Tax cut could have big impact on savings

Practice Pointers. By Cathy B. Goldsticker, amednews contributor. July 23, 2001.

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Question Now that the new tax law has been enacted and while there is still ample opportunity in 2001 to make changes to my tax situation, I am interested in what will impact me and my practice.

My solo practice is established as an S-corporation, and I am married with two children. My spouse is also a physician, and we both want to set aside retirement and college savings with help from Uncle Sam. How does the new tax law help us increase these savings?

Answer On June 7, the president signed into law the "Economic Growth and Tax Relief Reconciliation Act of 2001." It is perceived as potentially the biggest tax reduction in the last 20 years, with such features as repeal of the estate and generation skipping transfer taxes, significant drops in the income tax rates over a six-year period and a midyear rate-reduction credit that will give you a tax refund check before Oct. 1.

The tax law changes are fairly complex with various tax relief phase-ins and phase-outs. Furthermore, it has a "sunset" provision, which effectively terminates the entire act's provisions beginning after Dec. 31, 2010. Nonetheless, there are tax provisions that will offer you benefits, especially in the areas of retirement and education, which should be incorporated into your tax planning.

There are several changes to the education IRA rules. Your practice is now permitted to make contributions to education IRAs. And you may now increase your education IRA contribution from $500 per year to $2,000. The act also expanded the definition of qualified education expenses to include elementary and secondary school expenses.

Finally, it is now possible to claim the hope or lifetime learning credits against your income taxes and exclude from income, distributions from an educational IRA, both in the same tax year for the same beneficiary.

Starting in 2002, you may now deduct from your gross income, under the act, qualified higher education expenses, such as tuition and fees paid during the year to eligible educational institutions, up to $3,000. There are income-level limitations for this tax benefit, and 2005 is the last year allowed for this deduction.

Unlike the education IRA and qualified tuition programs, the deduction and education credits can't be taken in the same tax year.

The act brings many favorable changes to the qualified tuition programs or section 529 plans, which become effective for tax years beginning in 2002.

Distributions from qualified tuition programs are now excluded from gross income.

Effectively, the earnings accumulation in your tuition account is not subject to federal income tax and usually state income tax, assuming the funds are used to pay for qualified higher education expenses.

Another change allows you to claim the hope or lifetime learning credits and excludes from income the education distributions in a tax year for the same student, similar to the education IRA rules. The penalty for not using the funds for higher education expenses was eliminated and replaced with an additional tax.

Starting in 2002, the act makes modifications to the student loan interest deduction by increasing the starting point for phasing out the higher income taxpayers and allowing interest deductions indefinitely.

Retirement plans

There are many changes in the retirement plan area. The amount you may contribute to your regular IRA or Roth IRA will increase to $3,000 in 2002, to $4,000 in 2005 and to $5,000 in 2008 with $500 increments thereafter.

If you are at least 50 years old, you may contribute an extra $500 each year, starting in 2002 through 2005, and an extra $1,000 starting in 2006.

Your practice may now contribute up to $40,000 per employee to its defined contribution retirement plan, up from $35,000.

Starting in 2002, you may elect to defer $11,000 from your wages into your 401(k) account, with $1,000 annual increases from 2002 until it reaches $15,000 in 2006.

There are other retirement plan provisions of the act that may apply to you. You may now borrow from your retirement plan account, as an S-corporation shareholder. This was prohibited under the old laws. Furthermore, rollovers from one retirement account to another will be easier.

There are other provisions in the law that may impact your tax situation. Quite possibly you have been paying alternative minimum tax in addition to your regular tax. The act increases the AMT exemption amount by $4,000 for tax years 2001 through 2004.

Another provision in the tax act eliminates the overall limitation on itemized deductions (such as contribution, interest and tax deductions) and phase-out of personal exemptions. Unfortunately, this change doesn't begin until 2006 and then is phased in over five years, but once the act's provision commences, your tax bill will decrease dramatically.

After you wade through the complex phase-in and phase-out rules and determine which tax benefits apply to your income level, there are significant tax dollars to be saved from the education and retirement provisions of the 2001 Tax Act.

Practice Pointers is provided by the St. Louis-based accounting and management consulting firm Stone Carlie & Co. LLC. The author and publisher are not rendering professional advice and assume no liability in connection with its use. Consult with professional advisers regarding your specific situation. Readers are invited to submit questions to the Business Editor (bob.cook@ama-assn.org).