Understanding Your Tax Strategy: Are You Paying a Good Amount of Tax?

As a dentist, you might frequently wonder, "Am I paying a good amount of tax?" This seemingly simple question opens the door to a broader discussion about your annual strategic tax planning and how it impacts your financial health.

It's not just about the tax you pay this year but also about how your strategies work for you before, during, and after the tax year. Here’s a deeper look into how strategic tax planning can benefit your practice and personal finances.

The Importance of Strategic Tax Planning

When considering your tax situation, evaluating the effectiveness of the strategies you employ annually is crucial. Effective tax planning isn't just about saving money today; it’s about creating a sustainable plan that offers benefits over the long term. This involves looking at your business activities and recurring deductions, such as:

• Retirement Plan Deferrals and Employer Contributions: Maximizing contributions to retirement plans allows you to prepare for the future and benefit from significant tax deductions.
  
  

• Paying Family Members: Employing your children and matching their wages with tax-free contributions to Roth IRAs and 529 plans provides immediate tax savings and long-term financial benefits.
  
  
• Strategic Investments in Your Practice: Investing in your practice, such as hiring new team members, can reduce your taxable income through deductible overhead costs.

These strategies help reduce your tax liability and support the growth of your practice and your family's financial future.

Real-World Example: Long-Term Benefits

Consider a scenario where you’ve employed your children over the past ten years, paying them a reasonable wage based on their job descriptions. If each child earned approximately $100,000 over this period, the tax savings can be substantial:

• Total Savings: You could save around $70,000 in federal and state income taxes.
  
  
• Net Benefit: After accounting for Social Security and Medicare taxes, you might leverage a net saving of $50,000. This amount can be viewed as a scholarship or direct funding for their college education.
  
  

Understanding Your Income

For business owners, knowing your actual income each year can be challenging. It’s important to differentiate between your cash flow and taxable income. Here’s how:

• Adjusted Gross Income (AGI): This is a key figure used by banks and institutions. It includes salaries, wages, and business income from K-1 forms (if you're an S Corporation).
  
  
• Discretionary Tax Deductions: Items like retirement savings, paying your children, auto or home office reimbursements, and accelerated depreciation can significantly lower your taxable income.
  
  

Reviewing Your Tax Return

An annual review of your tax return can provide clarity on your financial health. You can understand how your tax strategies impact your income by walking through discretionary items. For instance:

• Retirement Savings: Maximizing 401(k) deferrals.
  
  
• Family Wages: Paying your children reasonable wages for their work.
  
  
• Depreciation: Taking advantage of accelerated depreciation on new assets.
  
  

These reviews help demonstrate how your adjusted gross income reflects your long-term tax strategies, ensuring that each year's tax plan aligns with your overall financial goals.

Long-Term Tax Strategy

The ideal approach to tax planning is to implement and review strategies over a multi-year period. By reassessing every three to five years, you can measure how much you’ve saved and redistribute income effectively to minimize taxes. This long-term perspective allows you to:

• Maximize Annual Deductions: Ensure you capture the most accurate and beneficial tax deductions each year.
  
  
• Align Investments with Tax Goals: Combining tax deductions with investment strategies to place your money in tax-deferred or tax-free environments.
  
  

Regularly reviewing and updating your tax strategies is crucial. Understanding and implementing the right tax plans ensures that your financial activities are transacted beneficially, capturing the most appropriate tax benefits for your situation. This process minimizes your tax burden and supports your financial objectives, ultimately providing peace of mind and clarity in your financial planning.

Not sure where to start? Contact us today!