THE MILLIONAIRE DENTIST PODCAST

EPISODE 37 TRANSCRIPTION

Announcer:
Hello, everyone. Welcome to the Millionaire Dentist podcast brought to you by Four Quadrants Advisory. On this podcast, we break down the world of dentistry finances and business practices to help you become the millionaire dentist you deserve to be. Please be advised, we do speak with an honest tongue and may not be safe for work.

Casey Hiers:
Hello and welcome. This is Casey Hiers and on today's podcast I have in studio with us Colt Smith, who is a senior tax accountant with Four Quadrants Advisory. I asked Colt to be on this podcast because so many practice owners around the country, they mention how their CPA will bring up basis or tax basis and there's a certain amount of confusion and frustration sometimes about what that means. And so today we're going to discuss that. We're going to dive into tax basis to give our listeners some valuable information.

Casey Hiers:
Colt, thank you for joining the Millionaire Dentist podcast today.

Colt Smith:
Casey, thanks for having me. It's good to get away from the computer screen and the email and kind of joining in on the podcast world for a little while. So I appreciate the nice change of pace and.

Casey Hiers:
Well, I appreciate you being here. And I imagine by the end of this, our listeners will appreciate you being on as well with the information you're going to share. First question, what is tax basis?

Colt Smith:
And that's a great way to shoot this off because a lot of practice owners have probably heard the term tax basis. Some probably haven't. And the ones that have heard it, they probably don't know what it is. And so when we talk about tax basis, essentially what it is is it refers to an owner's investment in the business and in this case in the practice. Essentially what that means is what is your equity in your practice? What is your inequity in your practice?

Casey Hiers:
So when you say investment in, does that mean they spent $650,000 on the practice? And is that what you mean by investment?

Colt Smith:
Yeah, that's one way. So to put it in layman's terms, there's positive tax basis, there's bad tax basis. And essentially to increase your tax basis, there's multiple ways to do that. One way to do that is contributing capital, contributing personal cash into your practice. Another way to do that is by building profitability in the practice. Those are the two main ways to increase your tax basis. Also selling off assets, things of that nature, those will also increase your tax basis.

Colt Smith:
Now ways to decrease your tax basis, things that are not good for your tax basis, are basically any expenses, any withdrawals from your business accounts. Those are kind of the two main ways of distributions. So taking cash out of the practice via distribution for personal expenses, those decrease your tax basis. So those are kind of the ways to increase and or decrease your tax basis.

Colt Smith:
And I wanted to kind of shoot off a couple of examples if you don't mind. So if you were to start a practice and you contribute about $100,000 of personal cash to get the practice going, the practice ends the year with about $100,000 of net profit. So therefore at the end of year one, after expenses you would have about $200,000 of tax basis, positive tax basis. And so basically what that means it rolls into the next year. So you start year two with that $200,000 of tax basis. Does that make sense?

Casey Hiers:
It does.

Colt Smith:
Okay. And so in another example, on the negative side of things, say you start a practice, you don't contribute any personal cash. You end the year with $100,000 net loss. Okay? Since basis cannot go below zero, basically what happens is those losses that you incurred during the year get suspended and carried forward into future years. These suspended losses cannot help shelter the income in the practice until you start building profit, until maybe you have some personal cash that needs to go back into the practice because you have some cash flow issues. So those suspended losses will essentially stay there until the practice becomes profitable and successful.

Casey Hiers:
So in that example, when a practice owner's accountant says, hey, we have some basis issues. That would be the reason why.

Colt Smith:
Yes.

Casey Hiers:
Okay, cool. That makes sense. I've got another question for you. I know you talked about the IRS cracking down on basis schedules and calculations. Why are they cracking down and why is that important for our listener to understand?

Colt Smith:
Yeah, that's a great question. So the IRS, they want to make sure that tax preparers are keeping annualized basis schedules that go along with each business owner's tax return for many reasons. One, if a business owner doesn't have good basis and they're taking a bunch of distributions out of the practice, that's going to cause an increase of tax liability to that business owner. And if there aren't any basis schedules to support that, the practice owner, the business owner could be getting away with not paying as much taxes they should.

Casey Hiers:
Oh, okay.

Colt Smith:
So the IRS wants to make sure they get their fair share of what they're entitled to, unfortunately. I know all of us kind of want to try and get away with, hey, how can we save taxes here, save taxes there. Well, the most important way to do that is having documentation, having support, having your tax basis schedules up to date, and make sure that you're on par with where everything should be.

Casey Hiers:
So I want to get your opinion on something. A lot of times I'll talk to a dentist and they'll say, again, never heard of basis. Now I'm hearing I have basis issues and it's causing me a headache. Share with our listeners what can happen if you and your tax team aren't talking about basis and aren't on the same page, and they look back and say, uh-oh, we have some issues here. What's that look like? What does that look like for a practice owner when basis issues arise?

Colt Smith:
Sure. So one good example, maybe you're middle of the way through the year, you're about six months in, so quarter two's over. Say you're with your tax preparer who doesn't normally give you advice throughout the year. He only does it at year end. And you think things are all roses. You have the money to pay for a new cone beam, right? $100,000 of new equipment, nice, shiny, fancy machine for all your patients. And you think, okay, cool. I'm buying this huge piece of equipment. My sales rep for Patterson or Henry Schein told me, hey, I get this huge tax write-off, so you don't have to pay any taxes for the rest of the year now. And then come to find out at year end, you have basis issues. So basically what that means is if you have basis issues and you have suspended losses already, what that means is you won't be able to take any write-off of that equipment right away. So essentially that tax bill that you didn't think was going to be there is now there. And now we have a huge tax surprise.

Casey Hiers:
People love the word write-off. It makes them feel good. There's probably an old Seinfeld episode out there about a write-off and a tax write-off and people chase them. But what you're saying is if your tax basis is upside down and nobody's aware of it, you get that comfort of, oh, I need to buy some equipment. I can use it as a tax write-off. Unless you're looking at those details or your accounting team has their arms around it, you very well could buy an expensive piece of equipment and because of basis issues not be able to write it off like you thought you would. Is that fair?

Colt Smith:
Yes. Write-offs are only good if you have good tax basis. If you have bad tax basis, you can't necessarily write things off.

Casey Hiers:
Well and that-

Colt Smith:
And that will be suspended later on down the line when your practice actually becomes profitable. And that could be three, five years. Could be until you sell. It just depends on the practice. Depends on the profitability, what kind of debt the practice is working with.

Casey Hiers:
So what decisions can be streamlined if a practice owner's tax basis is being tracked correctly by their team, by their accounting team, their financial team. What does having that mastered... What can that do for a practice owner?

Colt Smith:
Sure. So if your financial team is aware of the tax basis, which they should be. It's a very important part of owning a practice. They can help streamline decisions when it comes to when to purchase equipment. What makes sense? What's the dollar amount on that purchase? Does it make sense to do it at end of year, beginning of next year when maybe some of these carry forward losses are utilized because you've been very profitable this year. It can help when it makes sense to give yourself a pay raise. When it makes sense to give your staff year end bonuses. It can help with, hey, when should I take money out of the practice because I have a home project that I have going on. Is it a good time for me to take a distribution from the practice to where I can pay for this new pool that I want? Or should I wait a year? Because those types of decisions, if somebody doesn't know what the tax basis looks like for themselves, can cause a humongous tax bill if they take a $100,000 distribution without knowing what their tax basis situation looks like, and without consulting their financial team.

Casey Hiers:
Can really come to bite them.

Colt Smith:
Yes.

Casey Hiers:
After these decisions are made, after money spent, anticipating getting something back, but because your tax basis is out of whack and there hasn't been a ton of communication about it, that surprise is not a good one.

Colt Smith:
Yeah. No. Not at all.

Casey Hiers:
Well, Colt, I appreciate you at least giving our listeners a high level view of tax basis. If there's one thing consistent I've heard around that word, it's that it frustrates and confuses people and to be specific practice owners, dentists, who are smart folks. And they hear this and there's a sense of what is that. I appreciate you enlightening us and thank you for being a guest today, Colt. We appreciate it.

Colt Smith:
Yeah. Thanks for having me. And I appreciate all the listeners out there for tuning in.

Announcer:
That's all the time we have today. Thank you to our guests for their insight and for sharing some really great information. And thank you to you, the listener, for tuning in. The Millionaire Dentist podcast is brought to you by Four Quadrants Advisory. To see if they might be a good fit for you and your practice, go on over to fourquadrantsadvisory.com and see why year after year, they retain over 95% of their clients. Thank you again for joining us and we'll see you next time.