The Fairness Doctrine
The idea of fair is something that we struggle with as children until we come to the conclusion that the world is NOT fair.
While the government certainly portends to the arbiters of fairness by passing bills like The Fairness Doctrine to control biased public agendas on network television and renaming the tax department the Board of Equalization, it is often the government programs that lack what you could call fairness. Here are three government tax programs that don’t seem very fair and what you can do to avoid trouble:
WITHHOLDING ON 1099 PAYMENTS
The IRS recently released a memo to clarify that if you pay an independent contractor without first obtaining a W-9 with the proper tax reporting information, it is you (the payor) that is liable for the 24% backup withholding.
Let’s say you pay a contractor to do $1,000 worth of work (insurance verification, grounds maintenance, building repair, IT work, etc.) for you and you fail to get a W-9. When it comes time to file the 1099 in January and you can’t track them down, you’ll need to send the IRS a check for an additional $240.
To avoid this issue, you have two options:
Ensure that you have a completed and correct W-9 BEFORE issuing any payment. It is within your legal right to withholding payment until the W-9 is provided. This is best practice.
Withhold 24% from the payment if the contractor refuses to provide a W-9. This is not recommended but the threat of withholding usually results in a W-9.
FORFIETED REFUNDS
By law, you are required to hand over any patient credits to the government after a certain period if you can not make refund to the patient (each state’s unclaimed property laws vary - find your state’s law here). Interestingly enough, the IRS and most state tax agencies are not held to that same standard and your tax refund will be forfeited back to the IRS if you do not file your return or claim for refund within 3 years of the original filing deadline.
To avoid this issue:
File your returns by the tax extension deadline (September 15th for businesses and October 15th for your personal return) at the latest.
Have your tax preparer use the Efile system rather than mailing your returns, and request email verification of acceptance.
Use Where’s My Refund to check on the status of your refund and ensure that you have received it before the forfeiture period begins.
INFLATION ADJUSTMENTS
When a new tax law is put into place, Congress has the option to make the limits subject to inflation or make it a set amount. For example, the IRA contribution limits were set at $1,500 in 1974 and were not adjusted with inflation until law changes in 2001. Another more alarming example is the Net Investment Income Tax (NIIT) that was created to help fund the Affordable Care Act. The NIIT rate is relatively low at 3.8% and only applies to investment income (not wages or practice income). The little buried trick that does not seem fair is that the income limit where the NIIT kicks in was NOT set to adjust with inflation, so while it only affected 3 million taxpayers back in 2013, it is now expected to be paid by over 7 million taxpayers in 2023.
To avoid this issue:
Lower your Adjusted Gross Income (AGI) below the limit of $200k for single filers and $250k for married filers. Deductions like mortgage interest, state taxes and charity do not lower AGI, but contributions to IRAs and HSAs do lower your AGI. For a successful practice, reducing your AGI below the limit (see above) will be impossible, so see other options to lower your investment income subject to NIIT.
Do a majority of your investing inside your retirement accounts as opposed to taxable accounts, and consider the long term benefits of using a ROTH to avoid NIIT in retirement.
In a taxable investment account, consider using tax-free municipal bonds, as those yields are not subject to the NIIT.
Consider harvesting capital losses to offset a large capital gain, like the gain on the sale of your house over the exemption limit.
Use an installment sale to spread out the recognition of gain across multiple years rather than having a one year spike. This is particularly useful in selling your practice and/or practice building.
For the retired dentist, consider making qualified charitable distributions from your traditional IRA to reduce your AGI and investment income as well as consider conversions of traditional IRAs to ROTH IRAs in the early stages of retirement.
Since life and tax laws are not fair and each situation is different, please schedule a consultation with JNG Advisors today to avoid being subject to tax laws that you can and should avoid.