By The White Coat Investor
As promised yesterday, today I'm going to do an in-depth review of Advanced Tax Planning for Medical Professionals by Alexis E. Gallati, EA, MBA, MS Tax, CTP. Alexis is a blog sponsor and sponsored WCICON20, where she was passing out free copies of this great little $25 book. I took a copy, thumbed through it, and thanked her for writing it so I didn't have to. I still feel the same way after reading most of it. For those of you who have been waiting years for my often-promised tax book, here it is. The best part about it is that I learned a few things. I've read a lot of financial books. I'll be honest when I say I don't learn much from most financial books I read these days. So when I am actually learning some cool new things, that's a pretty good sign. And if I learned a few things, chances are good that you will too.
Alexis didn't lay the book out the way I imagined I would have, but in the end, I really like the way she did it. This is not a guide to how to complete your tax forms. It doesn't talk about the 1040 and all its schedules. It's a guide to tax reduction and it is logically divided up into categories of how to do it. Chapter 1? Business entity selection.
Tax Tips from the Business Entity Chapter
If you're an employee with no plans to ever own any sort of business, I suppose you can rapidly skip through most of the book. It'll mostly just make you feel bad. There are a few pearls there for you, but since owners qualify for far more deductions than employees, a book on deductions is going to lean heavily toward those in an ownership situation. Frankly, I'm a big fan of ownership and controlling your work environment and so apparently is the IRS. There are far more tax saving options available to business owners than employees, from the simple stuff like being able to write off legitimate expenses that your employer doesn't cover to the 199A deduction, larger retirement accounts, and the Medicare tax savings from an S Corp.
One tip I learned about was that if you are in a partnership with your spouse and you live in a community property state (AZ, CA, ID, LA, NM, NV, TX, WA, WI), instead of filing as a partnership tax return (Form 1065) you can simply file as a Qualified Joint Venture. Way better to fill out two Schedule Cs than one Form 1065 I assure you.
Another item I learned, or perhaps I knew but never connected, was that you can't deduct C Corp losses on your taxes. The corporation can't send you a negative dividend. But if you're a sole proprietorship, partnership, or S Corp, all pass-thru entities, you can. Now I hope that doesn't apply to too many of us, but it is yet another disadvantage that should keep most docs from choosing that entity.
Alexis also reminded me that S Corps are much less frequently audited than sole proprietorships, a nice little bonus. However, I also learned that some states don't really like S Corps very much. For example, AR, NJ, and NY require a separate form to be filled out to elect S status. DC, NH, TN, TX, and NYC don't recognize S Corps at all. Other states charge a special tax to S Corps including AL, CA, IL, OH, RI, PA, and WA. Now I don't know how much all this matters, since S Corps don't save you any state tax money (it's really all about those federal payroll taxes) but it is an additional hassle and potential cost in those states.
The chapter was one of the more comprehensive to the tax consequences of entity selection I've seen and goes from soup to nuts, even explaining how to close down your corporation.
Turning Your Medical Practice into a Family Affair
Chapter two covers all kinds of interesting tactics, but again for the business owner. In this chapter, she introduces the concept of income shifting. There are lots of interesting ways to do this that could work in your situation:
- Hire your kids (Not sure what they can do? Check this list out.)
- Hire your parents
- Give part of your business to your parents to help support them, then you get it back with a step-up in basis when they die. Clever eh?
- Sell or give property away, then lease it back.
There is a big long section on leasebacks here. There can be income shifting, tax, estate planning, and asset protection benefits involved in these sorts of schemes. The business can get a bunch of needed cash (if sold, not gifted) along with the deduction for the rent payments. Plus it no longer owns the property, which is important if the business is in financial trouble. Meanwhile, the new landlord has a new source of unearned income that isn't subject to payroll taxes.
Alexis also says that the IRS views age 7 as a reasonable age to start working. Below that, it looks a little funny. I can certainly confirm that from my experience as the government sends me additional paperwork each year asking what my toddler models are doing for all their income.
I also discovered that withholding rules on bonuses are different from regular paychecks. The business has to withhold at higher rates. Now withholding taxes isn't the same as paying taxes, but it can still create cash flow issues.
The one “miss” I found in the book is when Alexis recommends you pay your kids $6,000 more than the standard deduction and have them put it in a traditional IRA. That sounds like a terrible idea to me to take a tax deduction at 10% and later pay taxes at some much higher rate. Far better for the kiddos to use a Roth IRA IMHO.
Is Your Retirement Account Just an IOU to the IRS?
Finally, a chapter that applies to employees and owners alike. I was pleased to see this subject get a ton of attention in the book as it is the biggest tax deduction for most doctors. You get a full 82 pages on this subject covering all the usual culprits we talk about here all the time—401(k)s, Backdoor Roth IRAs, Mega Backdoor Roth IRAs, cash balance plans, HSAs, 529s, SEPs, SIMPLEs, profit-sharing plans, etc. Roth conversions and Roth vs traditional contributions are also covered. She even dives briefly into cash value life insurance, admitting that she and her husband made the same early career mistake I did—buying whole life insurance. Unlike most people who sell it, she actually tells you the loans are tax-free but not interest-free.
One beef I had with this chapter was her assertion that tax rates must go up. Everyone said that before the Bush and Trump tax cuts and guess what? They went down. So I'm pretty careful to try to forecast the future with regards to returns, interest rates, and even tax rates. I also would have loved to see the loss of the Backdoor Roth IRA as a downside to using a SEP and SIMPLE. The chapter would have been improved also by a discussion of how to use more than one 401(k) at a time.
Deductions, Deductions, Deductions
The next chapter gets into a lot of the common deductions that we see. She goes through the self-employed health insurance deduction and the home office deduction. She cautions against deducting the cost of lawn care as part of the home office deduction unless patients or clients actually come to your home. It has apparently been disallowed in the past. She talks about travel and business mileage deductions as well, noting that since the 2018 TCJA passed it is actually frequently more beneficial to deduct actual expenses than just the mileage. Bummer because the mileage is much simpler.
New tip for me here is that if you go on a part business/part pleasure trip, you can deduct that part of your lodging, meals, expenses, etc. that can be attributed to the business portion. But since you had to travel the whole distance even if you only did the business portion, you can deduct the entire airfare.
Alexis spends a significant portion of time discussing having an accountable plan, even for a single-member S Corp. We use this at WCI, allowing us to turn things we buy for the business into deductions for the business. This becomes particularly important when we realize something we bought with a personal credit card is actually a business expense!
I was pleased to see her include the 14-day rent loophole in the book. This is a large deduction for many folks. If you rent your place out for 14 days or less, that income isn't taxable, including if you rented it to your business (but it is a deductible expense for your business). That's a far larger deduction than any home office deduction for most of us. The rule stands for a second home too, but it might be even better if you can get it to qualify as a business. Yes, you lose those 14 days of tax-free rental income, but you can now deduct all kinds of losses, so long as you stay there less than the greater of 14 days a year or 10% of the days the property is rented. And “maintenance days” don't count, so be sure to do some maintenance on all days over 14 per year that you go down there.
Investing Associated Tax Breaks
The fifth chapter is all about investing and its associated tax advantages. Luckily, I learned nothing in this chapter. That doesn't mean it doesn't go into pretty significant depth though. It even includes a discussion of the 83(b) election for stock options, how to decide whether to use an Opportunity Zone Fund or do a 1031 exchange, and when to do a Cost Segregation analysis in addition to all the usual stuff about tax-loss harvesting. It had a nice discussion of Real Estate Professional Status (REPS) but was a little weak on the use of tax-efficient mutual funds and asset location topics. Maybe I'll have to write that book myself after all.
Giving It Away
Chapter six was all about the tax breaks associated with giving to charity. I have a lot of experience here and I didn't notice any significant gaps except that she didn't touch on Qualified Charitable Distributions. That's what second editions are for.
Chapter seven is about advanced tax strategies. I was excited to see which ones she considered advanced. There was more information on segregation studies and conservation easements. She also discusses restricted property trusts (RPT), and there is a discussion of Captive Insurance Companies (CIC) too. I don't really view CICs as a tax play, more like a business cost reduction play in my book. Alexis admits if you're bringing in less than $1 Million, the cost-benefit ratio of both RPTs and CICs are not favorable. She finishes the chapter with some ways to reduce estate taxes, such as a Qualified Personal Residence Trust. New to me was a Tennessee Investment Services Trust, but in the end, it turned out to be just another Domestic Asset Protection Trust, which is available in a lot more states than Tennessee.
Putting It All Together199A deduction, gives a few case studies, and breaks the news to employees that they're pretty much screwed tax-wise once they've maxed out their retirement accounts and HSAs and donated to charity (unless they want to get into the conservation easement game).
Overall, it's the best book I've seen yet on taxes for the high income professional. The investment-heavy The Overtaxed Investor by Phil Demuth fills a few of the gaps in this book, but the combination of the two should provide you a very strong knowledge of everything you can do to reduce your tax burden.
Alexis obviously wrote the book to direct traffic to her firm, but whether or not you hire her, you will find the book useful. If you're looking for a relatively advanced book for your CFE this year and have even a passing interest in taxes, check out this one.
What do you think? Have you read the book? Did you like it? What's your favorite tax deduction? Comment below!