Today’s world is an incredibly unfriendly tax & regulatory environment for physicians.
After all of the years of grinding hard work, being on call 24/7, and saving countless lives, you are likely getting paid a very handsome wage. And it has come at a cost.
Uncle Sam by cutting Medicare reimbursements (or at least discussing it every year) and by increasing your taxes due to the provisions of the Affordable Care Act, is out to get more!
However, the good news it that there are several steps that you can take to be proactive and keep more money in your pocket.
I don’t pretend to have a magic wand and have your tax burden magically disappear in a puff of smoke, but there are several specific strategies that you can take to minimize your tax burden each and every year.
Explore and learn with me how you can minimize this tremendous burden and improve your specific situation.
Pay Yourself First
Start contributing to your 401(k) plan (or 403(b) plan if you work for a nonprofit) as well as a 457(b) and a Health Savings Account (HSA) if they are available. Contributing boosts your retirement savings and lowers your income taxes as well. This money comes right out of your paycheck, withheld by your employer.
By contributing to your 401(k), every dollar you put in gives you a discount on your federal income taxes. For example, if you are in the 35% bracket, and you contribute $10,000, you have just lowered your taxes by $3,500. That’s like a 35% rate of return on your money today that can grow tax-free until you withdraw it someday, when it will be taxed likely at a lower rate.
Be sure to contribute at least up to the maximum match your employer provides. If your employer matches dollar-for-dollar, this is like an automatic 100% return. Even if your employer matches 50 cents or 25 cents on the dollar, that is still a 50% or 25% return just for contributing.
Get close as you can to maxing out your contribution. If you are under 50 years old, the maximum you can put in the 401(k) is $18,000 in 2017. If you are over 50 years old, you make do an additional catch-up contribution of $6,000 for a total of $24,000.
Set Up a Business or Moonlight as a Consultant
The American tax code is set up to benefit one-person: the business owner. There are many potential write-offs, including using a home office, which allows for many deductions. For instance, you could remodel your basement as a tax-deductible home office, and deduct 100% of all costs, such as utilities, insurance and depreciation, related to the office. Keep in mind- you don’t have to be the business owner; it can be your spouse.
Avoid Tax-Inefficient Funds
You can control capital gains and dividends when you own individual stocks and ETFs, because you can sell them anytime. Unfortunately, it is much more difficult to control them with mutual funds. Mutual funds will distribute capital gains even when you haven’t sold anything, a phenomenon called “phantom capital gains.” As assets come into a fund, the portfolio manager will buy stocks or other securities. Then, when investors redeem their money, the manager will have to sell stocks or other securities, creating taxable distributions.
This can be bad news for tax efficiency. If you are in a “hot fund” that had capital gains from unsold positions that the manager bought years earlier (before you invested in the fund), and investors start pulling out dough, you could be left with a big tax bill. You could actually lose money in a mutual fund and still get caught with a big capital-gain distribution.
Be very careful which mutual funds you invest in. Some managers are incredibly tax-efficient, but many are not.
Harvest Capital Losses
The idea of tax harvesting is to purposely create capital gains or capital losses to maximize your tax advantages. Of course, the government has no ceiling on the amount it can tax you for capital gains.
However, it does it have a floor on capital losses: $3,000 per year. Net losses above $3,000 must be carried over into the following year.
Perhaps you have no carry-forward losses and you have realized some capital gains. Instead, you may have some capital losses that you can harvest to offset the gains and perhaps even create a loss for the year. It’s simply a matter of selling one or more losers while holding onto your winners.
By donating to charity, you can get a tax deduction by unleashing your giving spirit. If you can get your itemized deductions above the amount of the standard deduction, you can have a higher tax write-off than many Americans. Remember your state income taxes are counted towards your itemized deductions, as well as mortgage interest. By adding some charitable giving to the mix, most of us can easily exceed the standard deduction limits and be able to itemize instead.
There’s no minimum to the amount of charitable gifts you can report. However, if your contribution entitles you to merchandise, goods, or services, including admission to a charity ball, banquet, theatrical performance, or sporting event, you can deduct only the amount that exceeds the fair market value of the benefit received.
For a contribution of cash, check, or other monetary gift (regardless of amount), you must maintain as a record of the contribution a bank or credit-card record or a written communication from the qualified charity containing the name of the organization, date of the contribution, and the amount.
As a physician, you’ve made a commitment to helping others and your community.
Now you need to make a similar commitment to your finances.
You can fight back at Uncle Sam through focusing on reducing your taxes by contributing to your retirement, setting up your own business, harvesting losses, avoid tax inefficient funds, and being charitable.
By being pro-active with your tax situation, you can then do the things you’ve long dreamed of doing and be well down the road to financial independence.
For even more tax hints and all the tax stats you can handle, download your 2017 Tax Cheatsheet by clicking on the link below.
About the Author
Dave Denniston, CFA is a professional wealth manager and financial advisor located in Bloomington, MN.
Advisory services through Capital Advisory Group Advisory Services LLC and securities through United Planners Financial Services of America, a Limited Partnership. Member FINRA and SIPC. The Capital Advisory Group Advisory Services, LLC (CAG) and United Planners Financial Services are not affiliated.
The views expressed are those of the presenter and may not reflect the views of United Planners Financial Services. Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation.
Neither United Planners nor its financial professionals render legal or tax advice. We work with you and your tax and legal counsel to assist you with your tax and estate plan.