Tax time is coming up. And unfortunately taxes are one of those topics that we as doctors just don’t learn a ton about. And while taxes are mandatory and, in my opinion, necessary, it doesn’t mean that we need to leave the government a tip. It therefore makes sense to improve our understanding of how taxes work. More specifically, how to maximize tax deductions as a physician.
This is obviously a huge and very nuanced topic.
As such, I asked Alexis Gallati, founder and CEO of Cerebral Tax Advisors and my personal tax advisor, to share her knowledge with us. Specifically, she was asked a ton of questions about how doctors can best maximize taxes. Her answers are widely applicable and her strategies have saved Selenid and me thousands of dollars in taxes.
Let’s dig into this juicy Q&A!
For reference, here is our tax plan that Alexis helped us design!
What is the #1 way that a physician can maximize tax deductions and credits?
My favorite strategy is retirement.
It is definitely a low-hanging fruit. And it’s a way for you to build your wealth, put money aside, especially as physicians. When you go from that very meager resident income, then you go to an attending income or private practice, retirement is one of the best ways to sock money away. Especially when you’re young to have that tax-free growth.
I find a lot of physicians retire or start at least slowing down by late fifties, early sixties. And so you have a good 10 year or so period before you’re required to take retirement distributions. So that’s the time when you can start doing Roth conversions. Then that money can be growing tax-free and come out tax-free at that point as well.
I know there are a lot of people out there that have heard about the backdoor Roth. This is a really great way to not necessarily save tax in that current year because you’re putting money in as post-tax dollars, but what you’re able to do is put that money into the Roth, let a grow tax-free, it comes out tax-free.
But you have to just realize that if you make too much, then you need to do it the backdoor way. That’s obviously an IRA. And if you have your own business then you can set up a solo 401K or a defined benefit plan to really go and increase your retirement savings. This allows you to save taxes because those are pre-tax deductions.
How does the backdoor Roth IRA compare to a SEP IRA or solo 401k?
The reason why I brought up the backdoor Roth was because a lot of people are like, “Oh, should I do a SEP IRA or should I do a solo 401K?” Well, with the SEP IRA, you’re not able to do tax-free Roth conversions. So what we need to do is keep you in a 401K that doesn’t have that same limitation in terms of pro-rata rules.
So I hardly ever recommend a SEP. The only time that I recommend it is if I have a client that comes to me after December 31st and they want to make a retirement contribution. Then we’ll say, “Hey, let’s open up that SEP, let you make that retirement contribution based off your 1099 income. And then we can go and set up the solo 401K and roll over that SEP IRA into the 401K.”
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By far, my specialties come with retirement and also that multi-state taxation. And especially with the retirement, there’s so many intricate details between the different types of retirement plans. Let’s say the practice that has employees, you have to offer those employees that same plan. So there are so many different hoops that you have to get through.
Can a physician use their kids to maximize tax deductions?
One of my ultimate favorite tax planning strategies are hiring your kids to your practice.
It’s an amazing way to shift income to their lower tax bracket. This allows you to save for their retirement. You can put that money right into a Roth IRA, you’re able to put that money just into savings for school or tuition, and you’re also able to just use it for after school activities.
So basically, it’s again a way for you to get a deduction for them working for you. The court tested age is seven. There are a lot of people out there that are like, “Hey, my kids are models for my website,” or something along those lines. Yes, but nowadays with iPhones and being it’s so easy for you to take pictures, unless your child is going and doing other modeling gigs, it’s more difficult to justify, a let’s say $6,000 salary just based off of modeling. And they say $6,000 because that’s the contribution limit for Roth IRAs.
Further, the court tested age for kids to be working for you is 7. You just sometimes have to get creative depending upon their age and their skillset.
What about cash balance plans?
So you can actually start a cash balance plan with this little about $50,000, $60,000 of gross revenue. An actuary actually calculates it. What they take into account is how much you make, so your compensation, and then your age, whether you have employees, and then a few other factors. But in general what happens is you need to keep it open for five years. And you need to fund it for a minimum of three years.
What’s great about it is you are usually able to put in a ton more than you would with just a 401K. So with the 401K, the basic calculation is about 20% or 25% of your compensation or profit, depending again on the entity. But if you are, let’s say like 35 or 40, it’s easy for you to put away about $75,000, $100,000 a year into retirement. Where the solo 401K limits you to that 20% or this year it’s $61,000, whichever is less.
So you’ll need to be aware, if you want to put more away, you can. But there’s also additional planning involved as well depending on the type of entity that you’re in. So even with that $50,000, $60,000, what you do is you put away, let’s say $100,000 of retirement. That ends up creating a loss, and then that loss can be deducted against your ordinary income.
And who administers the cash balance plan?
Unlike a solo 401K just by itself, if you have the 401K and a cash balance plan together then, or just a cash balance plan by itself, you have to use actuaries or a third party administrator to actually create the plan and to administer the plan for you. Now a lot of people are like, “Oh, well there’s extra costs.”
Yes, it’s a more expensive type of plan, but the benefits greatly outweigh the cost in terms of tax savings. And so that’s why it’s important though to run the numbers. To make sure if there’s a good cost benefit there.
Let’s talk now about using your home & car as a physician to maximize tax deductions?
Another really great strategy is the Augusta Rule. And this was named after the golf tour, the Masters in Augusta, Georgia. There would be people that rent out their homes for 14 days or less, basically the two weeks that the masters are there. And the IRS says, “Well you don’t have to pay tax on that rental income if it’s for 14 days or less in your personal residence.”
Now you’re thinking, “Well how does this apply for business people?” Well what you can do is apply it to your business as your business can rent your personal residence for 14 days or less, it does not have to be consecutive.
It can be one day a month for a monthly corporate meeting, and you’re able to go and take a deduction for the business for that rent, has to be reasonable rent, but then you as the individual do not have to pay tax on that income. So it’s an extra way that if you’re already using your home for having company parties or again those corporate meetings for yourself, then that’s an extra deduction you’re able to do.
Home office deduction
With your home office, it’s just the business portion of use. So let’s say 1,000 square foot house and you use 1,00 square feet for business, then you can take 10% of the expenses associated with the house, like the depreciation and the utilities, the security system, et cetera. And so property taxes, mortgage interest, and so you’re allowed to do that. And most of the time what my clients will do is they’ll have their office in the home because they’re using it for administrative purposes.
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So Jordan is doing all of his work in your home office for the Prudent Plastic Surgeon. And since he’s using that for business purposes, we’re going to go and take a portion of your home expenses based on that square footage of the home.
And even if you have, let’s say that you’re a physician and you have a side gig doing telemedicine for example, or you do have your own private practice. But you have an office in your home that you still read images in or you do the books for the business at the house, then by all means you can take that deduction. You just have to make sure just with anything that you’re properly documenting it.
And then when you have that home office set up, you can count the mileage from that home office to the hospital, when doing between hospitals or going to a clinic that’s way outside of town. You’re allowed to go write off that mileage as well. Same sort of concept, if you used your vehicle for 80% business, you can write off the tires, the maintenance, the car washes, the lease payments, the depreciation if you fully own it.
You can write off actually the full purchase of the car too. This is depending on whether you use it for 100% for business. So you just have to make sure you’re keeping track of those things. That way you can substantiate your reduction.
How can we use real estate as a physician to maximize tax deductions?
Real estate is a big topic in terms of education for physicians.
Because a lot of you are bombarded with, “Hey, get into real estate and have things covered and you can take all these deductions and credits and blah, blah, blah.”
Well, the problem is that you have to actually be a real estate professional in order to take those losses.
In a normal situation, since you guys end up making too much money, those losses that occur from depreciation or any other expenses that occur for that rental are passive losses. And that’s because you’re not active in the business. That’s how the IRS normally treats rental properties. And so those losses, you don’t lose them. They just carry forward until you either have passive income to put against it or you sell the property. So what some taxpayers can do is qualify for real estate professional status.
And that doesn’t necessarily mean you have to go out and get your real estate license
What that means is you have to be spending more than 50% of your time doing real estate activities, and you have to be spending about 750 hours a year doing those real estate activities. So there’s a huge hurdle you have to jump. And if you’re a full-time employee, it’s very difficult to do. And so a lot of times if you have a spouse, that spouse can end up qualifying or if you start looking at short-term rentals, which can … as long as the average number of days of rent is about seven days or less, then you can qualify those short-term rentals to be active and then those can go against your income just like you would if you were a real estate professional.
Wrapping things up
Taxes are a huge and very important topic for physicians to understand. Whether you are a 1099 physician or a W2 employed physician.
By maximizing deductions that you are already using as a physician, you can reduce your tax burden significantly. This keep score of your money working for you and accelerates your path to financial freedom!
Here are some additional resources related to taxes for doctors:
- 3 Important Things to Know About Our Progressive Tax System
- 5 Important Tax Tips for Physicians
- 5 Ways W2 Physicians Can Lower Their Taxes
What do you think? Have you developed a tax plan? How do you maximize your tax deductions and credits as a physician? Let me know in the comments below!