Written by: Corey Janoff
Most of our readers and clients of Finity Group are doctors, so naturally we get a lot of questions about tax deductions for doctors. This post is not meant to be specific tax advice, but rather information only. Consult with a tax professional for tax advice pertaining to your specific circumstances. Learn more about Finity Tax.
Today, we will look at some of the most common and effective tax deductions that doctors and physicians (and everyone for that matter) can potentially utilize. We will also wrap things up by discussing what is tax planning. Not all of these will be applicable to you. Depending on your employment status (salaried physician at a group or hospital versus self-employed), some tax deductions are more available to you than others.
In no particular order, here are some things you can do to potentially lower your tax bill as a doctor.
1. Contribute to Pre-Tax 401k/403b Retirement Accounts
Contributing to retirement accounts is a no-brainer that all doctors should be doing. If you are in practice, there are very few reasons why you shouldn’t contribute the maximum allowed each year (currently $19,500 salary deferral limit to a 401k/403b type account, plus $6,500 if age 50+ in 2021).
If you make pre-tax contributions, your taxable income is reduced by the amount you contribute. For an overly simplified example, if you earn $250,000 and contribute $19,500 to your 401k at work, the IRS only taxes you on $230,500 of income. Pretty cool!
If you are self-employed, or own your own practice, you can actually contribute up to $58,000 this year to a 401k. That can all be pre-tax. There are some additional requirements that must be met in order to contribute that much, but that is a great way to save on taxes while simultaneously saving for retirement.
2. Contribute to a Solo 401k for any 1099 Self-Employed Income
As mentioned above, if you are self-employed, you can contribute up to $58,000 to a 401k. The “employee” contribution limit is $19,500, and the “employer” can contribute additional monies up to $58k combined total. As a self-employed doctor, you are both the employee and employer.
The employee contribution limit of $19,500 is a combined total for all 401k/403b type accounts. So if you have multiple employers that offer you a 401k, you can only do $19,500 total.
If you have 1099 earnings outside of your regular W2 job, you can set up a solo 401k for that income stream and make the “employer” contributions of approximately 20% of earnings to it per year pre-tax, up to the $58,000 limit. For example, if you work at a private group, but make $100k/year taking call at a hospital and the income from the hospital is 1099 income, you could defer approximately $20k of that into a Solo 401k each year.
3. Contribute to a Cash Balance Pension Plan
Cash balance pensions are typically set up in addition to a 401k at your company. Some larger companies have them and set a fixed company contribution rate. If you are self-employed, or own your own practice, you could implement one of these too. I won’t go into the ins and outs of cash balance plans today, but they can potentially allow you to contribute upwards of $100,000 per year pre-tax (upwards of $300,000 if you are in your 60’s)!
There are many rules and nuances to cash balance plans. Depending on the number of employees you have and your company cash flows, this may or not make sense to implement, as your company will have to contribute some money to all employees’ accounts. However, as a self-employed physician, cash balance and other defined benefit plans can be pretty fantastic if you are looking to save a lot of money for retirement.
4. Roth IRA / Backdoor Roth IRA / Mega Backdoor Roth IRA
While Roth accounts don’t give you tax deductions today, all money and investment earnings can be withdrawn from the account tax free in retirement. Roth accounts are like tax deductions for your future self. You can contribute $6,000 to a Roth IRA/Backdoor Roth IRA in 2021 ($7,000 if over age 50).
Related: Backdoor Roth IRA
The Mega Backdoor Roth is where you contribute after-tax dollars to your 401k/403b at work, on top of the standard $19,500 employee contribution limit, and then convert those after-tax dollars into a Roth account (either within the 401k/403b or into a separate Roth IRA). No different than the backdoor Roth IRA, except you can potentially contribute a lot more.
Between employee salary deferrals ($19,500), employer matching/profit sharing contributions, and employee after-tax contributions, the total 401k contribution limit in 2021 is $58,000. For example, if you contribute $19,500 from your salary pre-tax and your employer contributes $15,000, that amounts $34,500. You can contribute another $23,500 after-tax and convert that into a Roth account. Whoop whoop!
Not all employers offer this provision in their workplace retirement accounts, but we’re starting to see it allowed at more and more places.
5. Own Your Home
Owning a home used to be more beneficial from a tax standpoint, before the standard deduction was increased several years ago and SALT deductions were capped at $10,000. If your itemized deductions exceed your standard deduction, you will elect to itemize. The big things you can deduct when itemizing are: mortgage interest on a balance up to $750k, property taxes, state income/local taxes, charitable contributions, and some other things. Again, the state/local/property taxes are capped at $10k.
Don’t buy more house than you can afford because the interest is tax deductible if your total itemized deductions exceed your standard deduction. If you’re in the 35% marginal federal tax bracket, you’re paying $100 in interest in order to save $35 in taxes. Not exactly a profitable formula.
6. Own Rental Properties
With income generating rental properties, there are a number of tax deductions you can claim, including depreciation of the property, that can be used to reduce the taxable amount of your rental income. If you leave the properties to your heirs when you die, they get a step up in basis to the fair market value of the properties on the date of death (under current rules).
Owning and managing rental properties isn’t for everyone and the tax rules can be very complex. Make sure working with a tax professional who is familiar with taxes surrounding rental properties.
7. Sell Investments at a Loss
This is known as tax-loss harvesting. Anytime you have an investment outside of a retirement account that is worth less than you bought it for, you can sell that investment and capture that loss on paper for tax purposes. If you sell an investment for a gain, you have to pay taxes on your investment gains each year. However, losses offset equivalent gains, so anytime you lose money, it can be beneficial to you from a tax standpoint.
In a perfect world our investments only go up in value and we happily pay taxes on our investment earnings, but the world isn’t perfect, so let’s make lemonade when the investment gods throw us lemons.
8. Contribute to Charity
If your itemized deductions, which include charitable contributions, exceed your standard deduction, then the amounts above the standard deduction are tax deductible. For those who give to charity or want to give to charity, it is an added little bonus that it might save you some money on taxes. I would like to think you give to charity out of the goodness of your heart, rather than solely for the tax benefits (because you’re giving away $100 to save $35 in taxes at the 35% marginal rate), but I doubt the charities receiving the donations care either way.
You can also donate appreciated stock (or other investments) to charity and are allowed to deduct the fair market value of the shares and avoid paying any applicable capital gains taxes on investment gains.
9. Eligible Business Expenses
If you own your own business, or have self-employed 1099 income from consulting or something, you can potentially write off eligible business expenses. You paid for CME out of pocket? That’s deductible. You have work-related travel? Write it off. You have to purchase office equipment and supplies? The government will pay for a chunk of that in the form of a tax deduction. Any other expenses that are essential to operating your business can potentially be deducted from your revenues to reduce your taxable income. Be sure to work with a qualified tax professional to learn what you can and cannot deduct as a business expense.
10. 529 College Savings Plan Contributions
Not everyone can deduct contributions to 529 college savings accounts, but some states offer a state income tax deduction if you use an eligible state-sponsored 529 plan. Every state is different. Some states cap the amount you can deduct, while a few allow you to deduct an unlimited amount of contributions. Some states don’t offer any state-tax incentives for college savings. If allowed in your state, contributions are only deductible from income for state taxes (not federal), so the tax savings likely isn’t huge, but we’ll take what we can get. Also, similar to Roth accounts, all money in 529 accounts, including investment earnings, can be withdrawn tax-free if used for eligible education related expenses.
What is Tax Planning?
There you have it. While none of these items mentioned will help you on your 2020 taxes if you didn’t already take advantage of them, you can plan to utilize them moving forward if it’s right for you. That is where tax planning is important.
What is tax planning, you ask? Tax planning is the mere act of planning ahead for things you can do to benefit you from a tax standpoint. Tax planning needs to be done before the conclusion of the year, in order to implement these strategies throughout the year.
I encourage people to have a mid-year tax planning checkup between May and August, to ensure withholdings and/or quarterly estimated payments are accurate. Also, discuss any tax-saving measures that could be implemented before the end of the year.
It’s good also to touch base in the fourth quarter of the year, in case there are any last-minute things to do to improve your tax situation and avoid any surprises in April. This is also a good time to talk about a tax planning game plan for the upcoming year.
It is no secret that the tax code is an evolving beast. Every time we get a new president, they want to change taxes around. We have all heard rumors of President Biden’s proposed tax plan. Time will tell what actually gets implemented and how the future tax rules will differ from the current ones. That is why working with a tax professional who can stay on top of this stuff is beneficial.
Best of luck with your taxes this year and in years to come!
- Why I Make Roth 401k Contributions
- How Does Tax-Loss Harvesting Work
- Retirement Plans for Doctors
- Podcast: Tax Loss Harvesting
- Podcast: Backdoor Roth IRA
- Podcast: Tax Planning w/Ryan Kramer
Disclosure: This is information only and should not be construed as individualized tax advice. Consult with a licensed tax professional to understand the specific tax implications for your individual circumstances. Roth IRA distributions are tax-free if made 5 years after the initial contribution to the plan and you are over 59 1/2 years old.