Tax writeoffs: What to take, what to avoid

January 25, 2013

Tax writeoffs can help alleviate your tax burden, but be careful. Discover what you can write off and what might cause an audit.

The first question a new physician-client invariably asks is, “What can I write off?” With financial pressures on physicians so great, it is no wonder that doctors are eager to leave nothing on the table when it comes to tax deductions.

Fortunately, many opportunities exist for reducing your taxable income by writing off your business-related expenses. This article will focus on three categories of deductions: deductions that are easy to take, deductions that require caution, and deductions that likely would be disallowed by the Internal Revenue Service (IRS).

It’s important to understand a few underlying principles before looking at specific writeoffs. The first principle is the difference in how deductions affect different types of income earners. The second principle is defining what the IRS terms “ordinary and necessary” as it relates to expenses.

OWNER VERSUS EMPLOYEE

Practice owners (sole proprietors or corporations), partners who receive K-1s, and independent contractors who receive the 1099 form have the greatest flexibility when it comes to taking business expenses to reduce taxable income. Although you should consider many factors when selecting a business entity, most business deductions are treated the same way, regardless of the type of business entity.

Deductions that practices are entitled to take generally are the same as deductions individual wage earners may take. If you are not a practice owner, partner, or independent contractor, however-if you receive income as wages that show up on a W-2-you may encounter hurdles that reduce or eliminate your incentive to track your job expenses in great detail. 

Doctors receiving income as wages will take tax deductions primarily on Schedule A as job expenses and certain miscellaneous deductions. The first hurdle is that these expenses have to exceed 2% of adjusted gross income before a benefit starts to be realized. This means that if you earn $175,000, you would have to have $3,501 worth of expenses to get the first $1 of deduction ($3,500 threshold = $175,000 ✕ 2%.)

The next hurdle is that, if you are subject to the alternative minimum tax, you will effectively get no federal tax benefit for deductions even above the 2% threshold. Those deductions often may be used to offset state income taxes, and when our hands are tied by federal rules, we certainly seek to maximize state income tax deduction benefits.

Because of the limitations on tax expense benefits for W-2 wage earners, often we will try more creative approaches when possible. If you are employed, your employer might be willing, as part of your compensation package, to pay for some of your continuing medical education (CME) expenses through the practice or organization. That way, your employer pays less payroll taxes, and you aren’t taxed on money that you would receive as income only to have to turn around and pay for your own CME.

ORDINARY AND NECESARY

The IRS says that for an expense to be deductible, whether by an employee or by a business entity, the expense must be considered “ordinary and necessary.” This broad principle means that expenses must be “common” and “accepted” in your industry as well as “helpful” and “appropriate.” For example, buying a business airplane for a 15-mile trip between your clinic and a hospital location typically would not create any efficiency in your day and, therefore, the IRS likely would question the business purpose of such a purchase.

KEEP DOCUMENTATION

Note that as part of an audit, the IRS is allowed to demand copies of invoices and receipts for all expenses incurred, as well as credit card statements and copies of checks or other forms of payment. For equipment and furniture purchases, the IRS will want to see documents showing proof of ownership of equipment and related loan or financing documentation. So it is best to keep documentation for anything you think you may want to claim as a deduction.

Everybody seems to know somebody who apparently manages to put every conceivable personal expense through his or her practice. Even somebody who is blatantly paying for personal expenses through his or her practice may not suffer any consequences from doing so if they manage to avoid IRS examination. Remember, however, that signing your tax return is your representation that the information contained therein is correct to the best of your knowledge.

In my experience, the IRS is not going to send you to prison for failing to have documentation of the business purpose for a meal out. A pattern of fraud can have consequences that you should take seriously, however.

After-tax money is the only kind of money you really can spend how you wish. Avoid incurring expenses just for the sake of the tax benefit; wasting $1 just to save 50 cents in taxes doesn’t make any sense. In the right situation however, it can be nice to know that buying the shiny MacBook is subsidized a bit by Uncle Sam or that a portion of your auto lease is reducing your taxes.

The author is a tax adviser and principal with Thomas Wirig Doll in Walnut Creek, California. Send your feedback to medec@advanstar.com. Also engage at www.twitter.com/MedEconomics and www.facebook.com/MedicalEconomics.

What you can write off

When my clients ask which expenses they can write off, in most cases what they are really interested in knowing about are specific deductions to which they are entitled and that will avoid triggering an IRS audit or that would have a basis for being allowed under an IRS examination. Here are some examples of deductions that are easy take, deductions that require caution, and deductions that would likely be disallowed by the IRS, along with commentary, where appropriate.

GREEN LIGHT - EASY TO TAKE AND NOT LIKELY TO BE FLAGGED BY THE IRS

Patient refunds
We now recommend presenting these refunds as “other expense” instead of as “returns and allowance.”

Health insurance premiums for practice owners and staff members
This category does not include out-of-pocket costs, which must be handled differently.

Mobile phones and related equipment
This category should not include your spouse/significant other unless she or he is a bona fide employee.

Licensing and professional dues

Malpractice insurance

Continuing medical education

Scrubs, white coats, and related laundry costs

Office supplies

Medical supplies

In-office computers, software, and ancillary equipment
It is a good idea to have a written business policy whereby you immediately expense items under a certain dollar threshold and capitalize and depreciate expenses over that threshold. The advantage of immediately expensing an item is that you don’t have to pay property taxes on it.

YELLOW LIGHT - PROCEED WITH CAUTION

Vehicles
This deduction is among the most asked-about type. Record mileage and keep receipts for all expenses associated with the car’s use to substantiate the deduction. Contrary to what some doctors think, placing a practice logo on your car does not automatically entitle you to write off the vehicle. You are entitled to take this deduction, however, and if you meet the requirements, it is worth the effort.

Business travel
Travel outside the continental United State requires separation of business and personal days. If a spouse or significant other accompanies you, do not split out lodging costs, but split out air travel. Lodging costs would be the same without a companion, but the air travel for the spouse would not be considered a business expense. Typical travel expenses associated with CME and conferences are not likely to attract IRS scrutiny. 

Meals and entertainment
These expenses are 50% deductible, provided that they are business-related.

Office meetings and parties
Reasonable accommodations for staff functions, including catering, are 100% deductible.

Employee gifts
Such presents can be worth only $25 or less, unless your practice has a written policy stating that an employee who has reached a specified number of years receives a specific type of gift.

Family members as employees
Those wages are deductible as long as the person is a bona fide employees with regular hours and job descriptions, just like any other employee.

Home office furnishings
This category includes computer and business-related storage furniture that makes sense to have offsite.  Be careful when claiming deductions for items that serve both personal and business use, such as cabinets, TV monitors or a computer in a home office.

Home Internet service
This service can generally be deducted, but it’s important to separate the cost of Internet service from telephone and television services, if they are bundled.

Home office rent, depreciation, and utilities
Do not try to claim expenses in this category. You must meet a large number of requirements to allow the deduction, so this may be an “audit flag” to the IRS.

Out-of-pocket medical expenses
Those expenses are deductible for employees of “C” corporations, as long as staff members are offered the same medical benefits as the owner(s).

RED LIGHT - AVOID PAYING THROUGH THE PRACTICE

Disability insurance
“C” corporations can deduct the premiums for this expense. If you do so, however, money you receive under a claim is taxable. Business overhead insurance is 100% deductible for all entity types.

Clothing
If the clothing is readily adaptable to daily wear, you should not pay for it through the practice.

Fitness club dues
Dues are specifically named as a non-deductible item, even if prescribed by a doctor.

Club dues
Even if you use membership in a club to market to referring doctors, the IRS will not allow this type of deduction.

Second home or permanent overnight accommodations
If you have to travel to a second location often enough, those accommodations are not deductible.

Gifts to referring doctors
You can make these payments through the business, but they are
non-deductible if they are more than $25 in value.