By Denise M. Holmes, CPA, Tax Partner | Healthcare & Medical Practices Industry Team
9 out of 10 Tax Professionals Agree…Proactive Tax Planning and Taking Advantage of Tax Deductions is Good for Physicians
One of the biggest tax mistakes physicians make is to think of taxes only at “tax time” when it’s too late to do anything about it. Generally, most doctors file their personal tax return on a calendar year basis which means that you pay on April 15 for everything that happened between January 1 and December 31 of the prior year… after the fact.
To avoid making tax mistakes that cost thousands of dollars, start thinking about this year’s tax bill right now, and check in with your financial advisor and your tax specialist throughout the year to see what you can do to pay no more than what you truly owe.
Bunch up your charitable deductions. Since the standard deduction has increased to $24,800 (2020) 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.
Charitable donations of cash or used items can save taxes but don’t forget that you can also donate securities from your taxable brokerage accounts. Consider donating appreciated securities to a donor advised fund to get a large tax break, then sprinkle smaller gifts to charity from the fund in the coming years.
By donating appreciated securities, you may gain a double tax benefit by getting a tax deduction for the gift and by dodging the capital gain on the sale.
You can also count the miles used to drive to and from your charity of choice and any other expenses associated with donating your time (although you can’t deduct a value for your time itself.)
Student Loan Interest
Generally student loan interest may not be deductible for most physicians due to the phase-out for high income taxpayers. The deduction for student loan interest for qualified student loans is $2,500 per return. The student loan interest deduction is limited by income of $85,000 for single filers and $170,000 for married filing jointly.
You may want to consider a cash-out refinance to get cash to pay down your student loan which converts the interest into a tax deduction.
Mortgage Interest – Refinancing your Home
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 portion of your deduction. Also, the interest on a home equity line of credit (HELOC) is now only deductible if used for home acquisition or improvement.
While many doctors usually make too much money to take advantage of deductions like interest on student loan payments, the interest you pay on your home mortgage is not currently subject to income limits.
Tax Loss Harvesting
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, as investors hate losing money, you can deduct up to $3,000 net of capital losses to offset ordinary income. This is a potential average savings of $1,000 to $1,500. You can sell a losing investment, and buy one that is highly correlated to the one you sold. And be sure to wait 30 days before repurchase.
529 College Savings Deduction
Skipping the 529 tax deduction is like skipping college. The Section 529 college savings plans are tax-deferred accounts that can be used to pay qualified higher education expenses including college tuition, fees, room, board and the cost of a computer.
How much you can contribute, how much you can deduct, how many accounts you need and whether the deduction is granted to one taxpayer, one return or one account—all vary from state to state. However, it makes sense to decipher the rules, especially in more expensive states where the top tax rate can run to 9 percent.
No matter where you live, 529 plan accounts can grow tax-deferred until you withdraw the money to pay for college, tax-free.
You can also use your 529 college savings plan to pay for private school. The 2017 Tax Act allows 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. You should also consider setting up 529 plans for grandchildren with the idea of paying for all their education before college.
Health Insurance – Health Savings Account (HSA)
A Health Savings Account (HSA) is a tax-advantaged savings vehicle that lets you make tax-deductible contributions, enjoy tax-deferred growth, and make distributions that are tax-free when used to pay qualified medical expenses. It is also one of the best tax breaks since it is a permanent benefit.
Anyone who is covered by a qualifying high deductible health plan (HDHP) can contribute to a Health Savings Account.
Health insurance is expensive, no doubt. But at least you can pay for it with pre-tax money. Your health insurance premiums are a deductible business expense, as are the contributions to a health savings account that you can use for co-pays and deductibles. A high-deductible health plan combined with an HSA isn’t the right move for everyone, but for the healthy, you can save a lot of money on premiums and on your taxes.
Don’t make the mistake of spending your HSA each year – you may throw away tax-free earnings that you could have used to cover the cost of healthcare in retirement. Once you reach age 65, you can use your accumulated HSA dollars for anything, treating it like any other IRA account. Your contributions to an HSA are deductible, and there’s no income limit for being able to take a deduction, unlike with traditional IRA contributions.
Retirement planning through tax-deferred retirement vehicles is one of the ways doctors can reduce their tax bill while at the same time saving more for retirement.
When you set aside money in a tax-deferred account, you’re reducing the amount of your taxable income, dollar for dollar. And, the opportunity for savings is significant.
If you’re self-employed, you can contribute as much as 25 percent, up to $57,000 (2020), to a SEP-IRA or 401(k) this year, in addition to your own individual salary deferrals of up to $19,500. And, if you’re age 50 or older, you can make “catch-up” contributions of an additional $6,500. Other ways to save on a tax-deferred basis include taking advantage of SIMPLE IRAs and profit-sharing plans.
While W-2 employees don’t have the same opportunity, they can still set aside up to $19,500 this year in an employer-sponsored 401(k) plan (plus “catch-up” contributions) for those over age 50.
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 are a great way to save for retirement. However, many will not be able to deduct their IRA contributions and should consider a “backdoor Roth IRA contribution” strategy.
Don’t Forget The Backdoor Roth IRA
A married couple can contribute $6,000 ($7,000 if 50 or older) each to a Roth IRA each year, usually via the back door for most high-income professionals since they make too much to contribute directly. If you are limited to a $19,500 contribution to your 401K, then making the 401K tax-deferred and also maxing out backdoor Roth IRAs should provide you the tax diversification that you’re looking for.
- Contribute to your traditional IRA
- Convert the traditional IRA to a Roth IRA
- Fill out IRS Form 8606 correctly
Physicians can stay financially healthy this tax season with a dose of tax planning.
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.