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Therapists: Strategic Tax Savings You Can Take Before Year-End
Putting strategic tax planning in place now will allow you to control and limit your taxes.
In our previous post, we discussed what strategic tax planning is and the stark difference between tax preparation and tax planning for self-employed psychotherapist’s taxes.
This post will dive into five powerful tax plan tools you can take before the year is over to preserve and build wealth.
But before we get started, some of us may think wealth is only for the rich and famous. That’s not true. That’s far from it.
There is an adage that says, “it’s not what you make that matters; it’s what you keep that can make a difference.”
True wealth building creates a financial foundation that will allow you to budget, save, and invest. The key is saving money for retirement or to ensure you have the means to carry out your goals.
If you don’t have the fuel to carry on, you will run on an empty tank, and we know where that can take us: nowhere!
For example, if you plan to purchase an office building, you would want to plan out when you want to make the purchase and start saving for a down payment.
Imagine the stress you would experience if you just started scrambling to find the money for a down payment during or close to the purchase. Hence, wealth building is ending up with more money than you started with when the idea to own an office building first came to mind. It takes planning and time.
Therefore, to build and maintain a profitable practice, you will need to incorporate wealth building into your business models.
Since saving is at the heart of wealth building, putting strategic tax planning in place will allow you to control and limit taxes during your life span. You will have funds to take care of yourself, family, and provide optimal care to your clients.
So, give yourself the space to create the opportunity to maintain and build wealth for you and your business.
Let’s now jump right into how you can incorporate tax planning in your practice today and for years to come.
Home Office Deductions For Your Private Practice
COVID-19 has forced us all to work from home. Some of us may still work from home while paying rent for our office space. Home office deduction is one of the most complicated deductions allowed by the IRS. Still, as long as the rules are met and proper documentation is maintained, you will reap the benefit.
When home office deductions are not kept throughout the year, it’s tempting to push off the deductions for another year due to the headache resulting from the scramble for paperwork.
But please don’t push it off this time. The tax benefits you will save multiplied by many years in business will be exponential.
To move away from the fatigue of fishing for home office expense paperwork, start making it a plan now. Checking to see if you qualify for the deduction and gathering the proper documents you need is essential. When tax seasons come, you will be prepared for Uncle Sam. There will be no need to scramble because you would have put proper tools in place beforehand.
Home office deduction is available to both homeowners and renters.
The IRS allows small business owners to choose either the simplified or regular method (standard method).
Starting in January 2013, the IRS introduced the simplified option, which significantly lowers record-keeping pressure. For this option, qualified practice owners can multiply the IRS allowable rate by their home office’s square footage. This method is in place of calculating actual expenses.
The standard method uses the actual expenses of your home office. These expenses include repairs, utilities (electric, internet, water, trash fee, etc.), mortgage interest, rent, homeowner’s insurance, and depreciation.
If your office space is in a room solely devoted to your practice or part of a room, then you will need to figure out the percentage of your home dedicated to your business activities.
Regardless of the chosen method (simplified option or the regular method), two requirements will first need to be met:
- Regular and exclusive use
- Principal place of your business
According to the IRS, you must use part of your home only for conducting business. For example, if you use an extra room to run your practice, you can take a home office deduction for that extra room.
You must demonstrate that you use your home as your primary business place for your business’s principal place. For example, suppose you conduct business at a location outside of your home and use your home “exclusively and regularly” to conduct business. In that case, you may qualify for a home office deduction.
If you are strapped for time and don’t have time to gather the proper records for your deductible home office expenses, the simplified method may be the way to go. But it may not yield the best tax savings for you.
This is where proactive tax planning comes into play and it is not to be overlooked. Figuring out your home office expenses can be done throughout the year and before the end of the year with proper tools in place.
Also, an analysis will need to be done comparing both methods to see which one will be the best choice for minimizing taxes.
From experience, sole proprietors in private practice mainly take home office deductions. However, if your business is an S corporation or a partnership, you can still take the deduction if you qualify.
According to the Journal of Accountancy, accountable plans “work on the simple concept that if reimbursement payments to business owners and their employees are properly claimed and documented, they are not taxable to the recipient… Accountable plans are a flexible tool to incentivize employees to pursue business goals and to facilitate employee-owners’ deductions of expenses they incur in running their businesses.”
For S corporation businesses, an accountable plan will need to be put in place to reap the benefit of claiming a home office deduction. In fact, we assist our clients with this plan throughout the year, so they are prepared and ready to take advantage of the opportunities during tax season.
Maximize Contributions To Your Retirement Plan
According to the Department of Labor and financial experts, we estimate that 70 to 90 percent of your current income will be needed during retirement to live comfortably. Now is the time to plan to save for retirement, which can be done through strategic tax planning.
One of the savvy ways I look to help my private practice owners reduce their tax burden is by guiding them on ways to maximize their retirement plans. Contributing to a retirement plan is one area that provides much room for income tax savings.
If you don’t have a retirement plan in place, consider looking into ways to establish one. Since you are a small business owner, you are on your own and are responsible for your own retirement planning.
If you have one established, consider reviewing the plan to ensure you are on the right plan. You may be taking advantage of maximizing your contribution, but are you maximizing your tax savings?
Maximizing your contributions in a retirement plan doesn’t mean you’re are taking advantage of increasing your tax savings. The best way to ensure you are not leaving money on the table is by reviewing your current plan and analyzing it with other plans you are entitled to.
If you have employees, you may consider plans that will allow you to help your staff plan for a successful retirement. An employer’s contribution made to staff retirement plans is tax-deductible as a business expense.
So, what retirement plans are out there?
If you do not have common-law employees, you would want to consider looking into:
- IRA (Individual Retirement Arrangements)
- SEP (Simplified Employee Pension)
- SIMPLE (Savings Incentive Match Plans)
- Profit-sharing plan, or
- One-Participant (solo) 401(k) Plan
For practice owners with employees, you can consider the following plans: Payroll Deduction IRA, 401(k), SEP, SIMPLE, and Defined-Benefit Plan.
Analyzing the pros and cons of each plan and choosing the one that works best for you and your employees will guide you in setting up a successful retirement plan.
The Power Of Savings And Compound Interest
Imagine you contribute $500 per month ($6,000 per year) to a retirement plan for 20 years. With the power of compound interest, your money grows exponentially.
Compound interest is the interest you earn on both your original contribution and the interest that your money earns.
Since your retirement contributions will be kept at a financial institution (ex. Fidelity, J.P. Morgan, etc.) and not touched, the number of compounding periods (5, 15, 20 years, etc.) makes a significant difference.
The longer the number of compounding periods, the greater the amount of compound interest. Therefore it is crucial to save for retirement now rather than later.
To give you an example of compound interest, let’s say:
- You put $500 per month ($6,000) in a retirement saving account with an interest rate of 6% a year, and your account compounds interest annually. After one year, your balance would be about $6,530. So, your money would grow by $530.
- For the next 5 years, you continue to contribute $500 per month totaling $30,000. The original interest of $530 will continue to earn interest, along with the original deposit of $6,000. In addition, interest will also be added to the rest of the monthly contributions made ($500) and interest earned between years 2 & 5. Without taking money out of your account, you would have about $34,492 at the end of the fifth year. Therefore, your retirement plan would grow by about $4,492 ($34,492 minus $30,000).
Because of the snowball effect of compounding, it is much more attractive to take advantage of the tax benefits available to you by contributing to a retirement account.
The earlier you take part in a retirement plan; the more compound returns you will make on the principal and interest besides the tax savings.
Take Advantage of All Your Tax Deductions
If your practice deductions are more than your business income, then you have a tax loss for the year. With some adjustments made to calculate the loss, the IRS calls this a net operating loss (NOL).
You may experience an NOL if you are starting your business or had a rough year. Before January 2018, businesses used to carry back NOL to two years prior and get immediate tax refunds from amending prior year(s) tax returns.
However, under the Tax Cuts and Jobs Act (TCJA), this tax benefit was removed. With TCJA, NOL can only be carried forward to reduce up to 80% of your taxable income in any future year.
With the Coronavirus Aid, Relief, and Economic Security (CARES) Act that went into effect in March 2020, two new NOL tax breaks can be taken to increase your practice cash flow:
- The CARES Act allows NOLs arising in tax years beginning in 2018, 2019, and 2020 to be carried back five years for refunds against prior taxes.
- The CARES Act allows 100 percent of the NOL to the carryback years.
As mentioned above, before the CARES Act, NOL could not be carried back to 2018 or 2019, but with the new tax breaks because of COVID-19, it can be done.
How would taking advantage of all your practice deductions benefit you?
Having proper documentation intact for your deductions will allow you to claim all the business expenses you are legally entitled to.
I have heard of business owners (especially new owners) and/or tax preparers hesitant to claim all the deductions that may produce a tax loss on a return.
If the expenses are allowed under the tax code and are incurred to run your practice, then you may claim the deductions. There should be no hesitation if adequate documentation is in place. If they are not, proper procedures can be put in place to combat it.
So, make sure you are taking advantage of all your business deductions.
Review or Change Your Business Structure
Evaluating your business structure (Sole Proprietor, LLC, PLLC, S Corporation, etc.) periodically is a strategic process to embark on. Collaborating with your CPA to review your current structure and going over your personal and financial goals while comparing everything to other business structures will provide great insight into whether you are maximizing your tax savings.
Taxes are not the only piece of the puzzle. That’s why it is important to figure out and vocalize your personal and financial goals while implementing proactive tax planning.
There is much buzz out there about setting up a practice as an S corporation. An S corporation is preferable to other business structures because it reduces the self-employment tax burden. You avoid paying taxes twice, and profits paid to the owners as distributions are not subject to Social Security and Medicare Taxes.
Electing your practice as an S Corporation has many tax benefits. Still, to identify if the business structure is in line with your goals and current tax situation, an analysis will first need to be performed to get evidence-based data. The onion will need to be peeled to get the best information on which direction to go.
Depending on your current business structure, you may not reap tax-saving benefits in 2020, but now is the time to plan for 2021.
With an effective plan put in place as you approach 2021, there will be clarity on the most helpful business structure. Modifying it in the middle of the year may produce some benefits, but making the change at the beginning of the year will prove worthwhile.
Partner With A Proactive Tax Planner
If you are a business owner, taxes can be more complicated. Engaging a CPA for year-end tax planning is essential to reducing your tax burden and maximizing your savings. This will allow you to invest in your business and to ensure you have the means to carry out your goals.
As therapists, you are in the business of changing the clinical outcomes of your communities. Together, we can help you improve or get greater clarity on your practice’s financial outcome so you can provide optimal care to your clients.
Aligning your dreams and goals with strategic wealth building is our goal.
At the CPA for Psychotherapists, we offer year-round strategic tax planning and preparation services to empower you to make the right tax decisions. This interactive process involves a careful examination of all tax planning strategies and our expert recommendations for tax liability reduction solutions.
We have experience working with therapists in private practice, expertise in accounting and tax, and the technology to partner with businesses all over the U.S.
Request your complimentary consultation today to determine how you can maximize your tax savings and improve your wealth-building without sacrificing your dreams and goals!
Now Let’s Turn It Over To You
I hope this post showed you the benefits of 5 powerful tax plan tools you can use before the year is over to preserve and build wealth.
Now I’d like to turn it over to you:
What’s the #1 tip from this post that you want to try first?
Are you going to reflect on what wealth-building means to you and how it may prevent you from moving forward? Or maybe you’re going to set up a time to meet with a proactive tax planner before December 31st to review and analyze which retirement contribution plan will be best for you?
Or perhaps you have a question about something you read.
Either way, looking forward to seeing your comment below.