All physicians should care about their taxes, and it’s very important to understand the different ways that physicians are taxed. Business owners and employers have a lot of opportunities for tax benefits. This includes those who own and run their own practice. Meanwhile, W-2 employees have very few opportunities for tax benefits, and more and more physicians are going the employed route, rather than starting their own practice. But there are still ways for all physicians to reduce their taxes.
A disclaimer: As we all know all too well, tax laws and regulations change ALL the time. So I am obviously commenting based on the current (2022) tax laws. Definitely consult with a tax strategist about your own personal tax situation.
As an employee, as mentioned, there are fewer ways to reduce taxes. For example, you are not able to deduct business expenses. In fact, after the 2017 Tax Cuts & Jobs Act, you are no longer able to deduct non-reimbursed business expenses as an employed physician. You also can’t deduct home offices, car mileage, or take advantage of the 20% qualified business income (QBI) tax deduction. When you do own your practice and function as a business owner, you can deduct all of these things, although the QBI tax deduction does have an income phase out limit that most physician exceed.
If you don’t own your business, there is a main strategy to follow: reduce your taxable income as much as possible. Your gross income is what you make pre-tax, but not all of that is taxed. Your taxable income is your income after all tax credits and deductions have been accounted for. So how do you lower that?
Maximize Tax Advantaged Retirement Accounts
I advocate for a hybrid investing approach and think it is important for all physician investors to contribute to their tax advantaged retirement accounts. When you contribute to a tax deferred retirement account, the money that you put in is not taxed. And that contribution amount is subtracted from your gross income to lower your taxable income. Plus, the money grows tax free. But it is taxed upon withdrawal of course. However, the tax advantages up front are important.
Examples of these types of retirement accounts include:
- 401k/403b
- 457
- HSA
- 529
Deduct with Tax Loss Harvesting
When your investments in the stock market drop, you can sell them (for a loss) and then buy another investment that is not substantially identical. Why would anyone do this?
Well, by selling an investment that has lost money, you lock in a loss. But by then buying a similar (but not substantially identical) investment, you maintain your asset allocation. This way, your loss is only a paper loss. You still own essentially the same investments in the same amount.
Each year, you can deduct $3,000 of these paper losses from tax loss harvesting from your taxable income. Of note: If you have more paper losses, these can offset passive gains now or in the future, but it will not reduce your W-2 income any more than this $3,000.
Invest in Land Conservation Easements
To align with our charitable endeavors, our tax strategist recommended we consider investing in land conservation easements (LCE). This is something you can do as well depending on your risk tolerance. LCEs allow you to invest in land which will be conserved from being developed and provide you a charitable contribution that lowers your taxable income by up to 50% of your adjusted gross income and, thus, lowers your taxable liability.
Please be aware that LCEs are listed transactions and on the IRS’s “radar” for tax abuse. It is important to work with a vendor who follows the rules although those rules have been loosely defined by the IRS. I cannot stress enough that you need to work with someone reputable who has a lot of experience with LCEs.
Invest in Real Estate with REPS
Investing in real estate (REI) is great for a ton of reasons. An important part of what makes REI so great are the tax advantages available to investors. That is because real estate undergoes depreciation which creates large passive losses on properties that in real life are also creating cash flow.
You can use these passive losses from real estate to offset passive gains. But this does not really help W-2 physicians lower their taxes, because it does not offset active income unless you or your spouse have attained Real Estate Professional Status or REPS. With REPS, these passive losses can now reduce your taxable active income by a substantial amount. We used REPS to generate a massive tax savings for our first investment property.
Start Your Own Side Business
I emphasized earlier that employers/small business owners have significantly more ways to reduce their tax burden.
By becoming a small business owner of a side business, you can begin to take advantage of even more deductions. The beauty is that you don’t have to start your own medical practice to do this. You may be like me and be very happy in your employed W-2 doctor job. In that case, start a small business for a side gig.
Now you can deduct:
- A home office
- Car mileage
- Renting your home out to your business under the Augusta rule
- Business expenses
- Business trips
- Meals
- Per diems
- And this is just the tip of the iceberg!
This is ultimately what my wife and I have done with our blog business, our real estate business, and her speaker business. And the tax advantages have been massive.
While you should absolutely consult a tax advisor, there are things you do little by little to bring your taxable income down. If you want to learn more about the tax deductions my wife and I are working with, you can see a full insider look at our complete tax plan.
Taxes are important. And we need to pay what we owe. But, we don’t need to leave a tip! So I strongly encourage you to optimize your own tax plan. Doing so will go a long way to helping you achieve financial freedom.
Do you have other tips for lowering your taxable income? Share your tax hacks in the comments.
Jordan is a graduating fellow in plastic surgery at NYU.
Image by Denis Novikov / GettyImages
