John K. McGill, MBA, CPA, JD
Recently, I incorporated my general dental practice of 10 years and elected to be taxed as a Subchapter S corporation, based on your recent newsletter article entitled, "50 Greatest Tax Tips." What percentage of my practice net income can I remove from the corporation as dividends, free of federal and state payroll taxes? How much of my income must I claim as salary in order to avoid an IRS audit? I would hate to get audited and find out that I was claiming too little salary and too large of a dividend. Thanks for your help.
In general, the IRS requires that Subchapter S corporations pay doctors a salary equal to reasonable compensation for their services rendered, with any excess funds available to be distributed as a dividend. In several cases where Subchapter S owners paid themselves no salary, the IRS has been successful in characterizing part of the dividends paid as salary income, leaving the doctor and his or her corporation to pay additional payroll taxes.
Reasonable compensation is defined as what you would have to pay another doctor to perform the same services for your corporation. In most cases, paying the doctor a salary equal to 25 to 35 percent of collections should satisfy the reasonable compensation test, with the balance available to be paid out as a dividend. However, since doctors' individual practice situations can vary significantly, I recommend discussing this matter with your CPA and/or tax attorney, before implementing definite salary and dividend payout amounts.
Some years ago, I established a SEP-IRA retirement plan. While that plan is now closed, the assets still are invested in stocks and bonds. I am concerned because I have read that SEP-IRA and other IRA accounts do not receive the same protection from the claims of creditors that ERISA-qualified plans do. I would like to transfer the SEP-IRA funds into a qualified plan. With that in mind, I contacted the ADA and was told I could transfer the funds to them, but the transfer had to be in cash, not in stocks and bonds. What should I do?
As a general rule, funds held within SEP-IRA accounts can be transferred tax-free into one or more ERISA-qualified plans, including a profit-sharing plan. In order to comply with the ADA retirement plan requirements, you could simply sell the stocks and bonds held within the account. Then, transfer the cash into the ADA profit-sharing plan to achieve protection from the claims of creditors.
When amounts are withdrawn from qualified retirement plans, do the withdrawals remain protected from the claims of creditors? Does this vary from state to state? Does it depend on the type of retirement plan involved? Furthermore, are assets held by profit-sharing plans with only one participant as protected from the claims of creditors as plans with more than one participant?
According to the IRS, an attachment, garnishment, levy, execution, or other legal or equitable process against a participant's qualified retirement plan benefits is not a voluntary assignment or alienation and, therefore, violates the anti-alienation rule. Accordingly, a transfer of a participant's retirement plan benefits to a creditor cannot be made while the benefits are held within the retirement plan.
However, once benefits have been distributed to the participant, the attachment or assignment of the distributed plan benefits does not violate the anti-alienation provisions. As a result, plan benefits generally are no longer protected against the claims of creditors, once they are distributed to the participant. This is generally the case, regardless of the type of retirement plan involved or the state in which the plan is operated.
The term "employee benefit plan" that is subject to ERISA creditor protection does not include any plan under which there are no employees as participants covered under the plan. For example, a retirement plan under which a doctor, as a sole proprietor, is the only participant is not covered under ERISA. Furthermore, a doctor and his or her spouse are not deemed to be employees with respect to a trade or business, whether incorporated or unincorporated, that is wholly owned by that doctor or by that doctor and his or her spouse. Moreover, in a partnership, a partner and the partner's spouse are not deemed to be employees with respect to the partnership. Accordingly, in a retirement plan in which the doctor and/or the doctor and his or her spouse are the only participants, the plan assets are not given federal protection from the claims of creditors.
John K. McGill is a tax attorney, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($199 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, call (704) 424-9780 or visit the Web site at www.bmhgroup.com.
