Doctors Pay More Than Their Fair Share of Taxes
Tax planning for doctors helps hard-working physicians take advantage of all the tax deductions, tax credits and tax exemptions that Congress and the Internal Revenue Service (IRS) will allow. These tax breaks and tax strategies offer ways for physicians to reduce their taxable income.
What does the new Trump Tax plan mean for doctors?
There's a lot of hype about the president's new tax bill, or the Tax Cuts & Jobs Act. Here's a breakdown of what it means to physicians:
Most doctors will pay less taxes. Unbelievable, right? But according to research from The Tax Foundation, a family with two children and $325,000 in earnings would save about $6,000 in federal income taxes.
Physicians in certain states will pay more. Since the state and local income tax deduction or "SALT deduction" is limited now to $10,000 for joint filers, doctors in high tax states like California, Oregon, New York and New Jersey will lose state income tax deductions which will increase their overall tax bills.
Estate taxes are pretty much a thing of the past. Since the federal estate tax threshold has been increased to more than $22 million (joint filers), there is a near zero probability that physician families will every pay the federal estate tax. With that said, every family who is subject to the $15,000 per year limit on gifts--including 529 college savings plan contributions--will get some relief since the $15K limit is part of the federal estate tax code. This change eliminates some cost and hassle when it comes to tax-related estate planning.
Top Tax Issues for Physicians in 2018
Like the last major tax reform passed back in 1986, this new law closes many loopholes and makes it even more difficult (if not impossible) to "work the system." Here are a few tax strategies to consider for 2019:
Bunch up your charitable deductions. Since the standard deduction has increased to $24,400 (2019) for married physicians, you may not be able to benefit from making smaller charitable donations. To work around this, consider making one larger donation every other year. Consider donating appreciated securities to a donor advised fund to get a large tax break this year, then sprinkle smaller gifts to charity from the fund in the coming years.
Be careful about refinancing your home. On mortgages originating on or after December 15, 2017, only the interest on the first $750,000 of debt is deductible. If you refinance a balance greater than this, consult your CPA to ensure that you don’t lose a chunk of your deduction. Also, the interest on a home equity line of credit is now only deductible if used to purchase or improve your home.
Use your 529 college savings plan to pay for private school. Thanks to a late inclusion by Texas Senator Ted Cruz, the new tax bill allows physician families to use Section 529 assets to cover the cost of private K-12 education up to $10,000 per year, per child. In states that allow for tax deductions on 529 plan contributions, you can put money into your plan and then use it to pay for private school. Older physicians might consider setting up 529 plans for grandchildren with the idea of paying for all their education before college.
Drain your kid’s UTMA/UGMA account. The new tax law practically penalizes doctors with children who are beneficiaries of "custodial" or Uniform Transfer to Minors Accounts (UTMA/UGMA). The new law ties the so-called "kiddie tax" to trust tax rates such that only the first $2,600 of capital gains and none of the ordinary income is tax free. To beat this tax trap, selectively harvest capital gains up to the limit, spend the UTMA assets for your child's benefit, and use freed up cash to contribute to a 529 plan.
Manage your qualified business income. Self-employed physicians with so-called "pass-through" entities including sole proprietorships, partnerships, S-corps and LLC's taxed as S-corps or proprietors, should contact their Certified Public Accountant (CPA) early in the year to manage their qualified business income (QBI). The rules are so complicated that rule-of-thumb planning will not suffice and custom tax planning strategies/projections are required.
Physician Tax Deductions
One way physicians can pay less tax is by careful tax planning to reduce their taxable income, taking all of the allowed deductions and protecting those deductions from being phased out. Common deductions include:
Pre-tax contributions to retirement plans such as a 401(k), 403(b), 457 plan or, in certain cases, tax-deductible contributions to Traditional IRAs. Many physicians will not be able to deduct their IRA contributions and should consider a “backdoor Roth IRA contribution” strategy.
Charitable donations of cash or used items can save taxes but most physicians forget that they can also donate securities from their taxable accounts. By donating appreciated securities, physicians gain a double tax benefit by getting a tax deduction for the gift and by sidestepping the capital gain on the sale.
Tax-loss harvesting is the act of selling a losing investment in a taxable account to intentionally realize the loss. While this may not sound appealing, physicians can use the first $3,000 of losses to offset ordinary income, saving the average physician $1,000 to $1,500.
Home mortgage interest is a common tax deduction for physicians, especially those with large homes and larger mortgages. Physicians can also deduct the interest on up to $100,000 worth of a home equity line of credit (HELOC) if used for home acquisition or improvement.
Student loan interest is not deductible for most physicians since high incomes cause this deduction to be phased-out. However, physicians can use a cash-out refinance to get cash to pay down student loans, thereby converting the interest into a tax deduction. This works for consumer debt, too. Just remember this triggers the $750,000 of principal limit for deductible mortgage interest.
All of these deductions are subject to limits, so physicians should consult their tax specialist for guidance.
Tax Deductions for Self-Employed Doctors
It seems like most of the tax code is written to benefit doctors who own their practices. For example, self-employed physicians receive a virtually unlimited tax deduction for business-driven expenses like travel, lodging, airfare, computers and mobile phones, office equipment, office supplies, medical equipment, board exam fees, licensing fees, continuing medical education expenses and membership dues. Doctors who are not self-employed should try to negotiate reimbursement for these expenses since employee physicians get no tax benefit at all for covering these expenses out-of-pocket.
To gain these same tax benefits, physicians who are not self-employed can easily form a small business (sole proprietorship or LLC, for example) to receive income from their locum tenens work as well as payments received from drug companies and medical device manufacturers in exchange for research, teaching and other services rendered to healthcare organizations as contractors. For rules about deducting business expenses, see IRS Publication 535.
Tax Strategies for Doctors with Families
ABLE Accounts Offer Tax Benefit for Physicians with Disabled Children
If you are the parent of a child who became disabled before their 26th birthday, consider making contributions to an ABLE account as you plan to financially support your child.
Like other accounts created under Section 529 of the tax code, ABLE accounts allow physician families to make contributions to a tax-advantaged savings account for qualifying children. Individuals can contribute up to $15,000 per child (in accordance with the annual gift tax exclusion amount), so a married couple could contribute up to $30,000 per child.
Earnings in the account can grow tax-deferred, and distributions made for qualified disability expenses of the disabled child or “designated beneficiary” are excluded from their gross income for federal and state income tax.
In addition to their tax advantages, ABLE accounts do not impair your child’s eligibility for certain means-tested federal benefits programs. Be careful though: only the first $100,000 of the ABLE account balance is not subject to the $2,000 personal asset limit that determines eligibility for Supplemental Security Income (SSI) benefits.
Sponsored by individual states, ABLE accounts are not yet available in all states, and physicians who want the tax-sheltered savings of an ABLE account must enroll in their own state’s ABLE plan. To learn more about ABLE accounts, visit the ABLE National Resource Center.
Self-Employed Physicians Can Save Taxes By Hiring Their Kids
Physicians who own their own business—medical or non-medical—including a sole proprietorship, partnership, or working as a contractor to another business, can add their children to the payroll in order to shift income out of their own high tax brackets and onto their child’s tax return where the standard deduction can zero out the tax liability.
For example, a physician who hires her three children can pay each child up to $12,200 in wages, an amount equal to the standard deduction for 2019, and that deduction will shelter all of these earnings from taxes. So if that physician is in the 37% federal income tax bracket, the total tax savings can amount to around $13,500 each year.
Wages must be reasonable given the child’s age and skill level, and this tax move must be fully-documented so that it will survive an audit.
Roth IRA for Physicians’ Kids Offer Tax-Free Growth
Physicians who have children that are employed by them (see above) or who have W-2 earnings from a summer job or any other source, can contribute to a Roth IRA. Contributions can grow tax-deferred and the account can grow tax-free with no required minimum distributions and no taxes due on qualified distributions under the current tax laws. Over time, the tax-free compound growth can help the children of physician families get a great start on retirement with no taxes due.
Advanced Tax Strategies for Physicians
While these strategies can save physicians thousands in taxes, they require advanced tax planning, special documentation, or the involvement of tax experts including tax attorneys or Certified Public Accountants who specialize in these areas. Seek legal and/or tax advice before proceeding.
Tax-free rental income is permitted by US Tax Code Section 280A(g), allowing physicians to rent out their homes tax-free for up to 14 days each calendar year. For example, physician families in Eugene, Oregon sometimes rent out their homes when sports events (like the Olympic Trials) come to town. Doctors who are self-employed can rent all or part of their homes to their business (board meetings, for example), giving them a business tax deduction and tax-free income. This tax saving strategy requires both a business purpose for the rental and careful documentation.
Defined benefit retirement plans (also known as “pension plans” or cash balance plans) allow self-employed physicians and doctors who are shareholders in their medical practices to deduct contributions to these plans and defer income tax to a later date. In addition to contributions to 401(k) plans, younger physicians might contribute an additional $30,000 to a defined benefit plan while doctors approaching retirement might contribute up to $180,000 per year, deferring somewhere between $11,000 and $67,000 in federal income taxes (assuming the 37% tax bracket). This tax strategy requires careful business planning, and often involves the services of a pension actuary or “third party administrator,” ERISA attorney, and a registered investment advisor.