DBP with a Safe-Harbor 401(k) plan. Using the same compensation number you can put up to $18,000 for elective deferral, with the defined contribution limit at $54,000.
The following is a table to give you a visual example of the information above:
When combining the two plans — and keeping in mind that the previous example was best-case scenario that 1 percent of employers qualify for — the taxpayer can deduct a total of $204,000. (If you have two employees, then between the two employees you only have to contribute about $8,000 while not running afoul of the stringent ERISA rules.)
These plans have effectively put a total of $204,000 in your pocket tax-free.
Tax-free Fringe Benefits
As an S Corporation, a more than 2 percent shareholder could not deduct tax-free fringe benefits. As a C Corporation you can deduct the following fringe benefits tax-free:
Health Reimbursement Accounts (HRA)
Dependent care benefits of up to $5,000
Tuition reimbursement of $5,250
That’s just to name a few.
One benefit I would like to highlight is an HRA. You can put any amount into an HRA, and it is not only tax-free. If you don’t use the amount placed in the plan in the current year, those benefits role over to the next tax year.
To explain the power of these contributions, all of your medical expenses will be deductible if you are sick. However, if you are healthy and you fund these accounts in the amount of $20,000 and never use them outside of the tax deduction, the amounts can be invested and grow tax free.
At retirement, the most expensive costs are health care. Most retirees are forced to take taxable distributions from their retirement accounts to pay these costs. If you diligently save these monies each year, you can use the funds with your HRA for health costs and you will not have to pay any taxes on the distributions.
As you can see, just changing some things around in your business can save you hundreds of thousands of dollars each year.
Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...