Tax Changes You May See in 1998 

A number of proposed tax changes are appearing in Congress. Here are some of the proposals of greatest interest to doctors: 
 
• Several estate planning techniques are on the Clinton administration hit list, including valuation discounts for family limited partnerships, Crummey Trusts (will impact life insurance trusts), and personal residence trusts (used to transfer a home from a parent to child). 
 
• Republican lawmakers propose further cuts in estate taxes. Moreover, many in Congress support complete elimination of death taxes -- they generate only 1% of all federal tax revenues. 
 
• Currently, taxpayers may exchange tax-free one variable annuity for another. Also, there's no tax impact when the investments in the annuity are reallocated. Under a Clinton administration proposal exchanges and reallocations would be taxable. 
 
• The Clinton budget proposal includes a credit of up to $2,000 for 50% of an employer's plan start-up expenses. 
 
• The administration proposes a new, simplified defined benefit-type retirement plan, called the SMART plan. The plan would provide a benefit of 1% or 2% of an employee's compensation for each year he or she is a plan participant. The plan would cover all employees with at least two years of service and at least $5,000 of compensation. 
 
• The first $2,000 of severance payments would be excluded from taxable income. 
 
• William Roth (R-Del) and Bill Archer (R-Texas) propose to eliminate the 18-month holding period for long-term capital gains. The holding period would be reduced to 12 months. 
 
• Congressman Archer has also proposed the Taxpayer Relief Act of 1998 that would eliminate the "marriage penalty," cap federal taxes at 19% of GDP (currently at 20.1%), reform the alternative minimum tax, and revise the income tax brackets to fix the hidden tax brackets caused by the phase-out of various tax deductions. 

We'll keep you updated on any tax changes as they progress through Congress. 

How does your practice's overhead compare to that of other practices in your specialty? Here are the overhead percentages for some specialties: 

(Source: NAHCC 1997 Practice Statistics) 

The overhead percentages shown above do not include any compensation to doctors nor any doctor professional expenses (retirement plan, health insurance, dues/subscriptions, travel, auto, etc.). The overhead does include all staff expenses. 

 

Last month's Doctor's Report (see "Is It Time to Refinance (Again)?") discussed the ins and outs of a home refinance. Unless you're doing a no-cost/no-points refinance, there are a number of other costs and considerations that you should include in your refinance decision. 

Paying Points: You can usually drop your interest rate on the new loan by paying a point (a fee of 1% of the borrowed amount, oftentimes called a loan origination fee). Each point you pay will drop your rate by approximately .25%. Unless you're borrowing to purchase or remodel your principal residence, points are tax deductible only over the life of the loan (i.e., amortized over 30 years for a 30-year loan). 

Other Closing Costs: Other costs to refinance can include title insurance, appraisal fees, documentation fees, local fees and taxes, and escrow fees. These costs are not tax deductible but are added to the cost of your home. You can estimate these closing costs at about 1.2% for a $200,000 loan, .9% for a $300,000 loan, .725% for a $400,000 loan, and .6% for a $500,000 loan. Some loans are available at no points, no costs. Expect to pay a higher interest rate for such loans. 

Jumbo vs. Conforming Loans: The size of your loan will impact the interest rate you're offered. Jumbo loans are those exceeding $227,150, and they typically carry a higher interest rate (approximately .25% - .50%). 

Adjustable vs. Fixed Rate: Your refinance decision will include 
whether an adjustable or fixed rate loan is best. When rates are high and may be dropping dramatically, an adjustable rate works best. To guard against future interest rate increases, fixed rates are best. Under current market conditions, we recommend a fixed rate loan if you think you'll keep the loan five years or more. 

15-Year vs. 30 Year Term: With lower interest rates, and assuming you can afford a higher interest rate, you should consider reducing the term of your loan. The difference in interest paid between a 30-year versus a 15-year loan can be considerable. For example the interest savings on a $200,000, 7.5% loan is $155,437 for a 15-year loan versus a 30-year loan. Also, consider that a 15-year loan usually has an interest rate of about .25% - .50% less than a 30-year loan. 

Here are some good websites for checking mortgage rates and doing refinance calculations: 

http://www.loanshop.com/calc.htm  

http://mortgage.quicken.com/  

http://eloan.com/  

http://www.bankrate.com/  

A recent report by the Heritage Foundation reports an extremely low rate of return of return for most taxpayers' social security investment. For example, Social Security's inflation-adjusted rate of return is only 1.23% for an average household of two 30-year-old earners with children in which each parent made just under $26,000 in 1996. Such couples will pay a total of about $320,000 in Social Security taxes over their lifetime (including employer payments) and can expect to receive benefits of about $450,000 (in 1997 dollars, before applicable taxes) after retiring at age 67, the retirement age when they are eligible for full Social Security Old-Age benefits. Had they placed that same amount of lifetime employee and employer tax contributions into conservative tax-deferred IRA-type investments -- such as a mutual fund composed of 50% U.S. government Treasury bills and 50% equities -- they could expect a real rate of return of over 5% per year prior to the payment of taxes after retirement. In this latter case, the total amount of income accumulated by retirement would equal approximately $975,000 (in 1997 dollars, before applicable taxes). Similar dismal returns are projected for taxpayers in other income brackets. Obviously, social security is a poor retirement vehicle. (Social Security's Rate Of Return, Heritage Foundation, 1/15/98; William W. Beach, John M. Olin Senior Fellow in Economics; Gareth E. Davis, Research Assistant; see the full report at: 

http://heritage.org/heritage/library/cda/cda98-01.html 

The Internal Revenue Service has announced an increase in the 1998 business auto standard mileage rate from 31.5 to 32.5. Moreover, the standard mileage rate may now be used by taxpayers that lease rather than own their business vehicles. Prior to 1998, deductions for leased vehicles could only be calculated using the actual expense method. Now doctors can choose either the actual expense or standard mileage rate method -- regardless of whether the auto is owned or leased. Obviously, you should choose the method which nets you the best deduction. Once you've chosen the actual expense method for a leased auto, you may not later switch to the standard mileage rate. 

The 1998 standard mileage rate for charitable driving is 14 and the rate for medical-related driving is 10. Tolls and parking may be deducted in addition to these rates. 

Roth IRAs can be established for the first time this year. For some taxpayers they present significant tax planning opportunities. Consider the following: 
 
• Want to do a Roth IRA conversion? Your adjusted gross income (AGI) must not exceed $100,000 in the conversion year. Consider dropping your AGI through deferral of income, accelerating practice expenses, and increasing retirement plan contributions. 
 
• Want to set up a Roth IRA? Your AGI can't exceed $150,000. Again, consider income deferral/deduction acceleration to get your AGI under the wire. 
 
• Contributions for children have many advantages since they can benefit from the long-term growth of a non-taxable Roth IRA. The child must have at least $2,000 of earned income (wages, self-employment income). Tax-free, penalty-free withdrawals can be made for first-time home purchase (maximum $10,000 withdrawal) and of the contributions (but not the appreciation) for any other purpose. 
 
• Retired taxpayers approaching age 70 must take mandatory distributions from IRAs and retirement plans. Roth IRAs do not have mandatory distributions. Consider a Roth IRA conversion to avoid the mandatory distribution rules. 
 
• Retired taxpayers already taking mandatory distributions should consider a Roth IRA conversion to discontinue the mandatory distributions. 
 
• Roth IRA conversions can also impact one's overall income tax and estate tax planning. Regular IRAs are subject to both income and estate tax. A Roth IRA is subject only to the estate tax. There are methods to gift a Roth IRA to completely eliminate it from one's estate. 

This will be a big year for Roth IRA planning. Congress could initiate changes to close some of these opportunities. Meet with your financial advisor to consider the impact of a Roth IRA on your own situation. 

Whether an expenditure is a repair or an improvement is an important distinction. Repairs are normally deducted in the year the expense is paid. An improvement is considered a capital expenditure and must be depreciated or amortized over the life of the property improved. In the case of an improvement to real estate, that can mean a depreciable life of 39 years. 

So, what is the distinction between a repair or improvement. A capital improvement is any amount paid out: 
 

(1) for permanent improvements or betterments which increase the value of the property; 

(2) which restores the value or use of the property; 

(3) which substantially prolongs the useful life of property; or 

(4) which adapts the property to a new or different use. 
 
Where only a broken part or piece of equipment is replaced by a new one, the amount is deductible as a repair expense if it does not prolong the life or increase the value of the equipment of which it is a part and does not adapt it to a new or different use. 

A new roof on an office building is an example of an improvement. On the other hand, replacing worn shingles or portions of gutters would probably be a repair. Replacing a tube in an x-ray unit would be a repair since it doesn't prolong the life of the unit. 

Consider the following example: Dr. Jones has a profit sharing plan for himself and his staff. The plan has individually-directed accounts for each participant. Dr. Jones funds $24,000 to his account on January 1, 1997 for the 1997 plan year. He funds nothing in advance for his employees. Before April 15, 1998 his plan administrator calculates the staff contribution at $8,000. Dr. Jones directs his accountant to place his income tax return on extension until October 15, 1998. On October 15, 1998 he funds the $8,000 staff contribution. 

Is there a problem with this scenario? From an income tax standpoint this is perfectly legal. January 1^st is the earliest a plan can be funded and October 15^th (assuming filing extensions) of the following year is the latest funding date. However, rules covering retirement plans would consider this discriminatory. Benefits, rights, and features under a plan must be made available to employees in a way that satisfies both the current availability and effective availability standards. The group of employees to whom a benefit, right, or feature is available must not substantially favor highly compensated employees. This determination must be made on the basis of all the facts and circumstances. 

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