By Dr. James M. Dahle, WCI Founder
I have found tax literacy among doctors to be particularly low, so much so that many doctors get sucked into questionable investments and “tax shelters” to save minimal amounts on taxes. But there are ways for medical practitioners to find plenty of tax deductions. Today, let's take a look at effective ways for doctors to get tax exemptions so that they can reduce their overall tax bills.
#1 Tax-Deferred Retirement Plans
Tax-deferred retirement plans are the biggest tax deduction I see doctors routinely missing out on. I'd guess less than one-quarter of doctors actually max out all the retirement account options available to them. Some simply don't save enough money (a related, but separate, issue), and others simply don't realize just how much money they can squirrel away into these things with huge tax benefits.
Every dollar put into a tax-deferred retirement account isn't taxed this year. If you're in the highest tax bracket and have hefty state and local income taxes, you could have a marginal tax rate approaching 50%. That means for every $2 you put in a retirement account, you save $1 on your tax bill. That's pretty darn good.
If you're a contractor paid on 1099s, you could contribute 25% of your income to a SEP IRA, up to a maximum of $61,000 . With a solo 401(k), you can contribute $61,000 , but if you're over the age of 50, you can also contribute a catch-up of $6,500 (that option is not available on the SEP IRA).
If you're an employee paid on W-2s, you may be limited to as little as $20,500 into a 401(k) , but many 401(k)s will match you or at least allow you to self-match up to the $61,000 limit. If yours doesn't, I suggest you talk to your employer.
A defined benefit plan can allow you to shelter additional money from taxes, sometimes as much as another $30,000, $50,000, or even more.
#2 The Backdoor Roth IRA
This one doesn't give you a tax break, and it has recently been in the crosshairs for some lawmakers. But it does allow you to shelter retirement investments from any future taxes. The Backdoor Roth IRA is a far better option than many insurance-related tax shelters that salespeople often push on you. You can put up to $6,000 into a non-deductible IRA  for you and $6,000 for your spouse (plus an extra $1,000 if 50+). Then you can instantly convert them to a Roth IRA. You'll pay the taxes this year but then it grows tax-free. There is one catch: you can't have any other SEP IRA or traditional IRA due to the pro-rata rule, but there are ways around this for most, such as rolling those IRAs into your 401(k). For a step-by-step tutorial on the Backdoor Roth IRA, read “The Backdoor Roth IRA Tutorial.”
Health insurance is expensive, no doubt. But at least you can pay for it with pre-tax money. Your health insurance premiums could be a deductible business expense, as are the contributions to a Health Savings Account (aka a stealth IRA) 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.
#4 Business Expenses
Many self-employed doctors miss out on all kinds of tax deductions just because they don't realize what is deductible and what isn't. If you are a sole proprietor, partner, or contractor, it would behoove you to keep careful records of your business expenses. Home office, travel, meals, accommodations, office equipment and supplies, medical equipment, CME expenses, licensing fees, communication expenses, board exam fees . . . the list goes on and on and on. The main benefit of being an owner, rather than an employee, is that you can get all these sweet deductions. That's offset by the requirement to pay the employer portion of your payroll taxes, but at least those are deductible, too.
Employees generally miss out on these great deductions. Prior to 2018, it was at least possible to deduct unreimbursed work expenses on Schedule A, but it was subject to a 2% of income floor, which for most doctors was far more than they spent. Now, you can't deduct unreimbursed work expenses at all. So, it's best to get your employer to pay for them. The employer gets to pay them pre-tax, just like you would if you were self-employed. For instance, many employees have a CME fund. You can also, of course, just become an owner. Just because 95% of your income comes from your main job, where you are an employee, that doesn't mean you can't get a moonlighting job on the side and get all the deductions a contractor would have. If the moonlighting job requires a medical license, DEA license, CME, etc., then you can deduct your business expenses from that income. Technically, you're only supposed to deduct it proportionally.
Your business doesn't even have to be medicine-related. When I originally wrote this post in 2012, the income from this blog wasn't taxed at all since I deducted office supplies, internet-related fees, and phone-related fees from it. This type of entrepreneurial path has changed the lives of many doctors allowing them to claim tax deductions and, even more importantly, helping them to reap the benefits of earning passive income. Every little bit helps.
#5 Mortgage Interest
Many doctors find themselves with hefty loans, including consumer loans, car loans, credit card loans, student loans, home equity loans, investing loans, and mortgages. While I generally advocate avoiding most of these loans and/or paying down those you take out as quickly as possible, the IRS makes carrying mortgage interest tax-friendly. If you're going to have the loans, you might as well convert them into loans that have a low rate and are tax-deductible if possible. Unfortunately, mortgage and HELOC interest is not nearly as useful as it used to be. Not only is the standard deduction higher (so fewer people deduct it at all), but these days you can't deduct interest from a mortgage or HELOC that was taken out to pay for anything besides the house and improvements on it.
Doctors tend to be charitable folk. If they don't give money, they often give time. Any donations to a qualified charity are tax-deductible, just like mortgage interest (assuming you have enough total deductions to justify itemizing them), or donating large items such as an old boat. You can use Turbotax's It'sDeductible to figure the value of things you give to Goodwill. 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).
#7 Tax-Loss Harvesting
Investors hate losing money. But in a taxable account, Uncle Sam will share your pain. You can even get a break on your taxes without having to “sell low” by doing tax-loss harvesting. You sell a losing investment, and you buy one that is highly correlated to the one you sold. For example, you might sell the Vanguard Total Stock Market Index Fund and buy the Vanguard 500 Index Fund. These two funds generally move in lockstep, but they are different investments. You can deduct up to $3,000 a year of investment losses against your ordinary income.
What other tax deductions do you use to lower your bill? Do you think itemizing these expenses is worth your time, or would you rather just take the standard deduction? Comment below!
[This updated post was originally published in 2012.]