The most expensive tax mistake we physicians make is failing to plan. I don’t care how good you and your tax preparer are with a stack of receipts on April 15. If you didn’t know you could rent your home to your business for 14 days as a business expense and keep that di minims income tax free, there’s no way to make that proactive strategy work. To take advantage of the myriad deductions available to businesses as described in the 67,000+ page tax code, we must have a proactive tax compliant strategy. Intrinsic to that strategy is the need to become our own businesses and let the IRS view us as such.
Retrospective vs. Proactive Tax Strategy
Hope is not a strategy. Most tax preparers work by looking backwards and taking the few deductions a non-planned tax strategy allows. They are timid about taking certain deductions since they know their clients don’t have the structures in place to legitimize legal deductions with proper entities and documentation. They don’t spend any time strategizing to protect your future income. They simply are not trained like a tax coach or tax attorney who understands the tax laws in a more profound way.
As a physician, you have two ways to put cash in your pocket: you can earn more, or you can spend less. For most of us, the latter is far easier. Well, guess what — taxes are your biggest expense. We often work until May or June just to pay the IRS! Unbelievable!
Most of us docs just take that as a painful reality. But it doesn’t need to be this way. The smartest approach is to focus on defending our income from the IRS where we physicians individually lose hundreds of thousands of dollars per year. The IRS profits greatly on the naiveté of physicians when it comes to professional tax planning for high-income earners. They even tell us: “taxpayers overpay a billion dollars [or more] per year due to missed income reduction opportunities.” Did you contribute your six-figures last year? Are you sure those dollars are being spent effectively—without waste—for social good?
Proactive tax planning guarantees results. Letting the IRS see you as a business, and operating as a business, allows you to work until March or April to pay the IRS instead of May or June like many of us physicians do (especially the poor W-2 earners).
Philosophy of Business
America was built on entrepreneurialism. Those who spur the economic engine by creating value in society, creating jobs and moving the GDP needle forward are rewarded for their risks and viewed as true patriots. With nine in 10 small businesses failing, risks are high and the government wants to reward entrepreneurs for taking these risks. They do this in the form of a “magical subsidy” that few understand: Tax breaks for businesses.
When you are a W-2 employee, your employer is viewed as the value creator, the economic engine that moves America forward in its own small contributory way. You—the W-2 earner—are viewed as a cog in the wheel. As such, your employer simply takes your taxes out for you in the form of withholding. Most — 99 percent — of the over 67,000 page tax code describes how the employer can deduct everything from travel, to (home) offices, to equipment, phones, computers, vehicles, rentals, workforce and more (even children down to 7-years-old!) As physicians, 1099 income is far superior. As a value creator in society, you can save hundreds of thousands of dollars each year for your business. You can then recycle that money back into your business to help it grow, and get those dollars working for you in the form of passive income. Many savvy, older physicians that I speak with already understand this principle, but sadly, it is so rare to be able to find a proper tax/business/legal team to have on our side like our peers in business, finance, law, and politics do. Physicians are just not networked that way financially, nor do we care about this type of thing in our early, idealistic career years.
How Deductions Work in The Real World
Ultimately, there are two kinds of dollars in this world: pre-tax dollars, and after-tax dollars. Pre-tax dollars are great, because you don’t pay any tax on them; earn a dollar, spend a whole dollar.
After-tax dollars aren’t horrible, they are just worth less. If you go to the store to buy a computer, those dollars may only be worth 60 cents if you don’t plan well. Now imagine extending that out to most of the dollars you spend. You lose every time you spend after-tax dollars that could have been pre-tax dollars. Proactive tax planning turns your dollars into legal, tax-compliant pre-tax dollars that you can then invest, save or spend. The ultimate difference in your financial freedom date and overall wealth accumulation can be dramatic.
Get structured, get a solid tax planning solution, and educate yourself. Stop sending your hard earned dollar to the government by the truckload. Keep more of what you earn, you deserve it.
Dr. Kaufman is an ER doctor in Northern Colorado who is the co-founder of Physician Tax Solutions, LLC - a company partnered with tax attorneys, CPAs, and Tax Coaches designed to provide tax strategies and solutions to physicians.