There are many opportunities for physicians to reduce taxable income. Medical Economics recently published an article containing seven tips for physicians who want to improve their tax situation:
1. High-Deductible insurance
It’s important to make sure maximum contributions are being made to a health savings account (HSA). For 2014, with high-deductible family coverage, up to $6,550 can be contributed. If you’re over the age of 55, an additional $1,000 may be added. People also tend to forget that a spouse covered under a high-deductible insurance plan can also contribute $1,000 to his or her own HSA if they’re 55 or older.
2. Income from outside sources
Any income that doesn’t come through your employers, such as medical director fees or research stipends, can be reported on a personal tax return to aid in establishing a retirement plan for the separate income.
However, if you’re covered under another retirement plan, you need to make sure that the two incomes don’t come from what is considered “controlled or affiliated service groups”. This is defined in detail in the Employee Retirement Income Security Act. A retirement plan for a sole proprietorship can allow for substantial funding, deductible against your income, without any major administrative costs.
3. Donate securities
Instead of donating cash, make contributions of securities with a low basis that you’ve had for over a year. You can receive a deduction for the market value of the securities donated while avoiding capital gains. Making an “in-kind” donation directly to charity can be time-consuming and difficult to coordinate.
Working with an investment advisor and establishing a donor-advised fund can make the process much easier. You can contribute the appreciated securities, liquidate them tax-free, and then make cash donations from the fund.
4. Save excess income
Contribute as much as possible to retirement plans and individual retirement accounts (IRAs), even if the contributions aren’t deductible. Any income taken from retirement plan accounts is exempt from the 3.8% surtax on net investment income. Also, consider putting retirement plan savings in Roth IRA accounts and/or converting retirement savings to Roth IRAs.
A Roth IRA account allows for more control over taxable income by providing you with the ability to pull retirement income from both pre-tax and post-tax accounts. If you’re unable to create a Roth account because your income exceeds the threshold, traditional (non-deductible) IRA contributions can be made and then immediately converted to a Roth account, regardless of income.
5. Take a “tax managed” approach
Most investment managers are focused on investment performance and give very little attention to the tax aspects of investment decisions. For doctors in high-income tax brackets, a “tax managed” approach to investing is very important. “Tax managed” mutual funds, exchange-traded funds, and other tax-efficient options should be considered. One of the most important objectives for managers of tax-managed accounts is to keep the investors’ tax consequences to a minimum.
6. College planning
If paying for a child’s higher education is a priority, you can avoid taxes on investment earnings and gains by using a “Section 529” plan. Saving for college within a tax-deferred environment can result in substantial tax savings because accrued interest, dividends, and capital gains aren’t taxed.
7. Net worth and Retirement
Those who have a net worth of more than $10 million need to evaluate their taxes in terms of income and estate tax, and coordinate planning to address both. Some strategies to consider include a gifting plan, insurance to cover some or all of the estate tax liability, leveraging wealth transfer through trusts and family limited partnerships, and charitable planning opportunities to make charitable contributions in a tax-efficient manner, while possibly generating annuity income for retirement.
With a substantial net worth, the best tax strategy is to spend money under the guidance of financial and legal advisors. This can help to ensure the appropriate strategies are being used to avoid the 40% estate tax on a net worth of more than $5.34 million per person.