As a physician, do you realize that, after the new tax increases for 2013 — between income, capital gains, Medicare, self-employment and other taxes — you likely spend between 45 to 55% of your working hours laboring for the IRS and your state? That is a lot of time with patients for someone else’s benefit. Given this, shouldn’t your advisors be giving you creative ways to legally reduce your tax liabilities? How many tax-reducing ideas does your CPA regularly provide you? If you are like most physicians, you get very few tax planning ideas from your advisors.
Given these sobering facts, the purpose of this article is to show you five ways to potentially save and possibly motivate you to investigate these planning concepts now, before the end of the year. Let’s examine them now:
1. Use the Right Practice Entity/Payment Structure/Benefit Plans
These areas are where the vast majority of tax mistakes are made by doctors today – and where many of you reading this could benefit by tens of thousands of dollars annually with the right analysis and implementations. Issues here include:
- Using the legal entity with maximum tax/benefits leverage – whether that is an “S” corporation, “C” corporation, LLC taxed as “S”, “C”, partnership or disregarded entity
- Using a multi-entity structure to take advantage of 2 types of entities and their tax/benefit advantages
- Managing the payment of salary, bonus, distribution, partnership flow-through to take advantage of maximum retirement benefits and minimize income, social security and self employment taxes
- Consider benefit plans beyond the typical profit-sharing/401(k) with which most medical practices start and end their benefit planning
2. Don’t Lose 17-44% of Your Returns to Taxes – Explore Investment Managers Who Manage with Taxes in Mind
It is quite well known that most investors in mutual funds have no control of the tax hit they take on their funds. What you might not know is how harsh this hit can be. According to mutual fund tracker Lipper, “Over the past 20 years, the average investor in a taxable stock mutual fund gave up the equivalent of 17% to 44% of their returns to taxes.” 17-44%! Obviously, over 20, 30+ years of retirement savings, losing one sixth to about half of your returns to taxes can be devastating to a retirement plan. Nonetheless, too many physician investors settle for this awful taxation.
While a 17-44% tax bite is awful, these numbers will likely be worse in 2013 and beyond, as federal capital gains and dividend rates now reach 20% for some taxpayers (where they were 15% before) and the new Obamacare tax adds another 3.8% for high income taxpayers as well. Of course, state taxes are an addition to these federal taxes. Such tax increases will only exacerbate the issue.
How to avoid this problem? Consider working with an investment firm that designs a tax –efficient portfolio for you and communicates with you each year to minimize the tax drag on that portfolio. In a mutual fund, you have only “one way” communication – the fund tells you what your return is and what the tax cost is. Working with an investment management firm, you get “two way communication” — as the firm works with you to maximize the leverage of different tax environments, offset tax losses and gains, and other tax minimization techniques. It is not by coincidence that we have two CPAs in our wealth management firm working on these issues with clients.
3. Gain Tax-Deferral, Asset Protection through Cash Value Life Insurance
Above, you learned about the 17-44% tax hit most investors take on their investments in stock mutual funds. Similar funds within a cash value life insurance policy will generate NO income taxes – because the growth of policy cash balances is not taxable. Also, nearly every state protects the cash values from creditors – although there is tremendous variation among the states on how much is shielded.
4. Consider Charitable Giving, Including Conservation Easements
There are many ways you can make tax beneficial charitable gifts while benefiting your family as well. The most common tool for achieving this “win-win” is the Charitable Remainder Trust (CRT). A CRT is an irrevocable trust that makes annual or more frequent payments to you (or to you and a family member), typically, until you die. What remains in the trust then passes to a qualified charity of your choice.
Another effective tax-planning tool in this arena, but little-known among physicians is the conservation easement. Donors may take a deduction for a “qualified conservation contribution” to a qualifying organization. In effect, a taxpayer can donate land for preservation and take a charitable deduction for the value of the land at its “highest and best” use. A valid qualified appraisal is required. The taxpayer can acquire a membership interest in an LLC which owns property eligible for a conservation easement. The taxpayer can then take part in the contribution of the easement and the tax benefits surrounding such a transaction.
This article gives you a few ideas for how to save taxes. For larger practices with $3-5 million or more of revenue, there are additional techniques that could offer significantly greater deductions. These are outside the scope of this article, but are mentioned in the articles on our website and are topics of our free e-newsletter. If you want to save taxes, the most important thing you can do is start looking for members of your advisory team who can help you address these issues in advance. Otherwise, you will be in this same position this April 15th…and next April 15th and the one after that.
David B. Mandell, JD, MBA, is an attorney and author of seven books for doctors. He is a principal of the financial consulting firm OJM Group, where Carole C. Foos, CPA works as a tax consultant. They can be reached at firstname.lastname@example.org. OJM Group, LLC. (“OJM”) is an SEC registered investment adviser with its principal place of business in the State of Ohio. This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. You should seek professional tax and legal advice before implementing any strategy discussed herein.