Since 2001, Congress has made nearly 5,000 changes to the Tax Code whose nearly 4 million words make it seven times as long as Tolstoy’s War and Peace but not nearly so easy to read. Congress’s most recent addition to this ongoing saga—the American Taxpayer “Relief” Act of 2012 (ATRA for short)—closes a chapter on tax uncertainty for many physician families at the expense of those earning more than $450,000. It’s a bittersweet bill that will bore you to tears so today I am sharing the cliff notes (yes, pun intended).
ATRA a Bitter Pill for Physician Taxpayers to Swallw
- Medical specialists are hit hardest. While the Bush era tax rates on the first six marginal tax brackets were made permanent for all taxpayers, Congress (Obama, actually) added a seventh marginal tax bracket that applies to physician families earning more than $450,000. In my experience, only medical specialists and double-physician families earn this much, so they’ll be paying 4.6 cents more in tax on every dollar they earn above $450,000.
- Almost every physician will pay more tax. Even though tax rates were effectively frozen, the total tax burden for practically all physicians went up substantially. Families earning more than $250,000 will have their itemized deductions reduced and their personal exemptions will phase out. That means deductions for charitable donations, home mortgage interest and property tax become less valuable.
ATRA Brings Sweet Relief for Physicians in Both Life and Death
- The "doc fix" is fixed again. Self-employed physicians escaped a 27% reduction in Medicare and Medicaid reimbursements. For some of you, this may be a huge win, particularly those whose census contains a greater proportion of elderly patients. The cuts will rear their ugly heads again on January 1 of 2014 since this is a temporary fix. If history repeats itself though, Congress will extend the doc fix again since they have extended it twelve times since the Medicare Sustainable Growth Rate (SGR) cuts became a part of law via the Balanced Budget Act of 1997. (Hospital docs may feel the pinch though since ATRA levied cuts to hospital reimbursements.)
- The federal estate tax rules are finally final. With the federal estate tax rate rising from 35% to 40%, the new tax rules may not sound like much of a win for physicians until you consider that rates were set to jump to 55% and the size of a taxable estate was set to fall to only $1 million.Now that the size of a taxable estate has been set to $10.25 million for married couples, there’s reason to cheer because the exemption is permanent now (so you can do your estate planning) and most physicians won’t be taxed at the federal level since the average physician family’s estate is well under $10 million, in my experience.With federal estate taxes more or less resolved for the bulk of physician families, you should turn your attention to state estate taxes if you live in one of the fourteen states that impose their own estate taxes. For example, Oregon taxes estates above $1 million, so that’s an issue for almost all mid-career physician families here in my state.
One of the more interesting provisions of the American Taxpayer Relief Act is a new rule that allows you to do a Roth conversion from your Traditional 401k account to the Roth portion of your 401k without having to leave your job or rollover your money to an IRA.
For most physicians, this in-401k Roth conversion will be useless. But for a tiny fraction of them it offers a chance to save big on future taxes. If you are expecting a big dip in your income (for example, if you take an extended sabbatical without pay or if you are disabled and not earning taxable income for the majority of a tax year), you might consider converting your Traditional 401k to a Roth so that your account will grow tax-free indefinitely. For other physicians earning six figures, the tax hit will likely make such a conversion less than palatable.
In February, Congress will sharpen its pen to write the next chapter, so stay tuned for more coverage in upcoming posts, and thanks for reading.