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 [2022]. With a solo 401(k), you can contribute $61,000 [2022], 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) [2022], 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 [2022] 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.”
#3 Healthcare
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.
#6 Charity
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.]
Under #1 (Tax-deferred Retirement Plans), don’t forget that the 401(k) and 403(b) limit has increased from $16,500 to $17,000. Additionally, those age 50 or older can deposit an additional $5,500 as a “catch up” contribution.
Under #6 (Charity) a strategy that has been very popular among physicians is using life insurance to leverage contributions to charities. For example, let’s assume that you donate $1,000 year to a medical association’s educational foundation.
You can take the same $1,000 and have the medical association apply for a life insurance policy (it can’t be term life as you might live longer than the policy does and then the charity gets nothing) on your life where they are the owner and the beneficiary. You gift the $1,000 to the charity and take the same income tax donation. Now, in the event of your death, the donation is increased substantially due to the insurance policy.
Now that I mentioned this, if you look at various medical socities or schools, you will notice that this option is usually mentioned and referred to as a “deferred gift”.
Another large tax deduction falls under IRS Publication 463 (Temporary Job Assignment). The travel, lodging, and 50% of the cost of the meals incurred during a job rotation outside the general vicinity of where you live. The rotation must be for a specific period of less than one year, and you must intend to return to the city that you were living in prior to the rotation. A good example is a Plastic Surgery Resident in New York that goes to do a hand Fellowship in California (one year or less) and then returns to New York. This is often overlooked and can save those in this situation thousands of dollars of their income taxes.
Larry-
Good catch on # 1. Fixed it.
The problem with using a permanent life insurance-based strategy to increase a gift is that you have to use the permanent life insurance. It would result in a bigger donation to the charity, but that’s mostly because it is a deferred donation. You get the tax deduction now, but the charity doesn’t get the donation until you die. If that’s your goal, then it works fine. But if your goal is to maximize your eventual donation to the charity, you may be better off skipping the life insurance policy and investing the money yourself, to make a bigger donation later.
The charity may prefer a smaller donation now rather than a larger one later as well. Or, they may prefer being able to invest it themselves and liquidate it when needed rather than waiting for your death and only getting the lower expected rate of return the insurance policy would provide over a more standard portfolio.
It really is not much different than using a irrevocable life insurance trust to provide money for heirs. The reason to give it away early aside from hopefully giving more in the end is to take advantage of the $13K/year gift tax exclusion each year, and reduce your estate taxes. I suppose you could do an irrevocable trust without the life insurance, but you don’t hear about it very often. I suppose because without the life insurance the trust would be paying taxes on the earnings at your marginal rate.
Business travel is a great deduction. The more you travel, the more you can deduct. Temporary Job Assignments are really just business travel. Keep in mind you can only deduct the costs your employer doesn’t pay. For example, when the military sent me somewhere, they paid for everything. No deduction obviously. I do like the idea of using it for a one year fellowship though. I’m curious how the IRS defines the “intend to” clause. If you “intend to” return, but at the end of the year decide not to, do you lose the deduction? How do they determine your intention?
I should clarify the life insurance for charitable giving strategy. Some associations have “benefits” for those that give cash or securities or make deferred gifts now. For example, the American Society of Plastic Surgeons has something called the “Maliniac Circle” in which members that donate to the Plastic Surgery Foundation receive special recognition. Since young members often don’t have the liquidity available or don’t want to take monies away from their family needs, the life insurance works great.
However, Whole Life insurance should not be used as it is expensvie and will build cash value that the foundation just does not really need now. Therefore, the member applies for a Universal Life policy with a Secondary No Lapse premium and pays for the number of years that they desire (essentially, purchasing permanent term insurance).
The member gets the recognition now, the charity gets the money later, and the needs of both have been met. The same strategy can work for schools as well.
The “intent” part is probably tough to prove. I had a client that left his home state to do a Fellowship and signed a contract for a job to return to his home state. He subsequently took another job to go to another state. I would argue that until the new contract was signed, his intent was to retun to his home state. He could then provide the signed contracts to the IRS in the event of an audit.
A great website is http://www.mdtaxes.com. It is run by Andrew Schwartz, CPA in MA and he and his brother, Richard, specialize in tax planning for physicians and other healthcare professionals. There is a lot of good information there, as well as, an interactive message board.
Does the average MD really need a CPA for tax planning? BTW, I have been impressed with Fairmark.com which looks like a much more active forum for asking tax questions.
Under #5, I do not believe you can deduct the portion of the refinanced mortgage that is used to pay off student loans, credit cards, etc. if you are subject to alternative minimum tax. Under AMT, I think the only interest that is deductible is that which is used to purchase the home.
Mark- I suspect the AVERAGE MD does need a CPA! But average MDs don’t read financial blogs, much less go to forums to ask questions and learn to do things themselves. I agree that Fairmark.com has a great forum for tax questions. I’ve used them many times. You don’t get your answers as quickly as on a busy forum like Bogleheads, but tax-wise, the advice is better.
Alan-
You are correct that home equity interest not used to improve, build, or buy a home isn’t deductible under the AMT system. Those who don’t have to pay AMT, however, can deduct the interest on up to $100K of home equity mortgage. Even if the interest isn’t deductible, it wasn’t deductible before anyway. So if you can get a lower rate, it still makes sense to fold it in with your mortgage/home equity loan.
Larry- Thanks for the link to MDTaxes. Lots of good stuff there.
even if you use gUL, its a bad idea. Since neither you nor the organization needs insurance, one will likely always do better investing seperately. The recognition now part is bogus. dont let any insurance agent con you into this being a good idea. If im not mistaken there have lawsuits about such gifting programs when things dont work out as expected with a large university in the south central region.
Why is the recognition now bogus? Got a link to the university gifting lawsuit?
White coat, what is this self matching to a 401k you describe. Are you talking about a solo 401k? I have tried to get more matched into our s corp, but i always run into new comparibility rules that requires more money given to employees than i could defer for ourselves as partners.
ill see if i can find it. it doesnt apply to anything id consider so ill have to search. as is typical in these lawsuits, what you read online depends on which site it comes from. The bottom line however is that using gUL or any insurance product to grow a donation is a bad idea. Never use insurance as a way to grow something. The reason its bogus is that there isnt anything special about that type of donation vs another type in regards to how your favorite charity will like you. The charity would much prefer cash or anything else for that matter but of course will take this instead of nothing.
You can find it here: http://chronicle.com/article/Lawsuit-Suggests-Oklahoma/63939/
This seems much more complex than just, “using gUL or any insurance product to grow a donation is a bad idea. Never use insurance as a way to grow something.”
By a quick glimpse it seems that there was actual illegal activity involved, not just poor performance of an insurance product.
Rex – One of the nice things about this blog is that, there is not much “blanket” advice being given. Although your statement may have some validity, there are situations where this strategy could work.
Suppose you structure this type of strategy, buy a $250K GUL policy for a $1600 annual premium and die in year 10. Can you enlighten me as to where else I can get a guaranteed 55% return? However, if you live for 45 years, it probably wasn’t such a great deal (4-5% return).
This has nothing to do with my perception or opinion of this strategy. Mainly just to show that there are cases where it may not be so bad.
RabbMD- No, its a profit sharing plan/401K, not a solo 401K, designed by MedAmerica for a group of about 100 docs and a few other employees. The plan allows for “self-matching” by highly-compensated employees (basically docs who haven’t made partner yet.) The non-highly-compensated employees actually get a match from the company. The partners also “self-match” up to $50K.
I’m no 401K attorney, but my understanding is that it is legal!
Rex and Michael-
“But, he said, the colleges discovered that if they sank the money into their endowments, they would get the same rate of return — but with less risk. The insurance idea “kind of died on the vine,” he said.”
There’s the important quote in the cited article. It sounds like Oklahoma State was actually paying for the policies with endowment money and got ripped off by the insurance company. That seems quite different from what we’re talking about here, that the donor buys a policy with an annual gift.
Michael- Since there’s no guarantee the insured will be dead in 10 years, I don’t think you can call the return “guaranteed”! Heck, the guy could die the next week for a huge return, but on average, the expected return should be less than the University (or the Donor) could get by investing the money themselves. You could guarantee the amount the University eventually gets (which you couldn’t investing it yourself or gifting cash), but you couldn’t guarantee when.
michael that isnt a strategy then its a gamble. How could an insurance company stay in business if they paid a higher return then they can get on their own investments? They cant. The only way to “win” is either extreme luck (which in this case is also bad luck since you are dead) or for the insurance company to accidentally puts you in a category they shouldnt (they think you are excellent health but you are not).
There are no magical investments in this world. Insurance companies use the same investments that other people do except bc of their guarantees they need to use conservative investments. They also need to pay their people and cover the true insurance risk. Thus as a way to grow money on average it will always be a loser on average. It has to be or the insurance company goes out of business and then those guarantees arent so valuable. That is why that statement will always be true on average. We could tell people play the lottery but we dont bc we know as a strategy it doesnt make sense. The same is true of using insurance to grow money. Its fine if you need insurance but not as a method to grow money. Always keep in mind how they make money and you will realize without the need (or possibly strong desire) for the insurance, it is not for you.
The idea behind the strategy is that (young) physicians might want to make donations to their society’s educational foundation but don’t have the liquidity or desire to make a large initial gift or commit to making gifts of a few thousand dolllars per year on an ongoing basis to meet the requirements for recognition.
This is typically done because they want the recognition of doing this by the society and/or their peers (Rex – who is to say if this is bogus or not if that is their desire) and like of the benefits that go along with it (typically at the society’s annual meeting) like a VIP suite or reception for donors.
Since most associations typically require a deferred gift of $50,000-$100,000 so, in most cases, that is the size of the policy being purchased.
It was mentioned for educational purposes and not something that I recommend that should or should not be done.
WCI – I saw that quote and completely agree with you. However, I believe that “But the complaint alleges that Mr. Lee and the other agents misrepresented details of the deal and even forged signatures on documents that they were required to show to university officials and the donors”, is a fairly critical factor in their filing suit.
Rex –
I’m not really interested in arguing this. My intent was not to be pro/against this concept, but rather to share unbiased information – hence why I provided two examples showing the good and the bad.
Having experience in the financial services industry and working with individual clients, these decisions are not always scientific like you make it seem.
I think the key factor is for people to understand their options so that they can make the decision that is most appropriate for their situation.
Nice article by the way, WCI. Well written – especially on the tax-deferred retirement stuff.
well you shouldnt argue for this bc its a horrible idea except for the agent. The whole reason the concept exists is insurance companies bringing it up to charities. Charities will take something instead of nothing but this is definitely not what they really want and it isnt what you will want either once you understand it and the drawbacks.
let say a young person does purchase gUL bc they dont have the resources to give a big gift (i didnt pick this as the ideal case by the way which it actually isnt the ideal case for purchasing gUL any way). Well if that person has any hard financial times later on and misses a payment then the policy goes bust. This can be especially true for someone who doesnt have the resources to give a big gift. If you actually live longer than you thought and thus dont save enough for retirement then again the policy goes bust and the charity gets nothing but you will have paid tons over the years. If you become too ill in your last few years of life (which also may have serious financial costs), then maybe a payment will be missed by accident alone and again the policy goes bust. If inflation goes through the rough then those guaranteed dollars become worthless over the next 50 years. Agents and insurance companies love all those situations.
You completely made up those additional perks and the concept that only by pledging with insurance that one could obtain them. If you just pledge money over time you will get the same reception.
Again the final factor always will be never use insurance to grow money (i should add under current tax laws). Only use it if you need insurance.
I did not make up those additional perks and never stated that they could only be achieved with insurance.
Here is one example:
http://www.oref.org/site/PageServer?pagename=shands_memberbenefits
no good reason to use insurance unless you want to gift less money and take on all the disadvantages i mentioned plus more.
No reason to use insurance unless you want to gift less money and give more to the insurance company. There is no good reason to use insurance in this situation.
I’ve never helped manage the investments for a charity, but it sounds like you have some knowledge on the topic based on your level of confidence regarding what charities want and do not want. What are your thoughts on the typical investment portfolio for a charity? One would assume that they cannot be too risky for fear of a negative public perception. So what type of return can a charity who needs to be moderately conservative expect over a 25-45 year time frame?
It seems a single premium insurance policy (which becomes an MEC obviously) would avoid many of those disadvantages Rex. The charity gets a guaranteed amount when you eventually keel over, that amount is more than you can now afford to give, and if the charity is willing to give you some benefit for it that you find valuable, then it is a win-win-win. I agree it isn’t my preferred way to give to charity (I give cash), but I’m not convinced there is NO reason not to use insurance for this. Should the charity prefer a small amount of cash on the barrelhead now? I think so. But that doesn’t mean they do.
michael if you are really in the financial industry then you either dont understand these products are okay with giving poor advice…if one use a gUL as mentioned above then you dont know the return bc it depends on when the person dies. The longer the person lives then the worse the situation. There is also the chance that you set the gUL incorrectly and outlive the guaranteed rate.
WC,
Well if you are going to provide a single premium MEC then yes it would eliminate some concerns (except of course the insurance company going under is still a risk and ill add that several companies are cutting back on their gUL bc of the low interest environment and it is also one of the reasons why long term care insurance is in trouble although not the only reason) although still a very poor investment but then it defeats the idea noted above about not being able to afford any significant amount up front so scheduling payments yearly. If you really care then do the smart thing and not the insurance agent thing.
any charity that has people in the know only wants this instead of nothing and if it helps them get something then fine. They will take it but they dont desire it over the cash for the reasons ive already listed. If you arent a single premium then there is always risk that once the individual realizes how poor an investment is that they stop paying or stop paying for a variety of other reasons i also listed and then again the charity gets nothing. Again there is no insurable interest and thus no need to add the fees of insurance. Agents like to pretend this is smart but it isnt. I like to think here we (physicians) give smart advice and explain why options are poor choices. If one wants to make a poor choice then as long as they understand it fine. Most of us know however that agents coach this conversation in ways so it seems like a smart choice when it is anything but that. Purchasing any permanent policy as an investment no matter how you cook it, is a bad idea. The primary reason must be a need for a permanent death benefit or possibly a strong desire knowing that this will likely result in less money.
Rexxxyy –
You can’t just turn every comment or conversation on insurance into an agent bashing session. It’s becoming clear that you must have had some poor experience with an insurance agent in the past and I’m sorry that you fell victim to buying something you now regret. While I agree that there are many agents out providing what I would consider to be poor (or perhaps misinformed) advice, there are also financial professionals out there making great recommendations some of which include insurance products.
If a 40 year old buys a $250k gUL for $1600 a year and dies at age 90 (beyond life expectancy) – that gets him a 4% return. Yes, I agree that one could contribute $1,600 into a personal brokerage account, invest at his/her own risk following the rules of designing a doctor’s investment portfolio, and would likely create more money if they live the same number of years. Trust me, I get it!! BUT, in the real world, not everyone would prefer to do it that way.
BTW, I’m yet to voice my personal view on this topic and do not appreciate you indicating that I “either dont understand these products or are okay with giving poor advice”. Just because I’m not bashing the insurance idea does not, in any which way, imply that I am in favor of it either.