In 1976 and 1977 extensive tax reform legislation was enacted. Several provisions of that legislation directly affect the business of dentistry as well as individual tax preparation.
T a x reform legislation of 1976 and 1977 Alan M. Komensky,
JD, Chicago
Since 1976 the field of federal taxation has been undergoing a massive overhaul with the enact ment of the Tax Reform Act of 1976. The Tax Reform Act of 1976 was the most comprehensive and complex piece of tax legislation ever promul gated in an attempt to simplify tax preparation and stimulate the economy. Again in 1977 more tax legislation was enacted to further simplify the tax return for the individual and to further stimulate the economy. The 1977 legislation is known as the Tax Reduction and Simplification Act of 1977. Provisions of both the Tax Reform Act of 1976 and the Tax Reduction and Simplification Act of 1977 affect the taxes everyone pays and the tax planning and tax return preparation everyone must do. The purpose of this article is to acquaint the dentist, as a business person and individual taxpayer, with the provisions of both the 1976 and 1977 tax acts most pertinent to him. Familiariza tion with tax laws that relate to the business of dentistry will aid dentists in business planning with their attorneys and accountants. Because the tax laws have been modified to a great extent, consultation with a tax professional for business planning is a must.
Tax Reform Act of 1976
The Tax Reform Act of 1976 has provisions af fecting the individual taxpayer, tax shelters, capi tal gains and losses, corporations, employee ben efit plans; in addition, estate and gift taxation was JADA, Vol. 95, December 1977 ■ 1067
radically changed. The following portions o f the Tax Reform Act of 1976 most directly affect the business of dentistry whether practiced by a solo practitioner, or as a partnership or professional corporation. ■ T a x s h e lte r p a r tn e r s h ip s : Before the Tax Re form A ct o f 1976, each partner could claim a de duction for the additional first-year depreciation on property purchased by the partnership. The old deduction allowed was $2,000 for a single tax return ($4,000 on a joint return), 20% of the cost of the property with a $10,000 limit for a single tax return, and a $20,000 limit for a partner filing a joint return. N ow the deduction for additional first-year depreciation can only be applied at the partnership level with a limit of $2,000 available for allocation among the partners. Therefore, partnerships and corporations are now treated equally in the deductions allowed for additional first-year depreciation. Several other sections o f the T ax Reform A ct of 1976 that concern partnerships include the denial of any deduction for the expenses incurred in the organization o f the partnership unless the part nership elects to amortize those costs over a period of not less than 60 months. N ew members o f a partnership will now have partnership income or losses allocated to the new member only for the portion o f the year he was a member o f the partnership. Allocation o f income, gains, losses, deductions, or credits o f a partnership will be made according to the partners’ interest in the partnership if the partnership agreement does not state the method of allocation. ■ I n v e s tm e n t c re d it: The changes in the invest ment credit are again very important to all dentists and apply to every type o f practice. If new equip ment is purchased for the business, the taxpayer will be allowed a 10% investment credit. The rate o f 10% has been extended through 1980 so a deci sion to purchase new equipment does not have to be immediate. A lso, a bonus credit of up to W i% , in addition to the 10% investment credit, can be realized by a corporation if contributions are made to an employee stock ownership plan (ESOP). The application of the bonus credit to a professional corporation would be determined by state law as to whether a professional corporation could have an employee stock ownership plan. The provisions o f the Tax Reform Act o f 1976 of most concern to the dentist as an individual taxpayer are: 1068 ■ JADA, Vol. 95, December 1977
■ A lim o n y : Since 1977, alimony payments have been deductible from gross income when adjusted gross income is determined; previously, alimony was an itemized deduction. Many taxpayers who previously itemized alimony payments will realize a tax savings under this change. In addi tion, the withholding tax rule was changed to take the alimony deduction into consideration to avoid overwithholding. ■ M o v in g e x p e n s e s : The taxpayer’s new place o f work will have to be at least 35 miles from his residence during his former employment for him to qualify for a deduction for a business-related move. Also the maximum deduction for premove house hunting was increased to $1,500 and $3,000 for qualified moving expenses; however, the pre move expenses must be deducted from the $3,000. The taxpayer must still remain at the new location at least 39 weeks. In addition, military personnel can deduct expenses for required moves even if they do not meet either the 35-mile or 39-week requirement. ■ H o m e — o ffic e s : To claim deductions for the cost of a home office, the taxpayer must establish that a portion of his home was used exclusively on a regular basis as a principal place o f business or as a place for meeting with patients in the normal course o f business. An employee would have to prove that the exclusive use was for the conven ience of the employer. Although the home office deduction was made more strict, if a taxpayer performs work at home in a separate structure that is not physically attached to his house, a deduction will be allowed, even if the structure is not a principal place of business. That structure must be used exclusively and regularly in connec tion with a trade or business. ■ C a p ita l g a in s a n d lo s s e s : The holding period for long-term gain and loss has been increased for
THE AUTHOR
Mr. Komensky is assistant sec retary of the Council on Insur ance and the Council on Bylaws and Judicial Affairs. KOMENSKY
1977 so an asset will have to have been held more than nine months; in 1978 the period will increase to more than one year. The holding period for commodity future remains at more than six months. In addition, the deduction for net capital losses against ordinary income has been increased to $2,000 for 1977 and to $3,000 for 1978. ■ Vacation homes: Deductions for depreciation and maintenance expenses for vacation homes that are rented when not in use by the owner will be reduced if the taxpayer uses the vacation home for personal purposes the greater of 14 days or 10% of the number of days the house is rented. ■ Foreign conventions: Since 1977 a taxpayer has been able to take deductions for the costs of attending only two foreign conventions in any year. In addition, transportation must be either coach or economy, and half or more of the total days of the trip must be spent on business-related activities. Deductions for meals, lodging, and so forth will only be allowed for days when a sub stantial amount of business activity is scheduled and at least two thirds of the activities are at tended. Tax Reduction and Simplification Act of 1977
The Tax Reduction and Simplification Act of 1977 did not contain as many new provisions af fecting business as did the 1976 Act. Two provi sions of the 1977 Act affect the dentist because one provision establishes the tax rates for corpo rations and the other provides a strong incentive to hire. The reductions in the corporate tax rates that were scheduled to expire at the end of 1977 have been extended through 1978. The rate of taxation on corporate income will be 20% on the first $25,000 of taxable income, 22% on the next $25,000, and 48% on taxable income over $50,000. The Act provides a new jobs tax credit to further stimulate the economy. If a new employee is hired by an employer in 1977 or 1978, the em ployer is allowed a maximum credit for each new employee hired of $2,100 (50% of the first $4,200 of wages). In addition to the hiring of the new employee, the total payroll of the employer must increase by 2% from the previous year. The maximum credit allowable for an employer or taxpayer is $100,000 a year. When taking the jobs
tax credit, the amount of credit claimed must be subtracted from the deduction for wages on the tax return. Another provision that results in a reduction in business taxes and provides a further stimulus to hire is a bonus credit to those who hire handi capped workers. The act provides an additional 10% tax credit for all new handicapped individ uals hired during 1977 and 1978 who have re ceived vocational rehabilitation; handicapped veterans also are included. To qualify, the em ployee must have a physical or mental disability that results in a substantial handicap to employ ment and must be referred to the employer after completing or while receiving rehabilitative ser vices according to a state or federal vocational rehabilitation program. There are other limitations to the jobs tax credit that must be considered. The amount of the bonus credit for hiring handicapped persons is limited, as is the credit available to a new or rapidly ex panding business. In addition, if a partnership or subchapter S corporation is claiming a jobs tax credit, that credit shall be appointed among the partners or shareholders. Thus, it is clear that the intent of the jobs tax credit is to stimulate hiring, and a dentist who is cbnsidering expanding his practice in 1977 or 1978 can take full advantage of the credit . Because of the computations involved in the jobs tax credit, it is important that careful records are maintained. In addition to the changes affecting business, certain changes were promulgated to simplify in dividual tax returns. The two-part standard de duction that was composed of the low-income allowance and the percentage standard deduction is replaced with a “ zero bracket amount” of $3,200 for married taxpayers filing jointly, $2,200 for single taxpayers, and $1,600 for married tax payers filing separately. These amounts are al ready built into the tax tables and rate schedules. The new tax tables that incorporate the standard deduction, personal exemptions, and the general tax credit will eliminate several steps that the taxpayer had to perform in preparation of the 1976 returns. A taxpayer may elect to itemize his deductions only if such deductions exceed his zero bracket amount (standard deduction amount). Since the standard deduction is built into the tax tables, the taxpayer whose itemized deductions exceed his zero bracket amount can only deduct his itemized deductions to the extent the itemized deductions exceed the zero bracket amount. After the tax Komensky: TAX REFORM LEGISLATION ■ 1069
payer reduces the total amount of his itemized deductions and th? amount of his zero bracket amount, he then subtracts the remaining itemized deductions from his adjusted gross income to de termine tax table income (amount of tax as listed). In the case of married individuals filing separate returns, both spouses must itemize even if one spouse’s itemized deductions are less than their zero bracket amount. In that case the total itemized deductions are subtracted from the zero bracket and the excess zero bracket amount is added to tax table income. The general tax credit adopted under the Tax Reform Act of 1976 was extended for another year. Thus, an individual is entitled to take a tax credit in an amount equal to the greater of 2% of
1070 ■ JADA, Vol. 95, December 1977
the first $9,000 of taxable income or $35 for each personal and dependent exemption. Finally, the gross income levels at which individual taxpayers must file income tax returns are increased to re flect the new flat standard deduction figures. The changes in the tax laws presented represent those that would most directly affect the dentist. Several other new provisions were added to both the 1976 and 1977 tax laws that must not be over looked in tax planning or tax preparation. With the changes in the tax laws in mind, the dentist, working with his attorney or accountant, could plan the most advantageous ways to expand his practice, purchase new equipment, or shorten the time in tax return preparation.
T a x reform legislation of 1976 and 1977 Alan M. Komensky,
JD, Chicago
Since 1976 the field of federal taxation has been undergoing a massive overhaul with the enact ment of the Tax Reform Act of 1976. The Tax Reform Act of 1976 was the most comprehensive and complex piece of tax legislation ever promul gated in an attempt to simplify tax preparation and stimulate the economy. Again in 1977 more tax legislation was enacted to further simplify the tax return for the individual and to further stimulate the economy. The 1977 legislation is known as the Tax Reduction and Simplification Act of 1977. Provisions of both the Tax Reform Act of 1976 and the Tax Reduction and Simplification Act of 1977 affect the taxes everyone pays and the tax planning and tax return preparation everyone must do. The purpose of this article is to acquaint the dentist, as a business person and individual taxpayer, with the provisions of both the 1976 and 1977 tax acts most pertinent to him. Familiariza tion with tax laws that relate to the business of dentistry will aid dentists in business planning with their attorneys and accountants. Because the tax laws have been modified to a great extent, consultation with a tax professional for business planning is a must.
Tax Reform Act of 1976
The Tax Reform Act of 1976 has provisions af fecting the individual taxpayer, tax shelters, capi tal gains and losses, corporations, employee ben efit plans; in addition, estate and gift taxation was JADA, Vol. 95, December 1977 ■ 1067
radically changed. The following portions o f the Tax Reform Act of 1976 most directly affect the business of dentistry whether practiced by a solo practitioner, or as a partnership or professional corporation. ■ T a x s h e lte r p a r tn e r s h ip s : Before the Tax Re form A ct o f 1976, each partner could claim a de duction for the additional first-year depreciation on property purchased by the partnership. The old deduction allowed was $2,000 for a single tax return ($4,000 on a joint return), 20% of the cost of the property with a $10,000 limit for a single tax return, and a $20,000 limit for a partner filing a joint return. N ow the deduction for additional first-year depreciation can only be applied at the partnership level with a limit of $2,000 available for allocation among the partners. Therefore, partnerships and corporations are now treated equally in the deductions allowed for additional first-year depreciation. Several other sections o f the T ax Reform A ct of 1976 that concern partnerships include the denial of any deduction for the expenses incurred in the organization o f the partnership unless the part nership elects to amortize those costs over a period of not less than 60 months. N ew members o f a partnership will now have partnership income or losses allocated to the new member only for the portion o f the year he was a member o f the partnership. Allocation o f income, gains, losses, deductions, or credits o f a partnership will be made according to the partners’ interest in the partnership if the partnership agreement does not state the method of allocation. ■ I n v e s tm e n t c re d it: The changes in the invest ment credit are again very important to all dentists and apply to every type o f practice. If new equip ment is purchased for the business, the taxpayer will be allowed a 10% investment credit. The rate o f 10% has been extended through 1980 so a deci sion to purchase new equipment does not have to be immediate. A lso, a bonus credit of up to W i% , in addition to the 10% investment credit, can be realized by a corporation if contributions are made to an employee stock ownership plan (ESOP). The application of the bonus credit to a professional corporation would be determined by state law as to whether a professional corporation could have an employee stock ownership plan. The provisions o f the Tax Reform Act o f 1976 of most concern to the dentist as an individual taxpayer are: 1068 ■ JADA, Vol. 95, December 1977
■ A lim o n y : Since 1977, alimony payments have been deductible from gross income when adjusted gross income is determined; previously, alimony was an itemized deduction. Many taxpayers who previously itemized alimony payments will realize a tax savings under this change. In addi tion, the withholding tax rule was changed to take the alimony deduction into consideration to avoid overwithholding. ■ M o v in g e x p e n s e s : The taxpayer’s new place o f work will have to be at least 35 miles from his residence during his former employment for him to qualify for a deduction for a business-related move. Also the maximum deduction for premove house hunting was increased to $1,500 and $3,000 for qualified moving expenses; however, the pre move expenses must be deducted from the $3,000. The taxpayer must still remain at the new location at least 39 weeks. In addition, military personnel can deduct expenses for required moves even if they do not meet either the 35-mile or 39-week requirement. ■ H o m e — o ffic e s : To claim deductions for the cost of a home office, the taxpayer must establish that a portion of his home was used exclusively on a regular basis as a principal place o f business or as a place for meeting with patients in the normal course o f business. An employee would have to prove that the exclusive use was for the conven ience of the employer. Although the home office deduction was made more strict, if a taxpayer performs work at home in a separate structure that is not physically attached to his house, a deduction will be allowed, even if the structure is not a principal place of business. That structure must be used exclusively and regularly in connec tion with a trade or business. ■ C a p ita l g a in s a n d lo s s e s : The holding period for long-term gain and loss has been increased for
THE AUTHOR
Mr. Komensky is assistant sec retary of the Council on Insur ance and the Council on Bylaws and Judicial Affairs. KOMENSKY
1977 so an asset will have to have been held more than nine months; in 1978 the period will increase to more than one year. The holding period for commodity future remains at more than six months. In addition, the deduction for net capital losses against ordinary income has been increased to $2,000 for 1977 and to $3,000 for 1978. ■ Vacation homes: Deductions for depreciation and maintenance expenses for vacation homes that are rented when not in use by the owner will be reduced if the taxpayer uses the vacation home for personal purposes the greater of 14 days or 10% of the number of days the house is rented. ■ Foreign conventions: Since 1977 a taxpayer has been able to take deductions for the costs of attending only two foreign conventions in any year. In addition, transportation must be either coach or economy, and half or more of the total days of the trip must be spent on business-related activities. Deductions for meals, lodging, and so forth will only be allowed for days when a sub stantial amount of business activity is scheduled and at least two thirds of the activities are at tended. Tax Reduction and Simplification Act of 1977
The Tax Reduction and Simplification Act of 1977 did not contain as many new provisions af fecting business as did the 1976 Act. Two provi sions of the 1977 Act affect the dentist because one provision establishes the tax rates for corpo rations and the other provides a strong incentive to hire. The reductions in the corporate tax rates that were scheduled to expire at the end of 1977 have been extended through 1978. The rate of taxation on corporate income will be 20% on the first $25,000 of taxable income, 22% on the next $25,000, and 48% on taxable income over $50,000. The Act provides a new jobs tax credit to further stimulate the economy. If a new employee is hired by an employer in 1977 or 1978, the em ployer is allowed a maximum credit for each new employee hired of $2,100 (50% of the first $4,200 of wages). In addition to the hiring of the new employee, the total payroll of the employer must increase by 2% from the previous year. The maximum credit allowable for an employer or taxpayer is $100,000 a year. When taking the jobs
tax credit, the amount of credit claimed must be subtracted from the deduction for wages on the tax return. Another provision that results in a reduction in business taxes and provides a further stimulus to hire is a bonus credit to those who hire handi capped workers. The act provides an additional 10% tax credit for all new handicapped individ uals hired during 1977 and 1978 who have re ceived vocational rehabilitation; handicapped veterans also are included. To qualify, the em ployee must have a physical or mental disability that results in a substantial handicap to employ ment and must be referred to the employer after completing or while receiving rehabilitative ser vices according to a state or federal vocational rehabilitation program. There are other limitations to the jobs tax credit that must be considered. The amount of the bonus credit for hiring handicapped persons is limited, as is the credit available to a new or rapidly ex panding business. In addition, if a partnership or subchapter S corporation is claiming a jobs tax credit, that credit shall be appointed among the partners or shareholders. Thus, it is clear that the intent of the jobs tax credit is to stimulate hiring, and a dentist who is cbnsidering expanding his practice in 1977 or 1978 can take full advantage of the credit . Because of the computations involved in the jobs tax credit, it is important that careful records are maintained. In addition to the changes affecting business, certain changes were promulgated to simplify in dividual tax returns. The two-part standard de duction that was composed of the low-income allowance and the percentage standard deduction is replaced with a “ zero bracket amount” of $3,200 for married taxpayers filing jointly, $2,200 for single taxpayers, and $1,600 for married tax payers filing separately. These amounts are al ready built into the tax tables and rate schedules. The new tax tables that incorporate the standard deduction, personal exemptions, and the general tax credit will eliminate several steps that the taxpayer had to perform in preparation of the 1976 returns. A taxpayer may elect to itemize his deductions only if such deductions exceed his zero bracket amount (standard deduction amount). Since the standard deduction is built into the tax tables, the taxpayer whose itemized deductions exceed his zero bracket amount can only deduct his itemized deductions to the extent the itemized deductions exceed the zero bracket amount. After the tax Komensky: TAX REFORM LEGISLATION ■ 1069
payer reduces the total amount of his itemized deductions and th? amount of his zero bracket amount, he then subtracts the remaining itemized deductions from his adjusted gross income to de termine tax table income (amount of tax as listed). In the case of married individuals filing separate returns, both spouses must itemize even if one spouse’s itemized deductions are less than their zero bracket amount. In that case the total itemized deductions are subtracted from the zero bracket and the excess zero bracket amount is added to tax table income. The general tax credit adopted under the Tax Reform Act of 1976 was extended for another year. Thus, an individual is entitled to take a tax credit in an amount equal to the greater of 2% of
1070 ■ JADA, Vol. 95, December 1977
the first $9,000 of taxable income or $35 for each personal and dependent exemption. Finally, the gross income levels at which individual taxpayers must file income tax returns are increased to re flect the new flat standard deduction figures. The changes in the tax laws presented represent those that would most directly affect the dentist. Several other new provisions were added to both the 1976 and 1977 tax laws that must not be over looked in tax planning or tax preparation. With the changes in the tax laws in mind, the dentist, working with his attorney or accountant, could plan the most advantageous ways to expand his practice, purchase new equipment, or shorten the time in tax return preparation.
