Written by: Corey Janoff
It’s tax season, so of course, we’re writing blog posts about tax tips for doctors. While there’s not much, you can do to improve your tax scenario for this tax filing. You can do a number of things throughout the rest of the year to put yourself in the best tax position possible next spring. That’s the thing about taxes – we typically file our taxes by April 15th for the previous calendar year. Once the year is over, there’s not much you can do after the fact. Therefore, the best tax tip I can give you is to start your tax planning now for next year’s taxes.
Try not to get too hung up on reducing taxes because there is only so much you can do. Paying a lot in taxes is a good thing – it means you made a lot of money. We live in a marginal tax system, where the more money you make, the more you pay in taxes (in terms of dollars and a percentage of your total earnings). All else being equal, if you make more money, you’ll pay more in taxes, but you’ll take home more at the end of the day than someone earning less money. So, it’s in your best interest to make more money.
With that, let's dive into some tax tips for physicians.
Hire a CPA / Tax Professional
Imagine practicing medicine on one patient per year every spring, without any formal training – you maybe watch some YouTube videos and read some blogs to figure out the best way to treat that patient. Except that patient is you. And the condition is your tax return.
A simple tax tip for doctors is to work with a CPA or otherwise qualified tax professional. You don’t know what you don’t know. The tax code is thousands of pages long and constantly evolving. It helps to have someone who is immersed in it as their full-time job to help you out.
Sure, if you are a single-income W2 employee with a super-basic financial situation, TurboTax might be appropriate. But the moment things get more complex, or the moment you lose the desire to do your own taxes (whichever comes sooner), hire a tax professional.
A good tax professional will not only file your taxes for you, but they’ll also help you plan ahead for taxes (more on that in a moment). They can uncover things you were unaware of. They can give you advice on the tax implications of different actions and help you make informed decisions.
Start Your Tax Planning Early
As mentioned in the beginning, the best tax tip for doctors is to start your tax planning early. After tax season, sometime between late spring and mid-summer, connect with your tax professional to do some tax planning for the year. If you reach out to your CPA in March or early April to do some tax planning for the upcoming year, they will grit their teeth and politely tell you, “Not now, please reach back out after the tax deadline.”
The whole point of doing some tax planning early is to identify any opportunities to better position yourself from a tax standpoint. Are there any deductions you can take advantage of this year? Maybe you are thinking of adding a new piece of equipment to your practice, and there is a special provision that allows you to accelerate the depreciation on it if purchased before the end of the year. Whatever your circumstances are, try to uncover any tax-saving measures.
In addition to proactively saving on taxes, you can avoid critical missteps, too. There may be some things you are unaware of that could be costly from a tax standpoint.
I can think of one physician couple I know where one of the spouses immigrated to the US several years prior, and they still owned property overseas. That property wasn’t previously disclosed on their tax return, which is a big no-no with the IRS. You can face serious fines and even jail time if non-US holdings are not reported on your tax return. Fortunately, the CPA caught this issue and was able to get it corrected and appropriately documented.
Utilize Available Tax Deductions
In February, we wrote a post about tax deductions for doctors. I encourage you to check it out if you didn’t already. I won’t go too in-depth here since there is an entire blog post on tax deductions for physicians that you can read.
An obvious one includes maxing out any and all eligible tax-advantaged retirement accounts. Pre-tax accounts are great for tax-deductions today. Roth accounts are great for avoiding taxes tomorrow. With retirement accounts, you are limited in how much you can contribute each year, and you can’t go back and add money for missed years. So do your best to contribute the maximum allowed every year.
Owning property can be another beneficial tax tip for physicians. Your primary residence, rental property, and even your office building if you are a practice owner. Now, real estate can end up being costly, so don’t go out and buy properties because there may be some tax benefits. Make sure the property makes sense for you and your financial goals.
Own Your Practice or Have a Side Hustle
If you are a business owner or earn income as an independent contractor, you can do a number of things to reduce taxes. Any eligible business-related expenses can be deducted. You can set up retirement plans to defer some of your earnings pre-tax. That one is a win-win: saving on taxes while saving for retirement in a tax-efficient manner.
Our tax code incentives those who create and invest in businesses—capitalism at its finest. Use your capital to create more capital.
Start Investing Early and Often
Earnings from investments are typically taxed much more favorably than ordinary income. Currently, the top federal tax rate on long-term capital gains (aka, investment earnings) amounts to 23.8%, while the top marginal rate on ordinary income is 37%. At almost all tax brackets, the taxes owed on ordinary income is over 50% greater than the taxes owed on investment earnings. In fact, if you are in the bottom two federal income tax brackets, your capital gains tax rate is 0%! For a married couple filing jointly, that’s an adjusted gross income of $81,050 or less in 2021.
You may be thinking, “What physician earns under $81,000 in a year?” Most doctors will earn considerably more than that while working. But what about when you are retired? You only need enough money each year to cover your living expenses. Any money pulled out of pre-tax retirement accounts is taxed as ordinary income. However, eligible money pulled out of Roth accounts is not taxed at all, and if your AGI is low enough, you don’t owe any taxes on your capital gains.
For example, you could cover $10k/month of living expenses by pulling $50,000 from a pre-tax 401k, $20,000 from your Backdoor Roth IRA, and $50,000 from a taxable account, of which $25k is cost basis and $25k is investment earnings. In this overly simplified example, you would owe 10% federal tax on the first $19k withdrawn from the 401k and 12% on the remaining $31k. 0% tax on the Roth and 0% on the capital gains, since the AGI is below $81k married filing jointly. You withdraw $120,000 from your various accounts for the year and pay about $5,600 in federal taxes. Not too shabby.
Assuming kids are out of the house (and off the payroll) and the mortgage and student loans are gone, spending $10k/month is a pretty good life. You’re taking some trips and drinking some good wine!
The above example doesn’t even include a standard deduction. Also, it assumes there is no Social Security income and no dividend income or other capital gains distributions from investments you own. Again, overly simplified.
The tax code could definitely change in the future and likely will every four to eight years. Every time we get a new President, it seems like they want to change taxes around. However, a constant theme is that our tax code favors investment earnings (capital gains) over ordinary income.
There’s no magic wand you can wave to completely avoid taxes. The more you make, the more you will pay in taxes, but you’ll take home more at the end of the day. If you want the most flexibility with your taxes and the most favorable tax treatment, start a business and start investing. Our tax code currently favors investors and business owners, so use the rules to your advantage.
This is information only and should not be construed as individualized advice. Consult with your tax professional for tax implications pertaining to your unique circumstances. Investments involve the risk of loss, including total loss of principal.