Compared to professionals in other industries, physicians rank among some of the highest-paid individuals in the United States. And, as all American workers know, the more you earn, the more you pay in income taxes.
The 2020 tax season is quickly approaching. If you haven’t already started planning how you’re going to file your fiscal 2020 tax returns, the time to start is right now. By putting the right strategies in place, you can reduce your tax burden and devise a sound financial plan for retirement.
Ready to learn how?
From diversifying investments to reducing taxable income, here are the five tax planning strategies every physician needs to know.
Table of Contents
Why Tax Planning is Important
Let’s start by defining what exactly tax planning is.
Investopedia defines tax planning as:
“…the analysis of a financial situation or plan from a tax perspective. The purpose of tax planning is to ensure tax efficiency. Through tax planning, all elements of the financial plan work together in the most tax-efficient manner possible.”
Tax planning involves selecting investments and retirement plans that will lead to a more secure financial future. There are a variety of different strategies you can take, but the goal is always the same:
To lower your tax liability and create as much tax-free or tax-favorable income in retirement as you possibly can.
Tax planning is important for all professionals, but it’s especially essential for physicians earning over $200k per year. Federal tax laws dictate that the more you make, the more you pay in taxes. But there are a variety of ways to reduce your tax burden while still paying your fair share to the IRS.
The goal of tax planning is not to figure out how to cheat the system and pay $0 in taxes. It’s to ensure that you monitor your income and investments in a way that you don’t find yourself paying more than you should.
Related: Tax Planning For Physicians
Major Tax Planning Changes Since the Tax Cut and Jobs Act
The Tax Cut and Jobs Act of 2017 had its first impact in 2019, on taxpayers filing returns on their 2018 earnings.
The new tax law enacted numerous changes for American taxpayers and, specifically, for physicians. These include new tax brackets, a change to the pass-through income deduction, and changes to the alternative minimum tax.
New Tax Brackets
The current tax brackets for 2020 are as follows:
Individual taxpayers filing single:
| Taxable income | Tax Due |
| $0–$9,875 | 10% |
| $9,875–$40,125 | 12% |
| $40,125–$85,525 | 22% |
| $85,525–$163,300 | 24% |
| $163,300–$207,350 | 32% |
| $207,350–$518,400 | 35% |
| $518,400 and up | 37% |
Married, filing jointly:
| Taxable income | Tax Due |
| $0–$19,750 | 10% |
| $19,750–$80,250 | 12% |
| $80,250–$171,050 | 22% |
| $171,050–$326,600 | 24% |
| $326,600–$414,700 | 32% |
| $414,700–$622,050 | 35% |
| $622,050 and up | 37% |
While the Tax Cut and Jobs Act changed the bracket percentages, the income thresholds for those who belong in each bracket vary from year to year. In fact, if you have the exact same amount of taxable income in 2020 as you did in 2019, you may fall into a new bracket this year.
For example, an individual taxpayer with a taxable income of $200,000 in 2018 was in the 33% bracket. In 2020, that same taxpayer will be in the 32% bracket.
Compared to 2018, the 2020 brackets are good news for taxpayers, as the thresholds for each bracket have been reduced. But if we look back to 2017, before the new brackets went into effect, we see that some taxpayers are paying more than they were just two years ago.
For a complete comparison of 2017 and 2018 tax brackets, click here.
The New Pass-through Income Deduction
The pass-through income deduction allows you to take a 20% deduction on certain income from a sole proprietorship, LLC, or S-Corp. But the Tax Cut and Jobs Act includes a restriction for those in professional services, including physicians.
Doctors are still eligible to use the deduction, but the maximum amount of income you can earn in order to meet the threshold has changed.
As of 2018, you can use this deduction if your adjusted gross income is less than $157,500 for single taxpayers or $315,000 if you’re married filing jointly.
New AMT Limits
The Alternative Minimum Tax is in place to ensure that high-income earners are paying, at the very least, a minimum tax. It was designed to make sure that wealthy taxpayers could not get out of paying taxes based on tax breaks and other legitimate deductions.
Here’s how it works:
Taxpayers calculate their adjusted gross income then add certain items back into that total to determine their alternative minimum taxable income. If they meet a certain threshold, they can then subtract the AMT exemption to determine their taxable rate.
Prior to 2017, many physicians had to pay the alternative minimum tax. However, the thresholds for who has to pay have changed.
In 2020, the exemption limits for the AMT are now $113,400 if you’re married filing jointly and $72,900 if you’re filing as an individual. Prior to 2019, these limits were $84,500 and $54,300 respectively.
Raising these limits means that fewer doctors will be affected by the AMT
There is also something called the “phase-out limit” — this refers to a specific dollar amount. Once you reach that dollar amount, you are no longer eligible for the AMT exemption.
With the Tax Cut and Jobs Act, the phase-out limits have also increased. Prior to 2017, most physicians had income that exceeded the AMT phase-out limit. Most doctors made far more and were not eligible to take this deduction.
In 2019, however, the increased phase-out limits started to allow far more physicians to take advantage of this deduction. The old phase-out limits were $160,900 for taxpayers married filing jointly and $120,700 for individual filers. As of 2020, those limits are now $1,036,800 and $518,400, respectively.
Related: Buy Borrow Die Tax Planning Strategy
5 Tax Planning Strategies for Physicians
Ready to start planning for your future?
Here are five tax planning strategies for physicians to develop now:
1. Diversify Your Investments
Tax planning isn’t just about reducing your tax liabilities for this year. It’s also about optimizing your tax efficiency when you retire.
One way to do this is to diversify your investments.
To diversify your investments, you need to take a look at all of your financial accounts. Check your tax-deferred accounts, tax-favored accounts, and taxable accounts. Spreading investments among various accounts will optimize your tax situation during retirement.
You cannot rely on your 401k, IRA, and other tax-deferred vehicles alone. These are all important aspects of your portfolio, but they offer little flexibility in retirement.
Diversify your investments and spread your money among a variety of different accounts now. This will put you in the best possible financial situation once you hit retirement age.
2. Reduce Your Taxable Income
To pay fewer taxes and keep more of your earnings for yourself, you need to reduce your taxable income. But that doesn’t mean that you need to work less and earn less. It simply means that you need to restructure your income and contributions to bring your taxable income down.
One way to reduce your taxable income is to make charitable donations of securities from investment accounts. Unlike donating cash, donating investments offers a double tax benefit. You’ll get one deduction for making the gift and enjoy the added benefit of not having to pay capital gains taxes on the sale of those securities.
You can also reduce your taxable income by making pre-tax contributions to retirement accounts. Contribute the most you can to 401k plans and consult with a financial planner to discuss if you can make use of the backdoor Roth IRA strategy.
Another way to reduce your taxable income is to take advantage of tax-loss harvesting opportunities. With tax-loss harvesting, you can sell a losing investment and realize the loss. You can use $3,000 of your losses to reduce your income, and that can save you up to $1,500 on your tax bill.
Reducing Taxable Income as an Independent Contractor
If you are a physician that has income other than as an employee, there are multiple ways you can lower your taxable income.
For example, if you’re an independent contractor or a locum tenens physician, you’ll receive a 1099 rather than a W2. And that might allow you to reduce your taxable income a bit more. This is because there are several things you can do to claim deductions against that income.
Careful planning in this area can mean up to 10% or more off of your overall income tax liability.
Advanced Tax Planning Strategies
Consult your financial advisor or Physicians Thrive to take advantage of advanced strategies like these:
- Cost Segregation Study — can help you recover lost property depreciation deductions.
- 14 Day Rental Rule — also called “The Augusta Rule”, this rule allows you to rent your home to your business tax-free for 14 days.
- S Corporation — saves you 0.09% Medicare tax on earned income tax above $200,000, among other benefits like QBI, Shift Income, and a lesser chance of being audited.
- Lease employees or hire contractors — this allows you to avoid FICA and FUTA and your workers can be managed by an outside PEO (professional employer organization).
- Research and Development Credits — ⅓ of qualified businesses never claim this credit. If you think you might qualify for previous years, get a “look back” study; if you had no taxable profit from such a project, the 2015 PATH Act may help you retrieve up to $250,000 against payroll taxes.
- Pay your family wages — you can have children and grandchildren as young as seven as employees if the work is commensurate with their age and ability, and the services directly relate to your business. The wages you pay them are then tax-deductible.
- Work Opportunity Credit (WOC) — if you have employees from high-unemployment demographics, you can claim this credit that gives you a dollar-for-dollar credit against your taxes.
- A Roth SEP — a Single Employee Pension IRA lets you make a tax-deductible contribution of more than the typical $5500 limit and can be converted to a Roth IRA.
- Defined Benefit Plan — it costs more to set up a DBP for your business, but those costs are offset by higher deductions and a small employer pension plan credit. You can also combine a DBP with profit sharing, SEP, or 401(k) plans.
Qualified Business Income
Another that may come into play for you is your qualified business income (QBI). Only 80% of QBI on 1099 earnings is taxable, so you can deduct 20% of your QBI from your tax returns, thereby reducing your total taxable income as long as it is not derived from restricted income sources.
Keep in mind, there are limitations as to who can take this deduction. In order to reduce your taxable income by the full 20%, you’ll need to earn less than $157,000 if you’re filing as single or $315,000 if you’re married filing jointly. In addition, specified service trades or businesses (SSTBs) do not allow the deduction. This includes physicians and pharmacists, so to qualify it would have to be for business-related income that is not a direct result of patient care. This can get pretty nuanced so make sure you speak with an expert about your specific situation.
3. Reduce The Amount of Taxes You Owe
The more you reduce your taxable income, the more you will reduce the amount of taxes you owe. And that means maximizing deductions as much as you possibly can.
Home mortgage interest is a common deduction that most homeowners take, but you can also deduct interest on up to $100,000 of a home equity line of credit. If you have a home equity line of credit, make sure you deduct that interest as well.
As a high earning physician, your student loan interest is most likely not deductible, but a cash-out refinance from your mortgage is. Consider refinancing your home to pay off medical school debt so you can use the interest paid on that loan as a tax deduction.
Some physicians may also be able to take tax credits. Continuing education costs, adoptions, and energy-efficient home improvements may qualify you for various credits.
4. Hire Professionals to Help
The best way to approach tax planning is to hire the right professionals. Do not wait until April 15th to start making a plan for tax preparation. Instead, hire a team of experts now so that you can take a look at your tax situation for this year and start next year with a solid plan in place.
There are three different professionals you need to have on your team:
- A financial planner
- A CPA or accountant
- A tax professional
A financial planner will work with you on a continuing basis to create a solid financial plan. This plan will reduce your taxable income, diversify your investments, and reduce your tax burden next year.
A CPA or accountant will track and monitor all of your expenses throughout the year. This will make it easier to maximize deductions, both business and personal.
A tax professional will handle the actual filing of your taxes. They will ensure that you take the proper deductions and reap the benefits of any tax credits that you’re eligible for.
Tax professionals know the current laws and stay abreast of changes to the tax code so you don’t have to. These experts can steer you in the right direction so that you can save as much money as possible, both on next year’s taxes and when you hit retirement age.
5. Create a Long-term Plan
Saving money on this year’s taxes is not the end goal. The bigger goal is to create a long-term plan.
With a strategic, long-term plan, you will save money on taxes. But, more importantly, you’ll be able to keep more of your income for yourself throughout the duration of your career and when you’re in retirement.
Related: The Complete Guide to Physicians Retirement Planning
How to Find the Right Professionals
Before you hire a professional, do your research to ensure that you hire experts who hold the proper licenses and certifications.
As a physician, it’s best to hire experts that have experience in working specifically with other medical professionals. If you’re ready to put a strategic tax plan in place, contact Physicians Thrive for all of your tax planning needs.
Tax planning is essential for all professionals, especially physicians, who are often faced with a heavy tax burden at the end of the year.
If you’re ready to develop a tax plan, these are the five tax strategies you should be aware of:
- Diversify your investments
- Implement ways to reduce your taxable income
- Maximize deductions in order to reduce the amount of taxes owed
- Get tax advice from professionals who know the laws and strategies
- Create a long-term plan
The time to develop strong tax planning strategies is today. Contact Physicians Thrive now to speak with an advisor who can put your plan in motion and put you on a path for future financial success.
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