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The listeners asked, and we responded. But it was mostly by email, and the people who asked the questions were the only ones who got the advice. So we had an idea: “Let’s choose the best financial questions from our loyal listeners and answer them on air.” Then we high fived each other and made this episode. You’ll hear Reese & Ryan answer a liquidity question from a graduating dental student, an entity structure question from a mid-career dentist, and a retirement plan question from a practice owner in his 60’s.
Podcast Transcript:
Reese Harper: Hey everybody! It’s Reese Harper here and thanks for tuning into the Dentist Money Show. Today’s episode is going to be a lot fun. We’re super excited about it. We get a lot of questions from loyal listeners and most of the time we answer them with an email or sometimes we interject them into a show. But today we decided to make an entire episode out of answering listener questions. On this episode, we’ll tackle three of them and they cover issues that dentists face at different career phases. There’s a question from a new dentist about liquidity, a question from a mid-career doctor about entity structure under the new tax code, and an investment question from a dentist in his sixties. So there’s something here for everyone.
We want to make this a regular thing, so please send us your financial questions so that we can answer them on upcoming episodes. As always, I want to make sure you know how to get a hold of us at Dentist Advisors, if you’re ready to have a consultation about your own financial situation. To schedule a call, just go to dentistadvisors.com and click the link at the top to book a free consultation. You’ll find time on our calendar that works for you and then we’ll have a discovery call to assess your personal situation, and show you how we can make work optional at an earlier age. If it’s easier for you, you can just give us a call at 833-DDS-PLAN.
Thanks again for listening to the Dentist Money Show. We really appreciate all of our loyal listeners. We look forward to hearing from each of you. Enjoy the episode.
Speaker: Consult an advisor or conduct your own due diligence when making financial decisions. General principles discussed during this program do not constitute personal advice. This program is furnished by Dentist Advisors, a registered investment advisor.
This is Dentist Money. Now, here’s your host Reese Harper.
Reese Harper: Welcome to the Dentist Money Show, where we help dentists make smart financial decisions. I’m your host Reese Harper. Here with my trusty, old co-host and king of podcasting, Sir Ryan Isaac.
Ryan Isaac Ooh, king of podcasting. How did that happen?
Reese Harper: I just thought I’d give you a new title today.
Ryan Isaac There’s a lot of great people in podcasting.
Reese Harper: King of podcasting?
Ryan Isaac I don’t even think I could be called the pauper of podcasting.
Reese Harper: Teeny bit of hyperbole there, to start out your morning.
Ryan Isaac Slight amount. Just a little bit.
Reese Harper: That’s our morning.
Ryan Isaac Okay. Yeah.
Reese Harper: We don’t want to imply that all of you listen to this in the morning at the crack of dawn.
Ryan Isaac No.
Reese Harper: But we are doing this at the crack of dawn.
Ryan Isaac At the early crack. Earliest crack of dawn.
Reese Harper: The sun’s not out yet because the clouds are so gray and the snow is finally falling on our mountaintops.
Ryan Isaac Ooh. Time to ski, man.
Reese Harper: We will find some time to go up there.
Ryan Isaac I’m about to master the green, the green hills.
Reese Harper: I’m just sick of… I got new skis for Christmas, and just destroyed them.
Ryan Isaac You can’t even use them.
Reese Harper: Because I’ve been going on rocks all year.
Ryan Isaac Yeah, it’s bad.
Reese Harper: It’s pretty fun.
Ryan Isaac Well, we have a good show today. We have a unique show. It’s kind of like a first, hopefully the first of many.
Reese Harper: Yeah, new versions. Well, we’ve been answering listeners questions for a while.
Ryan Isaac Yes.
Reese Harper: But today, we’re actually doing an entire episode as Q & A.
Ryan Isaac Only on Q & A questions.
Reese Harper: Yeah.
Ryan Isaac We’ve been getting too many and we’re trying to filter down the ones that are the best questions that we feel like are most applicable. Trying to grab a question maybe from a broad cross section of people, someone approaching retirement, some in retirement, some post-retirement, some in dental school, mid-career, early life.
Reese Harper: Yeah.
Ryan Isaac Today, I guess it would be nice to let everyone know, today’s topics will cover things like when to finance versus use your cash. We’re going to cover a question about, given the new tax bill, should dentists change their corporate entity structure. And then we’ll cover a question about retirement, a retirement question. Someone’s close to being done with work, have a certain amount of money, should they implement a certain kind of retirement plan right before they’re done. You know? So we’ll kind of cover the whole gamut of career choices.
Reese Harper: Let’s do it. So-
Ryan Isaac First of all, I guess first of all, let’s say, please send us some questions. So we’ll try to do this frequently. Right now, the best way to send us questions, ask us anything… Ask Reese about his upbringing on the farm in rural Idaho, if you’d like. Or a financial question.
Reese Harper: Yeah. Or just anything-
Ryan Isaac How to kill snakes with shovels.
Reese Harper: Yes.
Ryan Isaac Anything. Send an email to Reese@dentistadvisors.com. That’s “dentist,” not “dental,” it’s dentist advisors with an O-R-S, dot com. Or Ryan@dentistadvisors.com.
Pretty soon on our website, though, we will have a button that you can click. Click of a button, question, answer. Right, Q?
Justin Copier:/strong> That’s correct.
Ryan Isaac New website said [crosstalk 00:04:18]-
Justin Copier:/strong> On its way.
Ryan Isaac Pretty stoked.
Justin Copier:/strong> We’re nearing the finish line.
Ryan Isaac People are on edge. They’re wondering about this new website.
Reese Harper: They’re dying. That’s the most frequent question we get is when is the website finally done-
Ryan Isaac You’ve been talking about it for two years.
Justin Copier:/strong> We’ll have an educational library, tutorial videos.
Ryan Isaac New videos.
Justin Copier:/strong> It’s going to be pretty cool.
Ryan Isaac A button to push.
Justin Copier:/strong> There will be a button.
Reese Harper: Okay.
Ryan Isaac The biggest button.
Reese Harper: Let’s jump into question number one-
Ryan Isaac The biggest button.
Reese Harper: … that we kind of thought we should go through. I’ll let you kind of jump in and read her.
Ryan Isaac Okay, so this is from a dental student here in Saint Lake City actually. He says, “I’m currently in my second year of dental school here at the school. At University of Utah Dental School here downtown.”
Reese Harper: Yeah.
Ryan Isaac He said, “I have a question about my financial situation. In your podcast you talked a lot about the importance of having liquidity in the bank coming out of school. Right now I have about $35,000 in the bank and it’s in some mutual funds and stocks. Before I listened to the podcast my plan was to live off that until I ran out. Then, start pulling out more in student loans. I figured my wife and I would be able to live off that money for the next year, year and a half at least, before we need to start living off loan money. Would I be best off to save that money and start pulling out student loans now, or would it be better to just max out my loans my last year of dental school in order to have more liquidity. I’m not a huge numbers guy. I kind of depend on advice from smarter, more qualified people as yourself.” He’s talking to you. “Any advice would be much appreciated.”
So, the question comes down to I’ve got some money I’ve saved up. I can live on that and take a little bit less in loans, or I can just keep it around for when I graduate and, just get a little bit more loans right now. So, I’ll let you start off. What would you tell this fine young dental student?
Reese Harper: Well, the first thing that I remember… I mean, I remember this exchange via email. We went back and forth a little bit. I think the first question in my mind was are you going to be able to have, like… kind of, we got into like are you going to get an associates job or buy a practice right after school?
Ryan Isaac Yeah, what’s the plan?
Reese Harper: I think if you know for sure that you’re not going to be buying a practice, and you still have time after graduation to build up some liquidity, then maybe it’s okay to spend that money.
Ryan Isaac Yeah, it’d be fine.
Reese Harper: But, my initial advice was I would prefer that you use the… most people have subsidized. They’ll have a low interest rate portion on their loans, and a higher interest rate portion on their loans that they can draw from each year, and depending on the school that you go to you’re going to have a loan cap limit on each one of those. Typically, what I’d recommend is if you can just borrow on the low interest rate or the subsidized portion, and get by on that amount. And you don’t need to tap into that high interest rate portion of the loans. Then, I would probably maintain my liquidity.
I’d probably keep my $35,000, and keep it around because even if you think you’re going to get an associates job and have time to save up some liquidity after school-
Ryan Isaac That’s a nice shot in the arm. That’s a nice little jump start.
Reese Harper: Well, it’s a nice jump start, but you don’t know that you’re going to actually have an associates job for sure right after school.
Ryan Isaac Right.
Reese Harper: You might not have a job, and you might not be able to find work, and you might not… the only opportunity available might be an awesome opportunity of practice ownership.
Ryan Isaac Yeah, right off the bat-
Reese Harper: With a mentoring doctor who is willing to stick around for a while and help you out. So, if that’s your only opportunity but you spent all of your liquidity during school, and you can’t really qualify for a loan to buy the practice because you don’t have any cash then I would say it was a mistake. So, as a general rule, I hate to see people tapping into the high interest rate portion of their student loan debt if they don’t have to. And, this will apply differently to state schools than it will private schools.
There are several schools in Utah, and some of them are going to have more subsidy that you can get from the subsidized portion of your loans than the non subsidized portion. So, I think that you should try at all times to maintain an emergency fund, maintain liquidity, but if you don’t have that… if you’re going to be tapping into high interest rate loans, and you know for sure that you’ll have time to build liquidity before you’re going to buy a practice after you’re done with school, then maybe spending down your savings isn’t the worst thing.
Ryan Isaac Yeah.
Reese Harper: But when he said, the other question, he said mutual funds and stocks. My thought was-
Ryan Isaac Yeah, I wondered about that too.
Reese Harper: I don’t want that person to be invested in anything that’s aggressive right now, or anything-
Ryan Isaac [inaudible 00:08:45] 2008 and he’s like, “Cool, I have my liquidity.” Then it drops in half and needs it.
Reese Harper: Yeah, I want to know what kind of mutual funds, what kind of stocks those are in. I want to know how much. He says it’s in the bank, mutual funds and stocks, I want to know how much of that is in each. And you just wouldn’t want to see him lose all his savings. What would you add to this?
Ryan Isaac Well, I have conversations pretty frequently with new grads or people getting ready to kind of enter that phase of first jobs out of school. It’s a really common question, you know? What do I do with my extra money? If I have from a job an extra $1,000 left over, do I start paying down student loans? Do I start investing for retirement? What should I do?
It’s really similar because you just have to keep in mind there’s some big life changes coming up in that phase of career. You might not even stay in this… I mean, he’s here in Salt Lake City but he might not stay here.
Reese Harper: Yeah.
Ryan Isaac He might go to a-
Reese Harper: It’s likely he won’t.
Ryan Isaac Yeah. I mean, he might go to another city, another state, which carries all kinds of different changes in costs. You’ve got to think about at some point you’ll want to put down some roots, and maybe buy a place; depending on the city you’re in. Some people-
Reese Harper: Buy a home.
Ryan Isaac Yeah, buy a home to live in, or yeah, somewhere. So, you have down payment money. Then, what you just got done saying is the most important part and that’s career. Everything in the future, where you live, and the money you make and your retirement, that hinges on the right career opportunity. So, you don’t want to put that in jeopardy.
So, I mean, if I were in his shoes, we’re not talking about $200 grand. He’s talking about the difference of $30,000 and loans or not, you know? I’d keep my cash.
Reese Harper: Yeah.
Ryan Isaac Because you just never know. And like you said, you’d hate to have to pass on the perfect opportunity that you weren’t expecting but is just a really great fit, you know? It might take you to another state and then, you want to buy a house. So, I think-
Reese Harper: Yeah, I don’t think we want to minimize how expensive student loan interest is.
Ryan Isaac It’s crazy, yeah. And it’s a huge emotional burden and it last a long time-
Reese Harper: It’s a big deal. But either way, you’re going to have a large student loan balance when you graduate. I just think what Ryan is saying is probably the defacto advice we’d give is keep at least… I mean, I wouldn’t mind seeing someone have a year’s worth of personal living expenses, because at that age you’re talking about living being somewhere between $4,000 and $5,000 a month. Maybe $3,000 and $6,000 depending on the city, the state you’re in.
Ryan Isaac Right.
Reese Harper: So, if you had up to… I don’t think you’d need $100,000 worth of liquidity. That’d probably be a lot of money. If we saw that we might say, you know, pay some of your student loans down. But anything below $50,000, I’d say you probably need a little more liquidity.
Ryan Isaac Yeah.
Reese Harper: Like around $50,000 to me feels like a pretty good buffer because that’s going to cover the liquidity needs that most banks are going to have for-
Ryan Isaac I was just going to say that.
Reese Harper: … for down payment injection, or for at least a requirement they want to see for any size of practice that you’ll be purchasing. If you have less than that you probably don’t need to worry about whether you should pay off more debt because it’s a more important goal generally to have liquidity, than it is to minimize your interest during-
Ryan Isaac Especially when it’s… getting the right career hinges on that.
Reese Harper: Yeah.
Ryan Isaac Yeah. So, like you said, the banks don’t have a set rule but, it’s pretty typical for a bank to want to see about $50 grand. And I don’t know, even if you had upwards of $75,000 or $100,000, you won’t need that cash for a practice purchase, probably. Real estate might be a different issue if you buy some, but a down payment on a home, a place to live; you’ll need that cash.
Reese Harper: Yeah, totally.
Ryan Isaac So, there’s plenty of places for it to go other than debt.
Reese Harper: Love it. All right, what’s the second question we got into?
Ryan Isaac This one is the big one. This is a question that’s on everyone’s mind right now. This has to do with recent changes in the tax plan. So, this is a question that we’ve gotten from a few people. The question, the main question is, should I change my corporate entity structure? Right now, most dentists, unless there’s a larger practice and some management corporations, most dentists are filing as an S corp.
Reese Harper: Yeah.
Ryan Isaac For the most part. An LLC or mostly an S corp. So, some people are asking now that there’s a lower corporate tax structure on the C corp, should I switch? So, we’ll probably want to answer this in a few different ways. One would be let’s make sure we understand what’s the difference between a C and an S corp. What is the new taxation for a C corp? How does that apply to a dentist and his income, and then, same with an S corp. So, any thoughts first before we-
Reese Harper: Well, before… and I would like to say your own CPA is going to have the strongest opinion on this. Like we’re not tax advisors, and we’re probably slightly more qualified to answer this question hopefully than you are, the listener, unless you’re a CPA listening, which I know there are many.
Ryan Isaac Yeah.
Reese Harper: Then, just know that we’re deferring to your personal tax advisor in this answer, but we did think it would be helpful at least to orient you around the choice-
Ryan Isaac Well, I called like four CPAs anyway.
Reese Harper: Yeah. So, I mean, this isn’t just like yeah-
Ryan Isaac This is what I think. I called four CPAs in.
Reese Harper: Yep. So, I think this will be really helpful, but just make sure that you collaborate with your CPA around this, instead of just going to your CPA and being like, “I heard this on a podcast. We’ve got to do it.”
Ryan Isaac Yeah.
Reese Harper: Or whatever.
Ryan Isaac It’s on the internet.
Reese Harper: Yeah. So, let’s talk about how each one is taxed initially, and a little bit about the new tax laws.
Ryan Isaac Yeah. Well, so one of the first things every CPA told me was that every single… I mean, we’re middle of January right now. Every one of them said I’m still waiting for my tax software to update. I’m still waiting for official… there’s a lot of blog posts, and opinions, you know? But a lot of CPAs are still waiting for official statements on how things are going to work exactly.
Reese Harper: Yeah.
Ryan Isaac Which is kind of the consensus from a lot of people. There’s a lot of moving pieces to it.
Reese Harper: Yeah, and I think it’s good for dentists to remember, to know that, and depending on the level of sophistication that each tax advisor… I mean, they might not be getting up to date on these. We have a lot of clients whose CPAs still do their taxes on-
Ryan Isaac Pencil and paper.
Reese Harper: Pencil and paper.
Ryan Isaac And shout out, I guess.
Reese Harper: Shout out if you’re doing that because it’s still working, it’s still functional. You’re keeping people compliant, we get it. But ultimately, there’s going to be a range of how fast your advisor actually gets up to speed on this stuff too, and everyone is kind of in… I mean, we’re only two weeks in like Ryan said, into the year.
Ryan Isaac There’s a lot to learn.
Reese Harper: Yeah, there’s a lot to learn for everyone.
Ryan Isaac It’ll be an interesting year by the time everyone files 12 months from now.
Reese Harper: Yeah.
Ryan Isaac So, one of the first things would be, let’s start with the C corp. What is a C corp? It’s the oldest corporation structure. It’s still the most common corporate structure. You’ll tend to see it more in very large companies. Some of the benefits of a C corp benefit very large companies like unlimited shareholders, or multiple classes of stock. Higher amounts of deductions or right offs, especially in terms of like employee benefit programs. So, very large companies will tend to use these.
Some older dental practices, it was just more common 20/30 years ago. So, you’ll still see a few C corps around. You’ll see them where there’s multiple locations and maybe a management company that’s managing multiple locations. They’re just not as common in dental practices.
Reese Harper: Yeah, and I think one thing to note too is because they’re the oldest there is the most like established set of laws around C corporations. It’s not quite as… the larger national CPA firms will have the most experience interacting with them. But they’re probably the least used within the small business environment, right?
Ryan Isaac Yeah.
Reese Harper: And they’re the least common in the small business environment, and consequently, even some of the things that Ryan was listing, you know that may have been more common in C corporations historically, LLCs are starting to gain some traction, even with large companies. And shareholder classes, and the types of sophistication that’s being injected into the LLC kind of community is increasing a lot because some businesses don’t want the complications.
Ryan Isaac Yeah, sure.
Reese Harper: And the complexity-
Ryan Isaac Tax complexity.
Reese Harper: … that comes with a C corporation and the compliance complexity that comes with it too. So, there’s not really like a bad or a good one. But like Ryan is saying, there’s definitely the oldest and the most established body of law. And they’re most used by large businesses. Public companies will always be, I think in all circumstances I can think of, would be a C corporation. That’s where you’re going to see the most companies will be building toward that level of entity structure so they can raise money from the public in a much more sophisticated way.
Ryan Isaac Yeah, okay. So, let’s talk about the taxation of a C corp. We’ll keep it pretty simple. If you’re an owner of a C corp as a dentist, one of your sources of income will be your salary. So, just wages as in compensation to an owner. That’s your W2 paycheck. These wages are taxed normally how S corp wages are taxed. They come right out to you and they’re taxed at your ordinary income rates.
Reese Harper: Yep.
Ryan Isaac So, pretty straight forward. The other way that money is taxed out of a C corp that’s, this is the more complex way. This is what was being changed in the new tax bill was the corporate tax rate. So, in a C corp, the money left over, after you pay your wages and all your expenses the money left over, what would normally be called net income, right? In your S corp, that’s taxed at the C corp level. So, all the talk that we’ve been hearing about corporate tax rate and all the changes that did get changed, it used to be all the way up to 35% inside of the C corp. It’s now down to 21%.
The thing I actually don’t know that a couple of CPAs weren’t aware of either is if it’s a flat 21% or, if there’s still a bracket system that works up to 21%. I don’t know. Do you know?
Reese Harper: Okay, no I don’t. I thought it was a flat 21%. That’s the way-
Ryan Isaac I thought so too.
Reese Harper: … it’s published in a lot of blogs.
Ryan Isaac Okay. It seems that way and the consensus was, but there were a few opinions of whether or not there’d be a bracket. But now, so let’s… I’ll give an example. Okay, let’s say a practice does a million bucks in collections. Give some really round numbers. You’re paying $200,000 in W2 wages as the owner, single owner.
Reese Harper: Yep.
Ryan Isaac Let’s say there’s $200,000 going to staff wages. Okay, 20% of collections. And let’s say there’s $200,000 left over in net income. Okay? So, the W2 $200,000 goes out and gets taxed at ordinary income.
Reese Harper: Yep, so you’re making $200 and you’re going to pay the same tax rate that anyone will pay off their wages.
Ryan Isaac Yep. Just as an employee. Now, the $200,000 that’s left over in net income, that is first going to get taxed at the C corp level. Given the new tax rate of 21%, that $200,000 would get hit with 21% tax. The money left over after that, then comes out personally to the owner. That owner then pays tax at their long term capital gains rate, which could be 15% or 20%, depending on their income thresholds.
So, then whatever is left over outside of that, then just gets taxed again. So, this is that double taxation thing. This is kind of the downside to a C corp that people talk about. That’s where your double taxation is. So, what people will do is they’ll try to get rid of that through deductions, or write offs or increased salary so that there’s no [crosstalk 00:20:10]-
Reese Harper: So, just to clarify for people who haven’t talked to a bunch of CPAs about this, because I’m getting the sense that you know more about this than most of us.
Ryan Isaac Fresh on my mind.
Reese Harper: If I made $200, I might pay in the 30% range on my first $200 because that’s my wage. Then, there was $200 left over that got taxed at 21%-
Ryan Isaac First inside the corporation.
Reese Harper: Mm-hmm (affirmative). That’s what the business has to pay. Those are the business corporate taxes.
Ryan Isaac Yep.
Reese Harper: That’s very different than if I’m a S corporation owner, because I really don’t have business taxes inside of an S corporation.
Ryan Isaac That’s the difference, yeah.
Reese Harper: Just comes to me, right?
Ryan Isaac We’ll get to that.
Reese Harper: So, I pay my 21%, but then if I want to take that money out after I’ve paid the taxes, I take it out and it’s called a dividend.
Ryan Isaac It’s a dividend, yeah.
Reese Harper: And I have to pay capital gains tax on that-
Ryan Isaac On top of that.
Reese Harper: Just like I would any other stock that I would sell.
Ryan Isaac Yep.
Reese Harper: Or any other stock that I own, right?
Ryan Isaac Mm-hmm (affirmative), yep.
Justin Copier:/strong> So, we’re talking about three different kinds of taxes here, right?
Ryan Isaac Yeah.
Justin Copier:/strong> We’re talking about taxes on your ordinary wages.
Ryan Isaac Yep, your W2.
Justin Copier:/strong> You’re talking about capital gains.
Ryan Isaac Mm-hmm (affirmative).
Justin Copier:/strong> And you’re talking about [crosstalk 00:21:12] net income of your corporation.
Ryan Isaac So, the net income is the tax of the capital gains. Then, there’s the corporate tax rate. Yeah, there’s three different kinds. Yeah, exactly. So, that’s what people refer to as the double taxation. If you did the math on this, the effective tax rate of hitting with 21% and then, 20% capital gains is like 37% tax rate.
Reese Harper: So, you’re just taking the example of your million dollars in collections, $200,000 salary.
Ryan Isaac $200,000 left over-
Reese Harper: And you’re just saying what would the average tax rate be on all this? And you’re saying it’d be around 37%?
Ryan Isaac I’m just saying on the-
Reese Harper: On that example.
Ryan Isaac Just on the net income portion, it’s about 37%.
Reese Harper: Oh okay.
Ryan Isaac After you’re hit with the double taxation.
Reese Harper: You’re not taking the salary and averaging it.
Ryan Isaac No.
Reese Harper: You’re just saying at the end, that double taxation gets you at about 37.
Ryan Isaac Mm-hmm (affirmative).
Reese Harper: You’ve got to add your 15, plus your 21-
Ryan Isaac Yeah, if it’s the 15, then it’s 33. If it’s the 20% capital gains, then it’s 37. The point of throwing out those numbers is just to show kind of the range that switching to a C corp, which is the question here. Should I switch to a C corp because now there’s this lower tax rate? The point is to show that the range is not going to lower your tax rate. It’s not going to put you in a lower… it’s not like oh, well my tax rate is 21% now. Now, I’m paying less taxes. Overall, you’re not saving. You’re not going to… you might even pay more.
Reese Harper: Yeah.
Ryan Isaac If you did it that way.
Reese Harper: Yeah.
Ryan Isaac Not to mention if you ask your CPA about this, they’ll tell you a lot of other things about the complexities of switching from a S corp to a C corp, and the restrictions of going back if you ever want to. Re characterizing income and dividends.
Reese Harper: It’s not easy.
Ryan Isaac It’s pretty complex.
Reese Harper: Yeah. But it can be done, and I guess to the point you probably make is, the larger the business gets and the more shareholders there are… see, collectively a lot of these shareholders, a lot of them don’t, in a C corporation, they’re not getting wages.
Ryan Isaac Yeah.
Reese Harper: So, what they want to see is they want to see a business have the lowest possible tax costs as it can. And in the old world, when corporate tax rates were much higher than 21%, depending on the size of the business-
Ryan Isaac Two weeks ago was the old world.
Reese Harper: Two weeks ago, I mean, the overall taxes that you would pay as an individual by owning stock in a C corporation if you were an owner, and even if you had a wage or not, it was just much higher. What this has done, this new tax law, has created a little bit more parody, like a little bit more similarity between the taxes of an S corporation and an LLC and the taxes of a C corporation.
In the past, I think it’s just fair to say the taxes were much higher because of this double taxation than they are today. That’s why we were less competitive globally because there just wasn’t a lot of… there wasn’t an incentive that was super strong from a tax standpoint of having your business operate in the United States as it’s [inaudible 00:24:09].
Ryan Isaac Maybe we’ll see our market cap grow now.
Reese Harper: Maybe.
Ryan Isaac Maybe we’ll see that. So, the opposite then to this, and we don’t have to spend as much time, is an S corp, which is a much more common structure. There have been some changes to S corp taxation. So, again, these are-
Reese Harper: This is really important to know.
Ryan Isaac Yeah.
Reese Harper: Super important to know.
Ryan Isaac These are the things that are still coming out that, talk to your CPA about how this will affect you. So, just as it exist today, the basic structure of an S corp, as most practices are, it’s what’s called a pass through entity. That just means that all income passes through to the owner’s individual ordinary income tax rate.
Reese Harper: Yep, there’s no separation between the corporate tax and the individual tax.
Ryan Isaac Just goes to the individual. There is no tax rate at the corporate level. It just goes through and you pay it on your individual tax return. The difference that everyone is kind of waiting to see what would happen is there is a deduction. There’s an S corp deduction that can be taken if you’re under certain thresholds.
So, we’ll explain a little bit about that. So, the way this works in this new tax law is there’s a deduction that can be taken if you fall in a certain categories of business. Now, as everyone probably knows by now, service entities, service business are excluded from this deduction if you’re over the threshold. That means dentists can not take this deduction unless your income is under a certain threshold.
Reese Harper: Yeah, the threshold you’re talking about is if you make more than a certain amount of money-
Ryan Isaac You can’t have this deduction.
Reese Harper: You can’t have this deduction no matter what.
Ryan Isaac Yeah. So, here’s-
Reese Harper: But if you’re really small, you can get this deduction.
Ryan Isaac Or, I mean, I think this will apply to a fair amount of dentists honestly. Like single location dentists.
Reese Harper: Yeah, and I was just meaning like small being… a lot of the things this was-
Ryan Isaac This is geared towards very… yeah.
Reese Harper: Yeah, a service company typically are somewhat smaller relative to the other past through entities.
Ryan Isaac Yeah, okay. So, here’s where this new law can actually affect some of you. So, the threshold, we’ll just use married, filing jointly. The threshold is $315,000 of taxable income, which all the CPAs I talked to thought this was a really unique benchmark to use because usually it’s AGI that comes before taxable income.
Reese Harper: AGI?
Ryan Isaac Yeah, AGI, adjusted gross income. So, this is like when you get all of your income on your tax return, right on the front page, your personal tax return, there’s a little section called above the line deductions. We talked about that in podcast… it was a tax one, like three episodes ago. Maybe like one of six, one of five.
Reese Harper: We were wearing green hats on the podcast cover.
Ryan Isaac But the income after that is AGI. After AGI, that’s when you take all of your itemized deductions. This is mortgage interest, charitable contributions, state and local property taxes. That’s changing as well. There’s a cap on how much you can write off. That will affect a lot of people who pay high amounts of state and property taxes.
Reese Harper: Yeah.
Ryan Isaac But after you take your itemized, and after you take, if they’re available, dependent deductions, you know like child credits and all that kind of stuff, that’s your taxable income. So, that’s what they base this off of, which is kind of interesting. There’s not a lot of other thresholds, I don’t think, that are based on taxable income.
But if this number is $315 or less, then you actually are… even though you’re a service business who’s normally excluded from this deduction, you actually can take it if you’re under this $315 taxable income. The way the deduction works is it’s the lesser of… they go to your corporate tax return, and they take the lesser of 20% of your net income. So, that’s line 21 on your S corp. It’s whatever is left over in the business. If we use the same example of a million dollar producing practice with $200,000 of left over money, net income. It’s 20% of that money. So, $40 grand.
It’s the lesser of that or 50% of all wages paid by the corporation. So, in our example we had $200 to the owner, $200 to all the rest of the employees. That’s $400. 50% of that is $200. So, they would take the lesser of $40,000 or $200, which would be $40,000.
Reese Harper: Okay, I think you might have lost some people in that.
Ryan Isaac Lot of stuff.
Reese Harper: Let’s just back up real quick and make sure Q followed it because that’s our barometer of whether the…
Justin Copier:/strong> I was hanging in there for most of it.
Reese Harper: Yeah.
Ryan Isaac Yeah.
Reese Harper: So, basically… let me just restate this so we can kind of get some, maybe just I want to make sure I understand what you were articulating too. If someone is taxable income is below $315,000-
Ryan Isaac Married, filing jointly.
Reese Harper: If they’re married, filing jointly.
Ryan Isaac Yeah.
Reese Harper: That’s taxable income, it’s after all your deductions.
Ryan Isaac Yep.
Reese Harper: Then, you get a special write off. If you’re even, if you’re a service company.
Ryan Isaac Yeah.
Reese Harper: But, in that special write off, if we’re going to articulate it is what? What’s the special write off that I get?
Ryan Isaac It’s the lesser of 20% of your net income from the S corp, or 50% of all wages paid in the S corp.
Reese Harper: Okay. So, I get a deduction of the smallest of these two things. It’s either 20% of my net income or 50% of all my wages.
Ryan Isaac Yeah, yeah exactly.
Reese Harper: So, that could… and that’s typically going to result in somewhere between a deduction of $10, $15, $20 grand maybe-
Ryan Isaac Yeah.
Reese Harper: Depending on your tax rate. Now-
Ryan Isaac No one knows… nobody knows where the deduction will actually be taken, what line it will be in your tax form. Spoiler alert, it’s not a post card, sorry. But so, somewhere it’ll be similar to an itemized deduction. That’s where this new deduction will take place.
So, in tax planning. So, this is where having a good relationship and an ongoing, proactive, communication with a tax person in your life will help, because if your income is in that $350 to $400 range, you know be like gross income. If your itemized deductions and all the things you can take above the line, you know like your doing an HSA, and retirement plan contributions. If you can get your taxable income below that threshold, and you’re an S corp, you’ll have a chance to take that additional deduction.
Reese Harper: Well, and that’s where this new… that’s where your 401K, your defined benefit plan, your profit sharing plan, all these retirement accounts that we are setting up for people to try to drive that-
Ryan Isaac Number down.
Reese Harper: … taxable income down, it’s so crucial in this new plan. And what was kind of striking to me about this is, again I kind of… I just wish that there was a way to slowly take government out of the tax system a little bit more, rather than creating… because what they did with this is create a massive incentive for small businesses at a certain threshold to not even produce. Now, a lot of people are going to be obsessed with, do we really want to push that much harder because a 20% deduction on net income, or a 20% of all percent of all wages-
Ryan Isaac 50%.
Reese Harper: 50% of all wages-
Ryan Isaac All wages paid.
Reese Harper: Which would probably be the bigger of the two.
Ryan Isaac Usually, yeah.
Reese Harper: So, for us in dentistry, it’s probably going to be the 20% of net income that will be the number that we use, but net income for a lot of these doctors is going to be-
Ryan Isaac Quite a bit of money.
Reese Harper: They could be $40,000.
Ryan Isaac Yeah.
Reese Harper: In a deduction, if it’s a $200,000 net income.
Ryan Isaac Yeah.
Reese Harper: So, all I’m saying is that’s a massive deduction that if you’re just $20,000 above that threshold, like you lose out on it?
Ryan Isaac So, then there’s a phase out too. So, there’s like a $50,000 range above that $315 where it’ll phase out.
Reese Harper: Yeah, there’s always a little phase out, right?
Ryan Isaac So, what’s interesting too, people are making the argument of will you see people who are normally employed as W2 employees, and that would be a lot of associates who might now start saying, “Dude, I mean [crosstalk 00:31:40]”-
Reese Harper: Paint me as a 1099.
Ryan Isaac Paint me as a 1099, and then I think there will be an interesting give and take or push and pull between how much a dentist uses to push through W2 and how much… because there will be a perfect formula to maximize that deduction if you’re under the threshold.
Reese Harper: Yep.
Ryan Isaac But then, that also might butt heads a little bit with the number you have to push through W2 for retirement plan contributions. It’s just kind of, you know, like what will take precedent.
Reese Harper: And that’s the way, for me, it’s just frustrating to see a law like this… it will have an effect some. I don’t want to say everyone should think this way because for me, you’re trying to blow through that threshold and, keep growing your business a lot bigger than this minimum amount. You might be able to enjoy this every once in a while, but hopefully your business continues to grow.
So, I think there’s a lot of business owners that will keep… they won’t care and they’ll push through.
Ryan Isaac Yeah, it won’t affect them.
Reese Harper: But I would say the majority of the dental population is sitting in a situation where this really applies to them, and it can create some incentives that are like adverse to growth.
Ryan Isaac Yeah.
Reese Harper: So, I’m like man, just do something that’s more growth oriented.
Ryan Isaac Yeah, incentivize them.
Reese Harper: Like you get a 20% deduction for wages that you add to your corporation over the previous calendar year.
Ryan Isaac Yeah.
Reese Harper: So, if you’re adding jobs and creating jobs, you get more deductions.
Ryan Isaac See-
Reese Harper: But it’s like-
Ryan Isaac Reese Harper, 2020.
Reese Harper: Why are you doing a 20% deduction-
Ryan Isaac Opera Harper.
Reese Harper: … on net income? But you know, don’t make too much money because if you make too much money you’re going to lose that deduction.
Ryan Isaac You don’t get the incentive anymore.
Reese Harper: Well, thank you for incentivizing me to stay small, and not grow! Holy crap.
Ryan Isaac Yeah.
Reese Harper: Anyway, I’m just like-
Ryan Isaac I like the passion. It’s true. So, let’s go to-
Reese Harper: [crosstalk 00:33:29].
Ryan Isaac Number three.
Reese Harper: And I appreciate a friend CPA giving me a call and telling me how it’s not that bad and it’s a good thing because I need to be talked off the ledge here.
Ryan Isaac It’s good. And we appreciate all the CPAs that picked up the phone the last two or three days to help shape our answer in this question. So, question number three-
Reese Harper: So, we didn’t really answer it. Should a dentist switch? I would just say-
Ryan Isaac Every CPA said no, and I’m not telling any of my clients that they should switch.
Reese Harper: Yeah, [crosstalk 00:33:55] and I think what we’re highlighting here is there are more potential benefits of staying… if you’re kind of in this professional services, smaller business kind of world-
Ryan Isaac And I would say if collections are below… anywhere below a million, you might be able to benefit in an S corp from this new deduction.
Reese Harper: Yeah.
Ryan Isaac I mean, you might depending on… it’s just depending on where-
Reese Harper: And again, it’s my understanding this also applies to an LLC that’s filed as an S corp.
Ryan Isaac Yes, mm-hmm (affirmative).
Reese Harper: As long as you’re electing S corporation status.
Ryan Isaac Pass through entities.
Reese Harper: Right?
Ryan Isaac Yeah.
Reese Harper: Okay, number three. The third question that we’re going to answer.
Ryan Isaac Number three came from a dentist, I believe in Florida, who is near the later end of his career. He said, “I just listened to a podcast and you asked for situations where we’d like addressed in your next show.” He said, “I’m turning 60. I have about a million dollars saved, and no retirement plan.” I’m assuming-
Reese Harper: So, he’s turned 60. He’s got a million. I haven’t looked at this yet. So, I want to just make sure I get the question down.
Ryan Isaac Yep.
Reese Harper: 60, he’s got a million saved-
Ryan Isaac But no retirement plan at the office-
Reese Harper: No formal plan at the office.
Ryan Isaac Yeah, no like 401K or anything.
Reese Harper: Okay.
Ryan Isaac His question is, “Should I start a retirement plan, or since I’m almost done, should I just invest outside of the retirement plan?” Since he says because since fees and employee contributions cancel out the tax benefit on such a short time horizon.
Reese Harper: Okay. So, he’s worried that if he sets up this 401K he-
Ryan Isaac Maybe he’s got five, seven years left, three I don’t know. He didn’t specify, but he’s 60. So, maybe he’s winding down.
Reese Harper: Yeah, no I think this is a really good question for us to kind of [inaudible 00:35:30] on. What questions would you ask, if you were going to talk to this person. There’s obviously some follow up questions that we’d need to know-
Ryan Isaac Yeah, a lot.
Reese Harper: … before you give someone advice. What would those follow up questions be?
Ryan Isaac Yeah, well I’d want to know how long are you going to work?
Reese Harper: How long are you planning on continuing to work?
Ryan Isaac How long are you planning on continuing to work? Yep. I’d want to know-
Reese Harper: What if he says I don’t know, I just, as long as I need to.
Ryan Isaac Okay, that’s a fine answer.
Reese Harper: Okay.
Ryan Isaac How much do you spend at home? What’s personal spending like? How might that change in retirement? Are you paying for any kids in college that’s going to be done-
Reese Harper: Okay, so why are you asking him how long… why do you need to know how long he’s going to work?
Ryan Isaac Well, some future questions will help answer that better. Like how liquid are you right now? Out of that million dollars, is that sitting in brokerage accounts? I assume, when he said saved, I assume that means-
Reese Harper: Maybe it’s invested in something.
Ryan Isaac What if it’s in real estate? [crosstalk 00:36:20]-
Reese Harper: Maybe it’s in cash.
Ryan Isaac Yeah, I’d want to know what’s your practice worth? How much can you get out of your practice?
Reese Harper: You’re trying to get to how much are you worth?
Ryan Isaac What are you worth, and what do you spend, how about that?
Reese Harper: You’re trying to get to what is he worth and what is he spend, so you know how close he is to retirement.
Ryan Isaac How close to that total term number, are we a 20? Are we a 30-
Reese Harper: Because if he’s really close to retirement and he’s almost there, between all the things he has and the level of spending he has, then your answer is very different than if he’s still quite a ways away and needs another… let’s say he needed another million to-
Ryan Isaac Yeah, the other thing too is if you look on our elements the bottom row is five bricks. They have to do with net worth, and how your net worth is concentrated. The other thing I’d want to know is where is your net worth? Even if it’s enough, is it sitting inside a practice? Is it in real estate?
Reese Harper: So, you’d want those five bricks at the bottom. You’d want to know how much does he have in liquid, and retirement, and real estate [crosstalk 00:37:08] equity.
Ryan Isaac How much are we going to get when you sell a practice? How do you want to sell the practice? What other liquid assets are you going to have when you’re done working because if you’re liquid enough, or you’re going to have a fairly large liquidity event when you’re done working, then I don’t… I wouldn’t have a problem putting money for the last five years of a career into a retirement plan when maybe my income is the highest its ever been, and my tax rate is the highest its ever been. I’m assuming.
Reese Harper: Yeah.
Ryan Isaac We don’t know. I’d want to know that. What’s your tax rate? But I’d really want to know about balance sheet and liquidity, and how assets-
Reese Harper: All right, so all that given. It takes too long. So, the listener is like, I don’t care, just tell me the answer.
Ryan Isaac Yeah, should I do it or not? Well-
Reese Harper: I’m going to ask you. So, if the person… what would it take? When would you say, yeah of course set up the retirement plan? Give me the scenario when you’d say, yeah, you totally should set up the retirement plan?
Ryan Isaac A, there’s enough money to even fund one. So, left over cash every month that he can appropriately max out. So, don’t set up a profit sharing plan if you can’t max it out.
Reese Harper: So, if you can only do three grand a month, that’s very different than if you can do five or seven-
Ryan Isaac Yes.
Reese Harper: Or way more than that.
Ryan Isaac So, knowing what’s your savings rate. What’s your left over money?
Reese Harper: So, if he had a lot of left over money you’d say then-
Ryan Isaac Yeah, maybe a profit share, maybe a cash balance plan. You know, if you can save over the next five years of your career $25,000, $30 grand a year in taxes because you have some big profit sharing plan or cash balance plan, I’d take that.
Reese Harper: Okay, so you’re saying that the thing he’s probably missing here, because he’s saying the tax benefit is going to get-
Ryan Isaac That’s my second point. I would say don’t assume that.
Reese Harper: Okay.
Ryan Isaac Because he said, since it’s a short time frame the tax benefit will be canceled out by the fees and employee… the match. The costs of the match of the employees. I would not assume that at all.
Reese Harper: Don’t assume that’s the case necessarily.
Ryan Isaac Yeah, because it’s usually not. If you max out a plan-
Reese Harper: Appropriately.
Ryan Isaac Appropriately, there’s a net tax benefit to you, the plan owner. So, I don’t think that’s an assumption I would base this on.
Reese Harper: So, how do we know what’s a good… how do you measure like hey, that’s a good thing for you?
Ryan Isaac Funny you mention that. We covered this in episode 53. Everything you need to know about retirement plans.
Reese Harper: And what did we say in that episode? How do I know if my fees and my employee matches are eating up the benefit to me?
Ryan Isaac Yeah, we covered the various types of retirement plans you can have from a personal IRA all the way up to a big pension plan, and how to choose it based on the cashflow you have left over, and how much you can put into it, and your tax rate, and your timeline and your liquidity needs.
Reese Harper: So, does it ultimately boil down to how much of the money am I keeping for myself? Like if I put in $100,000. How much I keep and how much goes to other people?
Ryan Isaac Mm-hmm (affirmative). Yeah. What’s the net tax benefit. To answer his question, we’d want to know more about balance sheets, spending, career, assets and liquidity. Then, just tell him, you know, the right plan implemented to fit your cashflow is not going to be trumped by expenses and employee matches, you know?
Reese Harper: Yeah, [crosstalk 00:40:02] because in my experience I heard this question all the time, and it’s as simple to me as looking at okay, how much can we contribute? Then, how much of that total contribution stays with you?
Ryan Isaac Mm-hmm (affirmative).
Reese Harper: If you see 80 to 85 to 90… I mean, 90% plus of the total contribution going to you-
Ryan Isaac To the owner, yeah.
Reese Harper: But you’re going to say 40 cents in taxes on the dollar.
Ryan Isaac Yeah.
Reese Harper: And you’re about to go into retirement when your personal income tax is probably going to be a lot lower than it is at this peak point in his career, at age 60. Then, it really isn’t… there’s too many times an assumption that setting up a retirement plan in your 60s is not good for you. But in my experience that is the precise time when the pension plan contributions, the best plan you could have ever done in your career is available to you-
Ryan Isaac At the later end of it.
Reese Harper: At the later end of your career with the most amount of savings you can put away. And we currently have clients in their 60s saving over $250,000 a year.
Ryan Isaac Yeah, and the thing about that, I mean-
Reese Harper: Into a pension plan.
Ryan Isaac You’re talking about almost a six figure tax break.
Reese Harper: You’re almost getting $100,000 in tax savings. Now, you’re going to take the money out, and pay taxes on it. We get that. I mean, you’re starting at age 60, but we’re just talking about in this calendar year, right now, today. If you could save $100,000 in taxes, wait 10 years to take that money out when you’re 70. In this person’s case. Now, if you’re 66/65 it starts to get different. But a 60 year old, if you’re turning 60 and you’ve got basically 10 years before you have to take any money out of the account because at age 70 you’ve got to start taking-
Ryan Isaac Yeah, it makes you take it.
Reese Harper: A little bit, it’s actually age 70 and a half.
Ryan Isaac Yeah, 70 and a half-
Reese Harper: Whatever that means.
Ryan Isaac Don’t sell that six months short.
Justin Copier:/strong> It’s the same person that decided on 21%.
Reese Harper: Yeah.
Justin Copier:/strong> 39.6.
Ryan Isaac With a $315,000 taxable income limit, okay?
Reese Harper: So, I guess you’ve got to pick a number at some point, but I don’t…
Ryan Isaac Make it interesting.
Reese Harper: When you’re doing bad legislation you have to pick a number like that.
Justin Copier:/strong> I thought you stop talking about half ages when you’re like five. [crosstalk 00:42:10] four and a half man.
Ryan Isaac So-
Reese Harper: So, the answer to him is don’t assume it’s not going to be a good thing for you. But it could… there’s a chance it could be really bad. You have to run the numbers and see.
Ryan Isaac Well, I wouldn’t set up a plan that’s going to run me several thousand dollars a year just in administrative costs, plus thousands in employee matches, and then, not even max it out myself. Then, you will have a loss.
Reese Harper: Yes.
Ryan Isaac It won’t help you with anything.
Reese Harper: And, these are not expensive plans to set up if you’re doing them through the right service providers.
Ryan Isaac Yeah.
Reese Harper: So-
Ryan Isaac They’re very normal.
Reese Harper: You’re not going to wipe out all the benefits.
Ryan Isaac So, the other side of this too, real fast, and you kind of talked about this, was just the liquidity side. I wouldn’t worry about the lack of liquidity with my money going into a retirement plan, especially at the end of a career. If I’m close, I don’t have any big liquidity needs before I’m done working.
Reese Harper: What do you mean by that?
Ryan Isaac Like I don’t have to buy anything. I don’t need a down payment on a house or a building. I don’t need my cash-
Reese Harper: Not trying to relocate to a different state.
Ryan Isaac Yeah.
Reese Harper: With any cash [crosstalk 00:43:15].
Ryan Isaac Then, if I’m going to sell a practice at the same time that I’m done working, I’m okay locking my money up for the last five years of my career in a 401K or profit sharing or pension plan.
Reese Harper: Yeah, because the money that I’ll get from the sell of my practice-
Ryan Isaac It’s coming back, yeah.
Reese Harper: … is liquid and I can access it.
Ryan Isaac Yeah.
Reese Harper: What if someone had zero liquidity though? Like no… they had nothing and let’s say this million is already in-
Ryan Isaac Sitting in practice equity?
Reese Harper: In practice equity and that’s the only place it’s coming from.
Ryan Isaac I don’t… if I was 15 years from my retirement I would say no, I wouldn’t lock up all my savings in this thing. Five? I’d probably still do it, if I didn’t have any big… I mean, have a three to six month emergency fund, but…
Reese Harper: Yeah.
Ryan Isaac You know, I’d do it for the tax savings, if I’m that close.
Reese Harper: Yeah.
Ryan Isaac But call us, hey, you know. 833-DDS-PLAN. Okay, so thanks for the questions actually. This was a really fun episode to do.
Reese Harper: Yes, please send more. We love the questions.
Ryan Isaac Email Reese at dentistadvisors.com.
Reese Harper: That’s R-E-E-S-E.
Ryan Isaac Yes.
Reese Harper: Not R-Y-H apostrophe-
Ryan Isaac Which is a really common mistake [crosstalk 00:44:17].
Reese Harper: Sometimes I have my name misspelled, which is strange to me because the only one I know is the Reese’s peanut butter cups-
Ryan Isaac And that’s pretty simple-
Reese Harper: … candy wrapper, and that’s the one people would [crosstalk 00:44:27]-
Ryan Isaac Pretty straight forward.
Reese Harper: There’s some creative spellings of my name. So, it’s R-E-E-S-E.
Ryan Isaac At dentist advisors, R-O-S, dot come. Or Ryan@dentistadvisors.com.
Reese Harper: Some people misspell Ryan, and that’s where, for me, that’s a little bit harder-
Ryan Isaac That’s where we [crosstalk 00:44:39] wonder, who are you?
Reese Harper: Rayon!
Ryan Isaac Who is this person misspelling the word Ryan, the name Ryan? Email some questions. We’ll do this again soon. Go to our website if you’d like to schedule a conversation with us. We’d love to have a free consultation and have a chat with you about your questions, and point you in the right direction, give you some answers to things you’re trying to figure out. Go to dentistadvisors.com. At the top, there’s a little link to the calendar, and schedule a time at your own convenience. You can call us directly at 833-DDS-PLAN, which is the coolest phone number ever. We would love to hear from you. Thanks for joining us.
Reese Harper: Carry on!
Retirement Plans, Taxes