A very frequent question that I get asked is “How can W2 physicians lower their taxes?”
I believe I get asked this a lot because I am a W2 physician and I also have a keen interest in all things finance. But really, all W2 physicians should care about their taxes.
Remember, taxes are like a negotiation in a way. The government creates the tax code as a series of incentives for taxpayers to do the things the government wants. If you follow these incentives, you are treated better tax-wise.
And I am the first to say that I truly believe our taxes go to some very important causes and has a huge impact on society. But we are only obliged to pay the amount of taxes that we own…not any more. Heck, by saving on taxes you can grow your own personal wealth quicker. But you can also do more good by being able to donate directly to causes that are important to you.
How physicians are taxed
It is very important to understand the different ways that physicians are taxed. And largely this is the same for people in general.
Business owners and employers have a lot of opportunities for tax benefits. Meanwhile, employees have very few opportunities for tax benefits.
This is just the way it is. I’m not saying it’s right or wrong. But it is what it is.
But, with this being said, there are ways the W2 physicians can reduce their taxes. And that is what this is all about.
Because another fact of the matter is that more and more physicians are going the employed route. Rather than starting their own practice. Is that good or bad? Right or wrong? I don’t know. But it is the overwhelming trend.
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.
3 ways W2 physicians can lower their taxes
When you are an employee, your opportunities to lower your tax burden are much less than a business owner.
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% QBI tax deduction.
So, the main strategy as a W2 physicians when it comes to taxes is to reduce your taxable income as much as possible.
This is so important to understand that I am going to repeat it again: For W2 physicians, the main strategy to lower your taxes is to reduce your taxable income.
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, the name of the game is to lower that taxable income as much as possible.
How can you do that? Well, let’s get started!
Side note: Along with these 3 strategies, you will obviously want to make sure you maximize more obvious tax credits and deductions like the child tax credit etc. However, high income earners realize very minimal benefits from these.
1. Maximize tax advantaged retirement accounts
I advocate for a hybrid investing approach. So I 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:
- 529 (Kinda)
I say that a 529 is kind of a tax advantaged retirement account because money goes in post-tax, comes out non-taxed, and grows tax free as long as it is used on education costs for a beneficiary. But in many states, there is a tax deduction for contributions. So it can make sense to lower your taxable income this way if you have children and live in such a state. But remember, if you don’t use the withdrawals for education related expenses, then you get hit with a 10% penalty on withdrawal. So that makes it not worth it in that case.
2. Tax loss harvest
This is a powerful concept.
When your investments in the stock market drop, you can sell them (for a loss) and then buy another investments that is not substantially identical.
Why would anyone do this?
Well, by selling your investment that has lost money, you lock in a loss. But you then buy a similar, but not substantially identical, investment so that 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. If you have more paper losses, these can offset passive gains now or in the future. But it will not reduce your W2 income any more than this $3,000.
But still, this is a good way to further lower your taxes for W2 physicians.
3. 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 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.
Because of this, you want to find investments that include LCEs but also other alternative investments within the same partnership.
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.
However, by combining it with other alternative investments within the same partnership, you create potential residual income from those other investments. This helps to alleviate the argument that the partnership was only created with the charitable deduction in mind.
This can be a significant way for W2 physicians to lower their taxes. But I cannot stress enough that you need to work with someone reputable and who has a lot of experience with this!
Using the above strategies, you can lower your taxable income significantly and instantly reduce your taxes even as a W2 physician.
But you can do way more…
Bonus: Invest in real estate with REPS
Investing in real estate is great for a ton of reasons as laid out here.
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 actually making cash flow.
You can use these passive losses from real estate to offset passive gains. But this does not really help W2 physicians to 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 ton!
You can see more about how REPS works and how we used it to generate massive tax savings in this post about our first investment property.
However, attaining REPS is not totally simple. Selenid did it. But it took a lot of work. It also happened inside of our real estate investing business which allowed us to compound our tax savings even more…
…Which leads me to our second bonus…
Bonus: Start your own business!
I emphasized earlier that employers/small business owners have significantly more ways to reduce their tax burden.
So, become a small business owner!
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 W2 doctor job.
In that case, start a small business for a side gig. Like any of these side gigs for physicians!
When you do this, a whole new world (Aladdin, anyone?) opens up for you tax wise!
Now you can deduct:
- A home office
- Car mileage
- Renting your home out to your business (Augusta rule)
- Business expenses
- Business trips
- Per diems
- And this is just the tip of the iceberg!
This is ultimately what Selenid and I have done with our blog business, our real estate business, and her speaker business. And the tax advantages have been massive.
Most importantly though, less than 3 years ago, we would have thought it impossible for us to start these businesses. It seemed out of reach. But we had unhealthy mindsets.
So don’t limit yourself. If you want to do it, you can! We are living proof!
Here are some of my favorites posts about how we developed our healthy growth mindsets!
- What Is Your Why?
- Sorta Random Sunday: The Fallacy of Not Enough Time
- Sorta Random Sunday: You Need A Who Not How
- And, Sorta Random Sunday: Your Mindset Makes Your Success
What do you think? How have you lowered your taxes? As a W2 physician? How can we do more? Let me know in the comments below!