By Dr. James M. Dahle, WCI Founder
I had an interesting experience recently. A tax planner married to a doctor read my book. He had this to say:
“I am a CPA that specializes in taxes. [My wife] purchased your book and we read it together and I have to say, I was very impressed. I have several physician clients and I will be referring your book to them. Still, when I read the part where you said that you do your own taxes I was skeptical. It is true that many CPA's don't specialize in aggressive tax planning, but I find it hard to believe that your tax bill is as low as it could be if you are doing your own returns. Now that the tax deadline has passed and I have more time, I would like to issue a challenge: give me a copy of your 2015 tax return. Black out the names, address and the Social Security numbers and let me just see the dollar amounts. I am convinced I can show you some ways to save on your taxes. Prove me wrong.”
I'm not sure how he was expecting me to respond, but I like to think my ego isn't all that large and I've always got plenty to learn. I read this email as “here's a CPA willing to give me a free tax strategy session and look over my taxes for errors.” All it would cost me is a little time via email and phone and copying and blacking out tax returns. Plus, I was well aware that my 2015 return was significantly more complicated than my previous returns had been. I was particularly concerned about all the tax forms I had to fill out with regard to selling my rental property in 2015, since that was the first time I'd done that and I spent a lot of time on it. I've never actually had a tax professional look at my tax returns, and I haven't yet been audited. So who knew what he would find? I had a little worry that he would find I was underpaying my taxes by tens of thousands.
So a few days after I sent Scott Keithly at Keithly & Glenn Tax Consulting, LLC most of my tax forms (I just couldn't stand to copy, black out, and scan all 150 pages that Turbotax spit out) he got back to me with some great suggestions. Mostly, I was just happy that he confirmed I wasn't dramatically underpaying my taxes and that I'd done the rental property disposition exactly right. He noted a few minor things I could have done better, particularly on the WCI partnership return I did this year for the first time (I guess we'll find out how much the IRS cares about that) but really nothing worthy of filing a 1099X over. Which was good, since I had already done three of those this year! I was also curious about what he would charge to do my taxes and the figure came in around $1500, which was about what I would expect for such a complicated return. This year I definitely spent more than $1500 of my time doing them, but hopefully that'll get easier in the future.
At any rate, I thought it would be fun to write about some of the suggestions he made to me. These aren't suggestions in ways to fill out my tax forms better. They're suggestions in ways to live my financial life differently that would lower my tax bill.
#1 Form a C Corp
I've written before about C corps, years ago. There was this post about the benefits, this one about the downsides, and this one about how lots of doctors mistakenly think incorporating is the key to reducing their liability and taxes. However, when I wrote those posts, my financial life was significantly different- almost all my income was from my practice and WCI wasn't making squat. It was reasonable to reconsider a C Corp for WCI.
The big problem with C Corps is the double taxation issue. Yes, a corporation may have a lower tax rate than you on a limited amount of income, but when you pull that money out, it is taxed again at your qualified dividend rate. Once you've been double taxed, there isn't all that much benefit there. You minimize this double taxation by just paying out all profits every year as wages. By doing that, you get any side benefits of having a corporation and pay about the same amount in income taxes. The other issue with a C Corp is the expense and hassle associated with forming one, maintaining one, and dissolving one. So you're really weighing the side benefits against those costs and hassles. So my discussion with Scott was about the side benefits.
Here were the benefits that I could personally use if I incorporated. Be aware that most of these work for me because I'm a business owner, not a doctor and your situation will almost surely differ.
Decrease Medicare Taxes
Avoid paying medicare taxes on our employer 401(k) contributions. That's $35K a piece, or $70K a year. 2.9% * $70K = $2,030.
HRA
Set up a Health Reimbursement Account (HRA) and pay for our health expenses using that rather than our HSA (or what we're doing now, a taxable account.) This would allow us to pay for health care with pre-tax money while still allowing our HSA to keep growing. There would be some cost and hassle there for sure, but there's potential to save $1-2,000 a year there given our high deductible. According to this, the maximum that can be put in there is about half your deductible, so $4500 a year given our current plan. If it isn't used, it goes back to the employer, which is also me, so no big deal there. It could become a big deal if I start hiring non-family member employees for WCI though.
LTC
Pay for long term care premiums with pre-tax dollars. I'm not super interested in that option, as I plan to self-insure this expense.
NQDC
Set up Non Qualified Deferred Compensation accounts. Basically, this is a contract between me as an employee and me as a business that my business will retain some of my earnings, pay taxes on it at the lower corporate rates, and then pay it out to me at some later date. It avoids the double taxation issue because what is later paid to me and is fully taxable is a deduction for the corporation. So taking the money out, assuming the corporation is still making good money, is basically a wash from the tax perspective. Since the first $50K a corporation makes is taxed at 15%, the next $25K at 25%, and the next $25K at 35%, if I'm in the top bracket, there is an arbitrage there. If I just pulled that money ($100K) out and paid 39.6% on it, I would owe $39,600 in taxes. But if I did this, I would only pay 15%*$50K= $7,500 + 25% * $25K = $5,000 + 35% *$25K = $8,750 for a total of $21,750, a savings of $17,850 in taxes. (More if you include state taxes, especially if I move to a no-income tax state before withdrawing it.)
Now that gets me pretty excited. What's the downside? Well, I have to incorporate. That means either learning more tax forms or paying someone else to do them. I also would have to pay an attorney to setup and dispose of the corporation. And I'd probably have to pay a company to do my payroll. But all that pales in comparison to $17,850 a year. What could go wrong? Well, WCI isn't exactly GE. Who knows if it will be here and making good money in 20 years when I want to pull this money out. Without that deduction to offset my taxes on the withdrawals, I would end up just getting double taxed (it would end up being about 150% of what I would have otherwise paid.) This strategy would get even better if corporate tax rates are lowered. Clearly this could work great in the right situation, although I'm having trouble seeing where I would need to pull the deferred money out of WCI while WCI was still making lots of money. Maybe if I sold it, but then I'd have to worry about the new owners making good on the promised compensation. First world problems we're dealing with here.
Remember that doctors who form corporations for their practices often have to use a professional service corporation, which doesn't get those lower tax rates on the first $75K of retained earnings. It's all taxed at 35%.
My Thoughts on an S Corp
Now, I hadn't really considered doing a C Corp, but I had seriously considered an S Corp for WCI in the next year or two. I really only want enough wages out of it to max out our 401(k)s, which we were barely able to do for 2015. But let's say WCI hypothetically made $600K going forward. Well, we could take $200K each for wages, enough to max out our solo 401(k)s, and call the other $200K distribution and save the Medicare tax on it. That would save us $5800 a year, more as income goes up (if income goes up.) A C Corp couldn't do that. But the potential tax savings from the C Corp could be larger for us, particularly when you include the NQDC.
#2 Buying Life Insurance as a Business
Another thought Scott had, although he knew I probably wouldn't go for it and he actually hasn't ever had a client that did (he doesn't sell insurance so has no reason to give the idea a “hard sale”), was the idea of buying cash value life insurance through the business. He knew I'm not big on either lots of leverage or cash value life insurance, but he thought it was worth mentioning. Basically, the way it works is you buy a huge whole life policy using borrowed dollars and use the policy as collateral on the loan. The premiums aren't deductible to the corporation but the interest is. Then hopefully your tax savings is greater than your after-tax interest cost. I've written about a similar scheme before, and it won't surprise any of you to see that I'm not going to be implementing this suggestion. However, he calculated the potential to save up to $43,600 in taxes. A video about this strategy might be worth debunking some time. Let's just say I might save $44K in taxes, but I think I'd be better off skipping this option when all is said and done. It is clearly a great way to sell more insurance!
#3 Using a Charitable Lead Annuity Trust
We give a lot of money to charity every year. It helps keep our taxes low as we deduct it on Schedule A. Scott suggested we might like to use a Charitable Lead Annuity Trust (CLAT) instead for our charitable giving. Remember with a CLAT that you put a big lump sum into a trust, get a tax break for it in this year, the charity gets something like 6% annuity payments every year for 18 years or so, and then you get what's left. Meanwhile, the money is invested in something (like real estate) that hopefully earns more than 6% a year. So after 18 years, you get more money back than you put in, plus that big huge deduction 18 years ago. What you lose, however, are the costs associated with setting up the trust, all the taxes you owe on the earnings of the trust over the years, and the deductions you would have gotten from making annual cash donations to the charity from your earnings instead of the CLAT. I can see where this would work well for someone who is charitably inclined and received a big lump sum from the sale of a business or something and needed to lower his taxes in that year and who supports a single charity. For someone like me who expects to have rising income over the years (at least for a while) who supports multiple charities and doesn't want to be locked into one, and needs ongoing tax deductions, I'm not sure it is so useful. There would be some benefit from the time value of money (i.e. getting the deduction up front) but I don't think it works well for my charitable plans-i.e. contributing a percentage of my income each year.
#4 Oil and Gas Partnerships
I've frequently heard the phrase that the only investment that gets more tax breaks than real estate is oil and gas. As near as I can tell, that's true. In fact, Scott suggests it is possible to invest $50K into oil and gas and then write off $45K in intangible drilling costs that same year. He warns it does increase your AMT however. My big beef with this idea is that you never want to buy an investment just for the tax benefits. The investment has to make sense on its own first, and the tax benefits should be gravy. My little beef with this is that I don't know much about oil and gas and would need to find someone I trusted to assist with that investment. It's a nice idea, and maybe I'll delve in there at some point in the future, but not something I'll be implementing any time soon.
It was nice to have Scott take a look at things. Maybe I'll even use him in the future to prepare personal or business tax returns. If you're interested in meeting with a tax strategist, I'm sure he'd be willing to help out. [Disclosure: Since I wrote this, Scott now advertises here at the WCI and a number of readers have availed themselves of his services.]
What do you think? Have you ever met with a tax planner or strategist? Does your tax preparer do these sorts of things with you? Do you have a C Corp? Why or why not? Comment below!
Did he discuss option of an LLC?
What do you mean option of an LLC? I’ve got lots of LLCs on my return.
See comment to Keith below.
Replied to it already.
It seems like all of the potential benefits are either something you are not interested in or come with a potential serious down side. Sure, saving $20-30k on taxes sounds awesome, but if you are pulling in over $600k combined between your EM partnership and WCI then it isn’t exactly making or breaking you. The NQDC is the big carrot, but it seems to be attached to a large stick that might be a bit unwieldy.
I am all for optimizing when it makes sense, but reading this article also made me think of Harry Sit’s article from March 22 of this year – Leave Some Money on the Table; sometimes the extra time and hassle of optimization isn’t necessarily worth the effort.
Having said that, the simpler S Corp might be worthwhile. While those benefits are potentially lower than the C Corp the also seem like an easier guarantee. I’m with Dr. Mom, did he mention any potential benefits of the LLC?
An LLC doesn’t “do” anything by itself to your tax accounting. So it provides zero tax benefits as a practical matter.
An LLC, btw, is always “something else” for tax purposes. I.e., a one owner LLC can be treated as a disregarded entity and that means its income and deductions appear on its owner’s tax return. A multiple owner LLC would be treated as a partnership by default… But an LLC can also be treated as a corporation or S corporation.
These other options do get taxed differently. And then the question is whether you save more tax with an S corporation than you do with a, say, sole proprietorship.
Keith, I like your point about the extra time not being worth the hassle. My husband started his practice as a C Corp. It was not worth the hassle. Back then, it made the fiscal year fall on the calendar year. IDK if we could have changed that around. But, it made December become a hassle which detracted from the holidays for us. So, he easily changed it to an S Corp. Back then, an S corp allowed him to save more for retirement which may no longer be the case. It does require annual paperwork. But in 5-10 min., I have the annual forms ready for him. We sit at the kitchen table with a glass of wine and let him have meetings with himself. It’s a good laugh every March. He also put all his office equipment and ophthalmological toys into an LLC which the kids and I are part owners of. Tax rules have changed over the years so that may not be as beneficial as it once was. For WCI, I would wonder about structuring the website as an LLC with wife and kids as part owners. Then, electing the entity to be taxed as an S corp. Thoughts?
Yes, as the income climbs (? if it climbs) it makes more and more sense for WCI LLC to file as an S Corp. Probably happen eventually. Didn’t make sense for 2015, and prob not 2016, but maybe 2017.
I thought you could not have a HRA if you had a HSA
Not true. https://www.zanebenefits.com/blog/bid/97341/FAQ-Can-I-have-an-HRA-and-an-HSA-at-the-same-time
IRS Publication 969; 2016
“Other employee health plans. An employee covered by an HDHP and a health FSA or an HRA that pays or reimburses qualified medical expenses generally can-not make contributions to an HSA. Health FSAs and HRAs are discussed later.”
Interesting article. Regarding CLATs, I think the purpose has more to do with estate planning (as you’ve mentioned in your previous articles) than an immediate tax deduction. A CLAT is a good way to pass down appreciated shares or a stake in a business if you expect the shares to continue to increase in value.
Some comments from another CPA… (one who hasn’t seen your return of course).
The working interest in an oil and property does provide giant tax benefits but it’s a category that’s full of scams:
https://www.sec.gov/investor/pubs/oilgasscams.htm
Second, as discussed in your earlier post and comment thread referenced below, I am surprised your arrangement to create earnings for your wife to boost pension fund contributions generates enough value to offset the extra payroll taxes:
https://www.whitecoatinvestor.com/why-i-gave-my-business-away/
Curious that the CPA didn’t look at or mention that… (BTW, buried in one of my comments at that earlier blog post is a link to my painfully detailed analysis of your arrangement.)
Regarding the S corporation comment, I love S corporations. And we do a ton of work with S corporations, some small, many very large. But I’d wonder how much incremental value you get by using an S corporation as compared to the option of just treating the writing business as a sole proprietorship and doing a SEP. I.e., you can max your 401(k) via your employment as a physician and you can max your SEP via your blog and writing earnings. And do you really get enough true tax savings to pay for the payroll taxes you guys pay…
http://evergreensmallbusiness.com/should-you-use-an-s-corporation-for-a-sideline-or-part-time-business/
Can’t do a SEP. Screws up the backdoor Roths. The point about the extra payroll taxes vs lower income taxes is legit, of course.
He can max 401k same as the SEP in 2nd business, either sole proprietorship, LLC, or S-corp.
Can he really max the 401(k) a second time? Doesn’t he only get one $18K elective deferral?
Yes, but the 2nd 401k is all calculated by % of income, so you don’t get $18k off the top.
OK, that’s what I thought. I think I didn’t read your comment carefully. Sorry. 🙁
No problem – I have def had my share of blunders on WCI.
Nice write-up, WCI. It sounds like you’re doing great with your own taxes.
Maybe some of his suggestions will save you money, but there’s some risk involved and a lot of hassle. It’s much harder to quantify the downsides of these and the upsides of simplicity, yet they shouldn’t be ignored.
CPAs love Oil and Gas partnerships for their obvious tax advantages. What I haven’t seen is a way to capture these benefits without exposing yourself to *unlimited* personal liability if something goes wrong. If anyone has found a way of doing this I would love to hear about it.
Just for the record, not ALL CPAs love Oil and Gas partnerships.
The way to avoid liability is to buy into an LP (“Limited Partnership”) or LLC (“Limited Liability Co”).
Thank you for your reply.
Unless you are going to drill the well yourself, I believe the only way to participate and claim the tax benefit is by being a limited partner. However, the partnership agreements I have seen make it clear that (even though the probability of trouble is small) you nevertheless have unlimited liability if you want the tax deduction. The two seem to be joined at the hip. You can use insurance to offset this risk, but if when you look at the insurance policy will you find that it does not provide unlimited protection. So you can afford to take the risk, but Berkshire Hathaway can’t?
Have you studied a gas & oil partnership agreements and found something different? If so, I would be very grateful if you could point me to one so I can review.
PS I want to second the comment above that the field is littered with scams and by the time a proposal crosses a physician’s desk you can only imagine home many better-informed investors have passed on the opportunity.
Philip, I think you are right. I.e., if you only put (say) $50K into a oil and gas deal and get (say) a $100K deduction in year 1 and so save $50K of taxes, you need to be “at risk” for the entire $100K in order to write off the entire $100K…
What may/should happen is that somewhere down the road there’s in effect an “undo-ing” of the $50K of deduction you didn’t have “skin in the game” for.
I am actually concerned about something worse, e.g., that the EPA director in the city of Tulsa thinks your well has contaminated the city’s water table, and now the partnership is on the hook for billions of dollars to clean it up. My understanding is that as a partner, you would be liable for your share of the damage. I would love to be told otherwise.
That’s a question for an attorney not a lowly accountant… But like you, I’m sure, I’ve read about the liability for violating environmental laws. And then had trouble sleeping at night.
BTW, I don’t like oil and gas deals. Too many shady characters selling investments that don’t make any money.
In my experience, the best way to limit your liability in such a scenario is to invest in the oil and gas partnership through an entity of one’s own, e.g., a single-member LLC. My family invests in working interests through our family limited partnership–so any potential liability from those investments is limited to the assets of the family LP. If we were really paranoid, we might have the family LP create a single-member, single-purpose LLC for each working interest investment (with the LP being the single member). These convoluted corporate structures can be more or less effective depending on the state of incorporation and the location of the the project (I’m in Texas and so are the working interests).
Thank you for your insight here. People invest in these partnerships so there must be a way to do it. Presumably investing in them via an entity still allows the pass through of the front-loaded tax credits.
The other aspect of your comment that rings out for me is that your state really matters. In California, the courts would be delighted to toss out the single-member LLC at the least provocation. But in Texas, I would expect that these legal protections would be respected.
Dare I ask how you found the working interests in the first place? My guess is that they came to you from some trusted personal source rather than from a financial product salesman.
In general, the tax treatment is still favorable. The specifics can be dependent on state law.
Yes, the working interest we have is the result of a personal connection. However, we would not invest in one again, regardless of the source. A very close friend who owns an oil and gas company told us at the time we invested that working interest investments are a terrible idea for anyone who is not in that business, and he recommended against the investment (he was right). The risks are high and many, even when you can trust the operator, which is far from a certainty.
For most investors, a royalty fund is a better way to invest directly in oil and gas wells. With royalty funds, you can capture the upside from investing in oil and gas wells but without the unlimited liability. However, like working interests, royalty fund investments are highly illiquid. [Since that’s the case, I’ve always thought they would be a good substitute for an annuity if you can handle some volatility in the amount of your monthly payments. Granted, I would probably not recommend that strategy to the general public.]
We had terrible timing due to the collapse in oil prices but, to put it in perspective, we have been required to contribute additional amounts equal to about 5-10% of our initial investment, per year, to maintain our working interest. My point is that there are lots of high risk/high reward investments out there without the theoretically endless liability and capital calls that a working interest can entail.
Philip – Off topic, but I wanted to thank you for writing The Affluent Investor. For those of you who have not read it, the book is one of my personal favorites. It helped me solidify how I think about our personal finances. Thanks again. Best wishes!
You are too kind. Thank you!
PS I read this site all the time even though I’m a non-MD because Dr. Jim explains personal finance better than anyone I know.
Phil I also enjoyed The Affluent Investor and your new book Tax Alpha Dog. The books you co-authored with Ben Stein are also classics. I had never heard of Monte Carlo analysis prior to your book with Ben Stein. I have no plans to invest in oil wells or pipelines.
Thank you, Dr. Hatton1! I have been obsessed with taxes lately. I think the big takeaway for physicians is that they are likely to end up with big IRAs as they approach retirement, such that the rising required minimum distributions will force them into higher brackets as retirement goes on. This means they should do long-range tax projections in their 60s to see if they can avoid this.
I totally agree with you (re: large IRAs in retirement) and am so glad you posted this. You have an impressive body of work (where do you get the time???)
Thanks! I’m just an unreformed workaholic.
Yes I see this as a HUGE problem down the road. I am trying to do serial Roth conversions now to decrease this going forward. I am 59 and the rmds worry me quite a bit.
Perfect time in life to be doing Roth conversions.
There are worse problems to have than so much IRA income that it forces you into super high tax brackets. The fact is that a reasonable retirement spending plan is spending your entire RMD.
I just think lots of younger people do not realize that rmd are taxed at ordinary income tax rates not capital gains rates. Also when you get rmds you are also starting social security at 70. All this income will also raise part b rates on Medicare. Tax nightmare.
It’s not a tax nightmare, it’s an income dream if you have a large enough tax-deferred account to push you into the highest brackets. It is an indicator that you have been extraordinarily successful in the financial realm. At age 70 an RMD is 3.6%. Depending on your deductions, your first $20K+ comes out tax-free. Assuming you’re married, the next $19K comes out at 10%. Then you get $56K at 15%. Then another $77 at 25%. Your effective tax rate on that ~$172K of income would be something like 17%. Hardly a nightmare. Yes, it’d be a little worse if you have even more income (passive real estate income, Social Security etc) but that means you have EVEN MORE to spend. How large of a tax-deferred stash do you need to have if you were 70 today in order to have an RMD of $172K? $172K/3.6% = $4.8 Million. Oh if only I and every other doctor could have that problem.
So, is it something to plan for if you have been uber-successful? Sure. Should you do some Roth conversions if you’re in that category? Of course. Should this be some overwhelming worry? Absolutely not.
$4.8 Million may be a far stretch for most physicians unless they utilize multiple 401ks and defined benefit plans over a very long period of time. I think we should look at not just RMDs at 70 but also at 75 and 80 as well. This percentages starts to rise very rapidly and so do the taxes.
Fully agree that this is a good problem to have. The last thing I would want is to pay actuaries fees and accounting fees to fund retirement accounts and save 28% in taxes to find myself later paying 28%. Again very unlikely for most physicians, but I can see examples dual high income earners putting away $100k+ in tax deferred accounts every year for 30 years to find themselves in very high tax bracket during the withdrawal phase. At some point tax deferred accounts are not worth it, and they may be better of investing in taxable or even retiring early to do Roth conversions or simply starting to withdraw from tax deferred accounts.
Right. But people need to understand that people with RMD issues are generally multimillionaires.
I’ve used a CPA for years to do my taxes.
It saves me TONS of hours in time and probably a few hundred dollars (or more) given that they know way more about taxes than I do (and I know a lot).
Money well spent IMO.
+1. I especially like when the IRS sends a letter asking for explanations or questioning something, I just send it to the CPA and don’t stress over it myself.
I also use a CPA. Maybe I could figure out the forms maybe not. Too old to learn now.
Agree with all of these
I have to be honest and comment that CPAs have created more headache than they are worth for me. the 3 CPAs I have worked with had poor communication, made mistakes requiring IRS letters to arrive causing unnecessary stress, as well us double taxing me on backdoor Roth IRAs. Although the learning curve was a tough, actually understanding to do your own taxes has been much less stressful for me in the long run.
My life is actually easier and less stressful without the CPA. Plus I save about $2000 every year. between the S-corp, quarter filings, and personal taxes.
All the info I need to collect and present to the CPA I can just as easily present it to turbotax. Also, since I started doing my own taxes I stopped receiving questions from the IRS requiring more info.
🙁 Sorry about your bad experiences. We’re not all that way, but I don’t blame you for thinking otherwise.
It is a shame because I would have gladly paid someone to make my life easier.
Unfortunately Many of my physician colleagues complain of similar issues with their CPAs. I really wish it was not the case. I’m sure there are amazing CPAs that are terrific with their clients. I wish I can find a CPA I can recommend to my colleagues but I have yet to find one that is honest, timely, and dos not try and sell them some insurance product they don’t need.
Looks like Dr. Mom above gets audits from the IRS requiring answers. If a everything was done appropriately the first time that should never happen.
No audits. Just questions asking for further documentation which was not required on initial submission of return. I don’t feel it was error by CPA to not include something not wanted initially. We have done well with 529’s, so seem to get letters wanting to know the money was for qualified expenses. I also took advantage greatly of the Small Business Healthcare Tax Credit for my husband’s office. They often ask for more documentation there also. We are done qualifying for that one as of last year. Having a CPA we trust has been great. Sorry you have not found one. We got to ours by having him review returns we were pretty sure were wrong years ago. He saved us more than we thought we were due.
Late response so I’m not sure you will see this, but a question letter from the IRS is actually an audit.
Audits are usually not as scary as you see on tv. The IRS is just asking for extra information or clarifying something you submitted.
Pretty high level stuff here. I’ve been through all the various entities over the years (depending on the business and partners involved) and currently have a small business as a single owner C Corp. The HRA (aka MERP => Medical Expense Reimbursement Plan) is easily one of my favorite tax strategies from the past few years. I like being able to keep the HSA fully invested every year regardless of actual medical expenses. About half of our medical expenses from the past three years have been dental (regrettably) which aren’t applicable to our health insurance deductible. There were times when I couldn’t fund the HSA with enough money to pay for all the actual expenses incurred (due to the annual contribution caps), but having the MERP made everything 100% deductible regardless.
I’m slightly amused about your dedication to completing your own tax forms every year. My tax planning sessions with a CPA are well worth the cost. It’s not just just a second set of eyes on the overall numbers or my deep hatred of filling out endless government forms (or fighting with Turbo Tax). Most of these advanced strategies are very nuanced with cost/benefit tradeoffs that often involve guesstimates about the future. I like hearing a professional’s perspective on those things. After making strategic decisions with her, I could care less about punching all that information into the computer and making the correct IRS approved forms come out.
A great analogy is payroll processing. If you’ve ever experienced the joys of preparing and filing payroll forms for even one employee (much less multiple employees in different states), you would have to be a masochist to avoid using a payroll service to save a few bucks. That seems to be the primary motivation for doing your own taxes each year. After deciding on compensation and benefits for the year, I update the payroll service (Zen Payroll nowadays, but recently renamed as Gusto) and never think about it again for twelve months. All the forms are filed at the correct intervals, payroll taxes are withdrawn and sent electronically to the various federal and state agencies, checks are deposited in different accounts every payroll cycle. Doing that myself would be a major error-prone PITA.
Which is the same reason my experienced CPA files our business and personal taxes every year. 😉
A second, and perhaps more important reason to do your own taxes, is to learn the tax code. A third is because you enjoy it. But I confess it becomes less enjoyable each year.
#2 is definitely true and you probably already know my thoughts on #3. No enjoyment there.
I just see a difference between knowing the useful parts of the tax code and having to actually apply it. God knows how many pages it runs nowadays, but there isn’t a human being on the planet who “knows” the entire US tax code. It’s almost endless. Sites like yours (THANKS!!!) are much better for highlighting the things worth knowing about.
More seriously, you mentioned having to file three amended returns in a single year.
I’ve only filed one over the past 25 years with 12+ different business entities and our personal returns. Maybe things changed for you from circumstances outside of your control, but would that have been necessary had the pro put them together instead?
That’s the kind of thing that bothers me using Turbo Tax.
Valid criticisms all.
For the charitably inclined, I recommend looking into Donor Advised Funds (DAF’s). You can think of them as “family foundations for the affluent”. They are offered by community foundations, large brokerage houses (such as Fidelity Charitable), and other organizations.
Contributing appreciated assets to charity (such as appreciated stocks or mutual funds you have held for at least one year) gives you a double tax benefit: (1) you get the full charitable deduction, and (2) you never have to pay tax on the gain. This allows you to contribute significantly more to charity at the same net out-of-pocket cost.
But the logistics of contributing a small amount of appreciated stock to each of many different charities can be daunting. With a donor advised fund, you can contribute a single large amount of stock, then “recommend” grants from your DAF to the charities you wish to support. Fidelity makes this especially easy – you can contribute assets held in a Fidelity account to Fidelity Charitable online with a few mouse clicks, and can recommend grants online.
Another advantage of DAFs is that you can contribute to your DAF in a high income year (hence getting the biggest tax break), then grant funds from the DAF to your charities over a period of years, when your income might be lower or your cash flow tighter. This is especially useful for “pre-funding” charitable contributions when you are working, then making contributions to your charities after retirement.
Also, I rather enjoy doing my own taxes with Turbotax (strange, I know). I run tax “simulations” with Turbotax every December; these allow me to shift income and deductions as needed to optimize my taxes. (I live in California; when I become subject to Alternative Minimum Tax (AMT) my marginal (Federal plus State) rate rises from 34% to 42%-44% – a very significant increase. So, when feasible, I shift the year I pay rental property taxes, and/or make contributions to my donor advised fund, to keep my taxable income near the “threshold” where I become subject to AMT.
(I asked a very knowledgeable tax pro whether doing my own taxes increased my audit risk. He said there might be a small increase; probably not enough to be concerned.)
Great post. A few clarifications on the strategies:
1 – With regard to the Non-Qualified Deferred Compensation plan, you wouldn’t necessarily have to be earning a lot of money in order to deduct what you pay out to yourself in the future. You could convert it to an S Corporation and take it as an operating loss, creating a perfect offset. You would just have to make sure that you don’t run into passive activity loss limitations.
2 – It is possible for a doctor to take advantage of the NQDC. They could, in some cases, form a corporation that is not considered a “Personal Services Corporation” by the IRS if at least 5% of the stock is owned by a non-professional or if. Rules for this are complex and vary by state.
In addition to IRA/401K RMD’s beginning at age 70 1/2, one needs to claim Social Security (85% of which is taxable for most readers of this blog) at or before age 70. This can create some interesting tax planning opportunities. High income professionals may be in a high tax bracket during their earning years, in a much lower bracket from retirement until age 70, then in a high bracket again after age 70 when RMD’s and Social Security start. Others have already suggested making Roth conversions during the low income years. Other potential strategies are to realize capital gains during these years (taxed at a 0% rate if your marginal tax rate is 15% or below); or take early IRA distributions. (Also, Schedule A deductions such as mortgage interest and charitable contributions will be worth less during the low tax bracket years.)
(Another factor: Medicare premiums are significantly higher for those with high AGI’s. It may pay to keep your AGI just below one of the “thresholds” at which higher Medicare premiums kick in.)
So does a regular CPA have knowledge of all the strategies bein discussed here? How does one find a local “tax strategist”?
How do you go about with your advice to : “Decrease Medicare Taxes” ?
The main way to decrease Medicare taxes is to have unearned income instead of earned income. For a doc, that means being taxed as an S corp, either as an S Corp itself or an LLC choosing to be taxed as one. You declare some of your income “salary” (subject to payroll taxes) and some “distribution” (not subject to payroll taxes.) Since you’re not going to declare your salary to be less than $118K (which would be hard to justify to the IRS as a full-time doc), all you save if Medicare tax.
Can someone recommend a good tax strategist who is also CPA? Thank you
https://www.whitecoatinvestor.com/tax-strategists/