"Anybody who is considered to be in a group thatis a high-income earner [like doctors] is always lookingfor legal and proper ways to minimize that tax impact,and so therefore, they tend to get targeted by folks whoare trying to create illegal ways to do that," saysRaymond I. Hand, CTFA, private banking sales andservice manager at Branch Banking and Trust Company.
According to the IRS, scheme promoters find easyvictims in health care industries because they just don'thave time to focus on their finances. And many times,those that do, do so without appropriate tax counsel.
Tax Planning Pitfalls
There are many hazards in tax planning. If it keeps you from having to pay tax at all,vs just reducing your tax or deferring your tax, that's ared flag. "Uncle Sam has been at this a long time andhe's not giving away the farm and not without beingfully aware of it," Hand says.
Kathy K. Petronchak, the new commissioner of theSmall Business/Self Employed Business Division of theIRS, says, "Promoters of abusive tax scams often targethigh-income professionals. Physicians and others in themedical industry should be wary of too-good-to-be-trueschemes that make false claims."
"Taxpayers who participate in these schemes canexpect to lose the money paid in fees to these promotersand can be subject to civil and/or criminal penalties,in addition to paying back taxes and interest," Petronchak says. While some schemes are more obviousthan others, Bill Wandel, CPA, licensed taxpayerrepresentative for JK Harris & Company, and Hand,list the following more discreet, yet common trapsphysicians fall victim to:
â€¢Pursuing illegal tax deductions. Hand says purchasinga piece of new equipment for the depreciationallowance when the equipment is not actually necessaryis illegal. Updating equipment to make the practice moreefficient is legitimate. Also, the use of tax-exempt charitableorganizations to shield income and assets from taxationis on the rise. Participants move their assets andincome to a tax-exempt supporting organization andmaintain control, but still deduct that "contribution."
"The biggest thing is making sure you're reportingall of your reportable income and, at the same time,making sure you're taking all the qualified deductions," Hand says. For many physicians who work ina private practice, that means bringing in competenttax counsel for assistance.
â€¢Postponing the reporting of gains. "Notreporting capital gains in the tax years in which theyare realized is illegal," Hand says. "Make sure youkeep track of your cost basis in order to accurately calculateyour gain/loss." While there are provisions in thetax code that allow for deferral when a physician sellstheir business and investment property, it is stronglysuggested you consult a tax advisor to learn the details.
â€¢Investable income obstacles. "You can oftentimesfind investments that don't create regular income,such as an undeveloped piece of property that youexpect to appreciate in value over time, that does not,in the early years, produce income that requires you topay income tax on it," Hand says. "Or when you buya stock at $20 a share with the expectation that it willrun up to $100 a share. Then you control when yourecognize that capital gains tax in any given year whenyou sell the asset." Hand reiterates that financial consultationmay be necessary, especially when decidinghow and when to report those capital gains.
â€¢Overcontributing to a retirement plan. "Themost common mistake is overcontributing to retirementplans," Wandel says. "The maximum amountfor 2006 is $44,000. This amount is subject to familyattribution rules, which prohibit the physician frommaking excessive contributions by employing familymembers, such as spouses." If your significant other isa fellow physician in your practice or works in administration,the cap still remains the same.
â€¢Using trusts to hide income and assets.Sometimes physicians may be advised to set up theirbusiness in a trust, "and make all income andexpenses, including personal living expenses, gothrough the trust which then files a zero-tax-due1041 return," Wandel says. "We must keep in mindthat the basic definition of income tax is that it is atax on income. Income is normally for ordinary andnecessary living expenses, such as food and shelter,for most individuals." Hand also agrees that toomany people believe that using a trust to hide incomeis a legitimate method to prevent them from payingincome tax just because they acknowledge in thetrust document that they're not a tax-paying entity."That is a bogus claim," he says.
â€¢Using unregistered tax shelters. When evaluatingany investment opportunity that also provideshuge tax savings, Wandel advises an extremely importantprecaution. "Make sure that any such investmentopportunity is registered as a tax shelter and has a taxshelter registration number. This is a special numbernot to be confused with a taxpayer identification number,which most of us have." If you don't want to fallvictim to an illegal too-good-to-be-true opportunity,ensure that it is government approved.
â€¢Pursuing offshore schemes. To obscure thetrue ownership of assets and income, people use offshorebank and brokerage accounts, or they use offshorecredit cards, wire transfers, foreign trusts,employee leasing schemes, private annuities, or lifeinsurance to do so. The IRS continues to aggressivelytrack down taxpayers involved in these transactions.
"The Internal Revenue Service is mindful of themany ways in which schemes are presented to reduceor eliminate income tax liabilities," Wandel says."Every year in February, they publish a bulletin,which lists their current â€˜Dirty Dozen'most notorioustax scams to alert the general public in time forfiling season. Everything from return preparer fraudand employment tax evasion to offshore transactionsare mentioned in the list."
The IRS also documents a list of medical professionalssentenced and fined for illegal tax planning. Toview recent cases or this year's Dirty Dozen list, visitwww.irs.gov/newsroom/article/0,,id=154293,00.html.
It is important to treat your finances like youwould a new medical procedure or drugâ€”if a companyclaims their drug will cure cancer, you'd bewary and research the facts before utilizing it in yourpractice. The same applies to your finances. "Usecommon sense, retain the services of a reputableCertified Financial Planner practitioner, andresearch the investment or tax shelter exhaustively,making sure that legal and compliance requirementshave been met at the federal and state levels.Inquiries to government agencies or state attorneysgeneral may also be wise," Wandel says. "These aredifficult times for investors, and due care needs to beexercised to avoid predatory schemes."
Blindly pursuing a tax-saving opportunity couldland you in jail, and you can't enjoy your tax savingsfrom behind bars.