Article Date: 7/1/2003

business advisor
Preserving Your Income
If your situation fits, you don't want to miss out on this tax strategy.
By Jerry Hayes, O.D.

To get some ideas on how middle to upper income optometrists can save money on taxes next year, I recently interviewed Mr. Ken Hicks, a C.P.A. who works with a number of high-earning practice owners across the country. According to Ken, there's both good news and bad news on the tax front.

First, the good news

Because of the Economic Growth and Tax Relief Act of 2001, O.D.s earning $100,000 will see their federal income tax rate decline to 27% in 2003, 26% in 2004 and 2005 and 25% in 2006.

. . . now, the bad news

Unfortunately, these reductions are being offset by rising "payroll taxes" for social security and Medicare. In 2003, payroll taxes will reach 12.4% for social security on income up to $87,000 and 2.9% for Medicare without any cap on net earnings. The chart above right shows the dramatic effect these payroll tax increases will have on your total taxes due. And don't forget -- this doesn't include state or local income taxes.

As you can see, for an O.D. netting $50,000 fully 70% of his total federal taxes is comprised of 'Payroll Taxes.' For an O.D. netting $150,000 33% of his federal taxes is payroll taxes.

Given this situation, I asked our expert if there was anything else a high-earning optometrist who is already taking advantage of all your normal write offs can do to further reduce his taxes.

You can further reduce taxes

The answer is yes, you can convert to what is known as a subchapter S Corporation. According to Hicks, if you a) earn more than $100,000 each year and b) currently file as either a proprietorship or C Corporation, then an S Corporation will allow you to better control the amount of payroll taxes you pay on your own salary. This in turn can help you save thousands of dollars every year.

Here's how it works. Let's say that you are unincorporated and you earn $100,000 a year. You'll pay $22,000 in federal income tax and another $12,000 in payroll taxes. But if you convert your practice to an S Corporation, then you can pay yourself a smaller salary -- say $60,000 -- and take $40,000 in a nonpayroll distribution. You'll still owe income tax on the entire $100,000, but because you won't owe payroll taxes on the $40,000 distribution, you save $4,500 in taxes. That alone can justify converting to a subchapter S.

Understanding the downside

S Corporations do carry some disadvantages. For one thing, you'll have to file both a personal return and a corporate return every year, which can slightly increase your accounting costs. Also, if you're contributing heavily to a 401(k) or other retirement plan, you may have to lower your contributions because the amounts are based on your W-2 salary. And last but not least, state tax laws negate the advantages of an S Corporation in Texas and Tennessee.

Figure it out

If you're earning more than $100,000 each year, then you should ask a qualified C.P.A. how an S Corporation would affect your taxes. You can mull over various factors, but the bottom line is the tax savings are real.

 

The Effects of Payroll Tax Increases

NET INCOME INCOME TAX PAYROLL TAX % OF NET INCOME
$50,000 $3,000 $7,000  20%
$100,000 $22,000 $12,000 34%
$150,000 $30,000 $15,000 30%

KEN HICKS, C.P.A., CONSULTS WITH OPTOMETRISTS ACROSS THE COUNTRY ON TAX AND CORPORATE MATTERS. REACH HIM AT (601) 619-2930.

 



Optometric Management, Issue: July 2003