Dentist Tax Deductions
Posted Sunday, November 9, 2020
Ahh.. the good stuff. Yes, you work hard. Yes, you want to be able to get a little extra from your hard work and your dental practice. Yes, you want to make tax-advantaged decisions. We get it.
Our dentist tax deduction webpage is a condensed version of our small business tax deductions webpage, but it is enhanced to help dentists keep more money in their pockets.
Tax Deductions versus Tax Credits
What is more valuable? A tax deduction or a tax credit? They both sound pretty cool right?
Both typically require a dental practice spend money, but that is where it ends. A tax deduction reduces your taxable income. A tax credit reduces your computed tax obligation. If you spend a $10,000 on some equipment, that might put $3,500 in your pocket assuming a 35% marginal tax rate. In another words, you spent $10,000 and it cost you $6,500.
But what if that $10,000 equipment created a tax credit equal to the $800 under the research and development tax credit? You would still save the $3,500 in taxes as a tax deduction, but you would also add a “kicker” of $800 as a tax credit.
Generally speaking, tax credits are more valuable than tax deductions to your dental practice. We are going to explore this more!
Deciding to Spend Money
Every December WCG fields hundreds of phone calls and emails from dentists and other small business owners asking if they should buy something to save on taxes. Our response is a simple flowchart-
- Do you need the item you are considering? If No, then stop. Don’t buy anything. If Yes, then continue to the next question. Don’t buy stuff for the tax deductions; buy stuff because it makes operational sense for your dental practice.
- Is the current year’s income unusually high, or do you expect to earn more next year?
Without sounding snarky, why would you buy something on December 31 if your tax rate will only increase the following year? Wait 24 hours, buy the cool thing you need and get a better yet delayed tax deduction. And if you don’t need it, why would you spend money unnecessarily only to get a portion of that back in tax savings? Another way of saying this is- keep some small business tax deductions in your pocket for next year. You don’t want to be in a position where you ran out of perfectly good tax deductions in a year of increased taxable income.
Conversely, if your current taxable income is unusually high and you expect it to go down next year, then perhaps you should accelerate your timelines for major purchases. WCG can help with the tax modeling and planning.
All too often we hear people at cocktail parties say something silly like “Don’t worry, it’s a write-off.” Remember that money is still leaving your person, and the money you are getting back in the form of a tax deduction is substantially less. Just because it is a “write-off” or a business tax deduction doesn’t mean that you are using Monopoly money. Houses are green and hotels are red, but cash is real life.
185 Dental Practice Tax Deductions You Cannot Take
Ok, that’s misleading. There are probably way more than 185 deductions you cannot take… but the following short list details the common ones where we see a lot of confusion. Having said that, we are not trying to limit your tax deductions nor are we the government’s accountant. In other words, we are not the tax police but our job is to remind you that tax police exist.
WCG is your advocate, and we can help position you and your business to maximize your small business deductions. Here we go-
- 100% Cell Phone- if you have another cell phone for personal use, then great. Otherwise, this is tough.
- Automobiles- similar to cell phones, if you have another automobile for your personal use, then great. Otherwise to call your only automobile 100% business use is a tough sell. Several other options exist!
- Food- you can deduct office lunches for your dental practice including parties, but know the rules so you can position yourself carefully.
- Travel- want to bring your spouse to a dental conference? This works under certain situations.
- Country Club Dues- don’t shoot the messenger, but country club dues are not tax deductible. But there are some country club expenses that might be.
- Commuting Expenses- that drive to your practice is considered commuting and not deductible unless you qualify for a home office (which is totally do-able for dentists… ask us how!).
- Professional Attire- let’s chat about how your everyday attire under your protective equipment might be a business uniform and therefore a small business tax deduction.
- Continuing Education- continuing education is one thing, but what about sending your hygienists or assistants (or yourself) to additional training?
- Loan Payments- loan payments for financing are not tax deductible yet certain lease payments are (provided they are true operational leases and not disguised financing).
- Putting Kids on Payroll- adding children to payroll works and can be a wonderful tax deduction through income shifting, but there are some pitfalls.
We expand on this list and others in our book titled Taxpayer’s Comprehensive Guide to LLCs and S Corps, and our small business deductions webpage. Check it out!
Reasonable Business Tax Deductions
Small business tax deductions are critical for reducing taxable income. What happens if you are unreasonable? Good question… think of your last argument with someone who was unreasonable. Was that pleasant? Did the argument end up being resolved amicably? Probably not on both counts.
The IRS and tax court are full of humans, and humans respond to unreasonableness in a predictable way… they simply toss out whatever small business tax deduction you are arguing, ask for all kinds of proof, and then look at whatever evidence you do provide with extreme suspicion… a “Yeah… riiiiiggght” salvo.
Don’t get us wrong… just because your dentist tax deduction appears reasonable does not mean you don’t have to support it with proper record keeping. You must be able to prove the veracity of the business tax deduction if challenged. The button below is a link to a blog post outlining some reasonable and unreasonable positions on small business tax deductions-
Accountable Plan Reimbursements
Some dentist expenses above are mixed use such as home office, cell phone, internet and automobile expenses. These are called mixed-use expenses and are typically personally paid for by you the individual, and then later reimbursed by your dental pratice. Please check out the video which explains more.
You can also visit our Accountable Plan page which has fancy Excel spreadsheets and examples, and other nonsense.
Tax Planning with Depreciation Recapture
Please understand that depreciation is a tax deferral system rather than a tax avoidance system. Huh? When you sell or dispose of an asset, you might have to pay tax on the portion that was depreciated.
For example, you buy a $200,000 piece of machinery and use Section 179 depreciation to deduct the entire $200,000 in the first year. Five years later you sell the equipment for $150,000 because you slapped some new paint on it and you are a shrewd negotiator with your buyer. You will now have to recognize $150,000 of taxable ordinary income. Yuck. But there is a silver lining- depreciation recapture is taxed at your marginal tax rate up to a maximum of 25% tax rate. So, you could have depreciated your asset during 39.6% marginal tax rate years just to pay it all back at 25%. Bonus. Tax planning is a must! How many times have we mentioned that?
Dentist Tax Deductions Themes
There are some over-arching themes and concepts for all small business tax deductions. The business expense must be-
- Ordinary and necessary (IRS Publication 334), and
- Paid or recognized in the current tax year, and
- Directly related to your business, and
- Reasonable, and not lavish or extravagant (IRC Section 162 and IRS Publication 463).
Let’s break these down. An ordinary expense is one that is common and accepted in your field of business, trade, or profession… in your case, in the dental practice community. A necessary expense is one that is helpful and appropriate, although not necessarily required, for your practice. In Samp v. Commissioner (Tax Court Memo 1981-706), an insurance agent had a handgun since he traveled to an area with a recent unsolved murder. The tax court responded with “A handgun simply does not qualify as an ordinary and necessary business expense for an insurance agent, even a bold and brave Wyatt Earp type with a fast draw who is willing to risk injury or death in the service of his clients.”
You have to appreciate a Wyatt Earp reference from a tax court judge. Ouch. Clean up on aisle Allstate.
The expense must be paid or recognized in the current year. Expenses that were paid but not deducted in previous years cannot be “caught up” by deducting them today without amending your prior tax returns (which are easy to do, and should be done if there is money to be had).
Automobile Decision Tree
In deciding whether to own the automobile personally or through your dental practice, here is a simplified decision tree. It is not a hard and fast set of rules, but will provide some guidance.
- If you buy expensive automobiles, such as $80,000, and drive them 10,000 miles or less, then the business might want to own it.
- If you buy frugal automobiles, such as $30,000, and drive them 15,000 miles or more, then you should own it personally and get reimbursed by your business.
- What about the soft middle? The $60,000 automobile and 12,000 miles? If you cycle thru automobiles every 2-3 years, then the business should own it. If you keep automobiles for 5-7 years, then you should own it and get reimbursed.
These are not hard and fast rules. These are rules of thumbs and generalizations. We always caution people trying to split the atom to save some money. At the end of day, most small business owners do what makes him or her feel most comfortable, and the few bucks that might be left on the table is overshadowed by the lack of anxiety and headache. In other words, is the juice worth the squeeze? Or as Jason says, I love French fries but I am not running a mile for just one.
Here is some more information from our blog posts and LLC and S Corp book-
Also… the Tax Cuts and Jobs Act of 2017 created 100% Bonus Depreciation which means you can now deduct 100% of heavy vehicles using both Section 179 and Section 168. Luxury cars are still limited to $18,000, but the Hummer Loophole is back-
Multiple Work Locations
You can have multiple work locations. The IRS states that if you use a home office as your primary location for substantial administrative activities you are allowed to essentially have two work locations. For example, you get bored with the dentist thing, and decide to own a landscaping company where you have an office in your shop. You perform all your administrative activities such as hiring and firing employees, accounting, balancing your checkbook, talking to your attorney, chatting it up with your Colorado Springs CPAs at WCG, etc. in your home office, that office counts as a work location in addition to your office in your shop. Here is the play by play blurb from the IRS-
You can have more than one business location, including your home, for a single trade or business. To qualify to deduct the expenses for the business use of your home under the principal place of business test, your home must be your principal place of business for that trade or business. To determine whether your home is your principal place of business, you must consider:
- The relative importance of the activities performed at each place where you conduct business, and
- The amount of time spent at each place where you conduct business.
Your home office will qualify as your principal place of business if you meet the following requirements.
- You use it exclusively and regularly for administrative or management activities of your trade or business.
- You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.
So, does this work for a dentist and a dental practice? Absolutely. If you can demonstrate that you perform substantially all of your administrative activities at home and not at the office, you might qualify. A lot of business owners like to work on these activities at home since it is quieter, more private and allows for long-term concentration.
As mentioned before… Don’t forget that commuting miles between your residence and your office are not deductible, but if you have a home office suddenly these miles become business miles and therefore tax deductible. Boom! The use of Boom! is apparently out of fashion. Whatever.
Dentist Tax Deductions Consultation
Do you have questions about tax deductions? Are you asking for a “friend” who wants to ask, but is afraid? Let’s chat!
The Sutter rule allows the IRS to disallow a portion of your business meals when they consume a large part of your normal living expenses. In other words, if every meal you eat is a justifiable business meal, it might not matter under the Sutter rule. This rule was created in Richard Sutter v. Commissioner, 21 Tax Court 170 (1953),where Sutter expensed his lunch every day but the court found that “the deduction for the cost of lunches was apparently almost entirely payment for petitioner’s own meals when he attended such functions as meetings of the Chamber of Commerce. There is no evidence that these costs were any greater than expenditures which petitioner would have been required to make in any event for his own personal purposes. They must consequently be disallowed.”
Sutter was audacious- he deducted everything he could think of. It is a great read.
Again be careful. Business meals are low hanging fruit for the IRS. We’ve seen thousands of dollars in tax deductions disappear before our eyes during an examination because the client could not demonstrate the business purpose. To not lose an audit, make sure you keep receipts beyond relying on the credit card statement. In addition, keep a log or journal of the person(s) you met with and the topics of discussion. Be very specific. Memories fade, so if you intend to reconstruct this evidence upon receipt of your examination notice from the IRS, think twice. IRS agents are no dummies on meals and the associated tax deductions.
Let’s briefly discuss record keeping, and then jump into a famous New York entertainer named Cohan who ultimately provided a nifty rule that can be used during an IRS audit. To be able to demonstrate business tax deductions you need to show the date, the amount and the person or business you paid. A bank or credit card statement, or canceled check, satisfies this. The second element is the business purpose must be documented either through a logbook, planner or accounting software. Proof of payments plus business purposes equals tax deductions.
Do you need receipts? Yes and no. For travel, gifts and meal, if the amount is under $75 then you only need to document the event and business purpose in a logbook or planner. However, if you spend $10 at Costco for some paper, then you need proof of payment plus business purpose documentation. Seems a bit onerous and even contradictory, but it is true.
Enter Cohan vs. Commissioner, 39 F. 2d 540 (2d Cir. 1930). Yes, 1930 and we still use it today. George Cohan gave us “Yankee Doodle Dandy” and “Give My Regards to Broadway”, and he gave us a small business tax deduction rule. His rule is simple- you can approximate your business expenses and ultimately your business tax deductions. What?! No, it is not that simple.
You must have corroborating evidence that demonstrates your expense. For example, as an online accountant, WCG can demonstrate that we prepare so many tax returns which are so many pages in length, and therefore we can approximate our paper costs.Temp. Regs. Sec. 1.274-5T(c)(3) also gives latitude to the IRS to allow substantiation of a business expense by other means.
WCG has successfully used the Cohan rule in IRS examinations. We have also implemented it during tax preparation when records are incomplete or missing (i.e., one hot mess). Having said that, using estimates and approximations looks bad. Keep good records, please. Do not rely on the Cohan rule or some treasury regulation to save your butt.
The Cohan rule or any type of estimation cannot be used for travel, business gifts and meals. All the good stuff need strict record keeping habits. Section 274(d) of the U.S. Tax Code also states that listed property must be substantiated with proper documentation. Listed property includes vehicles, equipment generally used in entertainment such as cameras and stereo equipment, and computers. Seems a bit out dated, but there you go. So, if you are a photographer who drives a car for business while entertaining guests, you will be a master at record keeping.
Summary of Dental Practice Tax Deductions
This web page is huge, and has a ton of information in it and perhaps it is overwhelming. To reiterate information from the beginning of this hoopla there are some over-arching themes and concepts for all dental practice tax deductions. The business expense must be-
- Ordinary and necessary (IRS Publication 334), and
- Paid or recognized in the current tax year, and
- Directly related to your business, and
- Reasonable, and not lavish or extravagant (IRC Section 162 and IRS Publication 463).
We want to give you this table to help summarize the business deductions that are clearly not allowed (black), the ones that clearly are allowed (white), and the gaggle of exceptions (grey). We swim in grey waters with slivers of black and white.
|401k Plan||Get $500 tax credit from IRS for starting one. Great way to defer taxes. We can set this up. The SECURE Act of 2020 boosted the tax benefits as well.|
|Automobiles||Business use only. Use decision tree to see if you should own it or the business. Depends on price, turnover, miles driven, business use and marginal tax rates. Personal use added to W2 Box 1, 3 and 5 using Lease Value rates in IRS Pub 15-B.|
|Business Travel||All kinds of rules. Mix pleasure with business under some circumstances.|
|Business Meals||50% if business discussion with client, prospect or associate. 50% if traveling away from your tax home on business. 100% for company social gatherings or convenience of the employer (lunch).|
|Cell Phone||Business use only. Never 100% unless you have second phone. Reimbursed through Accountable Plan.|
|Client Gifts||Max $25 per recipient per year.|
|Commuting Expenses||No. If you have a home office, then commuting becomes business travel and subsequently Yes.|
|Copier Lease||If the lease can be considered a capital lease, then No. If the lease is an operational lease, then Yes. Depends on the facts and circumstances.|
|Country Club Dues||No. Don’t throw the book. Not our fault. Meals at your country club, Yes, if there is a business purpose|
|Defined Benefits Plan||Get $500 tax credit from IRS for starting one. Great way to defer taxes. We can set this up.|
|Education||Only if improves your current work skills or necessary for professional credentials.|
|Food||50% if business discussion with client, prospect or associate.50% if traveling away from your tax home on business. 100% for company social gatherings or convenience of the employer (lunch).|
|Golf Outing||No. Seriously. Let it go.|
|Guard Dogs||If you are a high risk defense attorney on the East Coast and need a security detail, then Maybe. Must be a bona fide occupational qualification.|
|Health Savings Accounts||Company contributions, Yes. Added to your W2 Box 1.|
|Home Office||If regularly and exclusively used for business then Yes. Multiple locations OK provided home office is primarily used for substantial administrative activities. Reimbursed through Accountable Plan.|
|Insurance||Business liability insurance, Yes.Auto insurance, Yes if the company owns the car. Health insurance, Yes and added to W2 Box 1. Dental insurance, Yes and added to W2 Box 1. Eye insurance, Yes and added to W2 Box 1. Long Term Care insurance, Yes but limited. Disability insurance, No. Otherwise your benefits become taxable income. Life insurance, No. Only in C corporations where the corporation is the owner and beneficiary (no S corp election!).|
|Kids On Payroll||Great way of reducing tax liability for the same amount of cash. Must do it correctly and follow state child labor laws.|
|Legal, Professional Fees||Yes.|
|Merchant Card Fees||Yes.|
|Per Diem||Maybe. If employees own more than 10% of a corporation, then No. Sole proprietors and single member LLCs including partners in partnerships, Yes.|
|Professional Attire||If the clothing is suitable for everyday use then No. If the clothing is a uniform then Yes. Possible advertising expense. No dry cleaning unless clothing otherwise qualifies.|
|Profit Sharing Plan||Get $500 tax credit from IRS for starting one. Great way to defer taxes. We can set this up.|
|Retirement Plan||Get $500 tax credit from IRS for starting one. Great way to defer taxes. We can set this up.|
|Taxes||Sales tax, Yes.Payroll tax, Yes for company portion. Estimated tax payments, No. Nice try.|
|Utilities||No, unless you have a separate office location. If using home office, utilities is a part of the deductible basis.|
There you go. There are tons of variations, exceptions, rules to follow, interpretations, positioning, and many more modifiers that we can’t think of right now. Please contact us if you have any questions or concerns- we love to run through small business tax deductions with owners. And like a good parent, we try to find ways to say Yes. Yes, you can go to Johnny’s house right after you clean your room. Yes, you can deduct that expense provided you document it this way.
Comingling of Money
We’ve mentioned this previously, and we’ll do it again here. Rule #1- Please get a separate checking account for your business, preferably with the same bank as your personal checking account so transfers (shareholder distributions) are easy. Rule #2- Do not pay for personal expenses or any mixed-use expense with business funds.
This is bad for several reasons- the IRS hates it. It erodes the corporate veil which is already dangerously thin since you are a closely held corporation. Lastly, if you need to re-construct your financials because of a QuickBooks disaster or some other disaster, having your business transactions compartmentalized within a bank account makes life better. All money coming in is income. All money going out is an expense or a distribution.
Do you get the feeling that we’ve said these words before? Like déjà vu? Ever have vuja de? It is the feeling that this has never happened before- opposite of deja-vu. Yes, we did mentioned this before in Chapter 5 on Operating Your S Corp. Here it is again.
Read Rule #2 again. It is imperative to keep an arms-length perspective on you, the employee, and relationship with the S corporation. If you worked for Google or Ford, you wouldn’t be able to get the business to buy your groceries or pay your mortgage directly. Same thing with your business. Here is another quick table to help you out with the “Which debit card should I use?” question.
|Cash Outflow||Checking Account To Use|
|Car Lease||Personal, unless lease is in business name.|
|Gas for Car||Personal, unless owned / registered by business|
|Estimated Tax Payments||Personal, since an S Corp is a pass-thru entity|
|Cell Phone||Personal, reimbursed through Accountable Plan|
|Home Utilities||Personal, reimbursed through Accountable Plan|
|Home Office Renovations||Personal, possible partial reimbursement|
|DSW, Banana Republic||Personal, but it would be nice|
|Self-Employed Health Insurance||Business|
|Out of Pocket Medical||Personal, unless you have an HRA|
|Accountable Plan Reimbursements||Business|
|SEP IRA Contribution||Business, but you should use a 401k instead|