Generally, doctors make a substantial amount of income but often face high tax burdens due to their earnings falling into the top tax brackets. The US tax system is tough on high-income individuals, such as doctors. Without proper planning, a portion of their income can be lost to taxes.
However, if doctors can leverage smart tax-efficient strategies, they can reduce their taxable income while increasing savings for personal and professional growth. Here's a guide to wealth management for doctors, highlighting key income strategies to keep more of what you earn.
Choosing the Right Business Structure
One of the first and most important things you can do to make your income more tax-efficient as a private doctor is to choose the right business structure. Typically, doctors in private practice can choose between different structures such as sole proprietorship, S Corporation (S-Corp), or Professional Limited Liability Company (PLLC). The type of business structure can affect tax outcomes. For example, an S-Corp provides several benefits, including the ability to split income into salary and distributions. Keep in mind that distributions are generally not subject to self-employment taxes. This can have a huge impact in helping you reduce your overall tax liabilities.
You can also consider operating as a Professional Limited Liability Company (PLLC), which offers a balance between liability protection and tax flexibility. Operating as a sole proprietorship can also provide certain tax efficiencies. This is especially the case for smaller or newly established private practices.
A key benefit is the simplicity it offers. As a sole proprietor, your business income and expenses are reported on your personal income tax return. This means you can eliminate the need for separate business tax filings, helping make your overall income more tax-efficient.
Charitable Contributions
A great way to have more tax-efficient income while also supporting community needs is to have more tax-advantaged charitable donations. To accomplish this goal more effectively, there are a few key factors to consider.
Rather than opting to simply write a check to a preferred charity, physicians might explore the option of donating appreciated stock to a donor-advised fund (DAF). A donor-advised fund (DAF) offers several compelling benefits, including an immediate tax deduction for the full value of your donation and the ability to avoid paying capital gains taxes on the appreciation.
For private doctors who are over age 70 1/2, making qualified charitable distributions (QCDs) from an IRA can also help reduce the income tax burden. A QCD lets them give up to $100,000 a year directly to a qualified charity, with the amount excluded from taxable income. This is especially helpful for those required to take minimum distributions (RMDs) but don't need the additional income.
Income Splitting with Family Members
Income splitting with family members is a creative yet practical strategy that private doctors can use to reduce their overall tax burden. Can you split income with family members? Yes, you can. It works by distributing income to family members who are in lower tax brackets, resulting in lower overall tax liability for the household.
This approach can be particularly advantageous when family members, such as a spouse or children, are employed within the medical practice in legitimate roles.
Is income splitting with family members legal? Yes, income splitting with family members is legal, provided it’s done correctly and in compliance with tax regulations. The key to ensuring legality is to maintain transparency and follow proper guidelines.
Maximizing Retirement Contributions
Another income strategy to consider for private doctors is to maximize their retirement contribution. This strategy is especially relevant for doctors who are actively planning for their future financial security.
Private doctors have access to a variety of retirement plans that allow substantial contributions while reducing taxable income. For example, you can consider the Solo 401(k) plan or the Simplified Employee Pension Individual Retirement Accounts (SEP IRAs). Both plans are excellent options for self-employed professionals, such as private physicians.
With a Solo 401(k) plan, you can contribute as an employer and employee, maximizing high annual limits and maximum tax-deferred savings. Similarly, SEP IRAs are designed for small business owners and allow contributions based on a percentage of income. As a private doctor, you can use this benefit for added flexibility as your earnings fluctuate.
You can also consider a defined benefit plan, which is a type of retirement plan that enables high-income earners, such as private doctors, to contribute much larger amounts compared to other tax-advantaged retirement accounts like 401(k)s or IRAs. If your goal is to accelerate retirement savings while minimizing tax burdens, a defined benefit plan could be the perfect tool in your financial strategy.
Utilizing Health Savings Accounts (HSAs)
One effective strategy for private doctors to reduce their tax liability is to leverage Health Savings Accounts (HSAs). HSAs are tax-advantaged accounts designed to help individuals save for qualified medical expenses. Using this strategy can allow doctors to set aside pre-tax dollars for medical expenses while also serving as a financial planning tool for patients.
As doctors often fall under a high tax bracket, reducing their taxable income can result in substantial tax savings. An added benefit of this strategy is that funds in an HSA grow tax-free, and withdrawals for eligible medical expenses are also tax-free. Doctors can use HSAs not only to cover immediate healthcare costs but also as a long-term savings tool, as unused funds roll over year after year and can even be invested to grow over time.
Leveraging Tax-Deductible Expenses
There are also other methods to reduce taxable income for doctors in private practice to keep more of their hard-earned income. By claiming qualifying business and professional expenses, they can significantly lower their taxable income.
For example, costs like office rent for the private practice, medical equipment, staff salaries, malpractice insurance (which can be expensive), and continuing education are often tax-deductible. Even professional memberships and licensing fees can usually be written off, which is a nice break since these costs can add up quickly.
You might be wondering, if all these expenses are tax deductible, then there must be a catch. Well, there isn’t one. However, you must understand and navigate the rules around them. Unfortunately, not all expenses are automatically deductible. The qualifying expenses must meet criteria set by tax laws. For instance, the expenses need to be "ordinary and necessary" for running the practice.
This means reasonable expenses that are typically incurred in running a similar private practice. Misinterpreting these guidelines could lead to deductions being disallowed and, in some cases, even trigger an audit.
It’s worth keeping in mind that you don’t want to reach a point where your private practice tax deductibles are impacting your eligibility for certain loans or lines of credit. Lenders often look at net income when assessing creditworthiness. So, make sure your strategy to leverage tax-deductible expenses doesn’t backfire.
Invest Tax-Efficiently
Along with tax-advantaged retirement accounts, you may have other options to invest your income for tax savings. Municipal bonds are great for saving on taxes. These bonds are issued by the state or government, offering savings for high-income earners, such as doctors. The interest on these bonds is typically exempt from federal income taxes, which is the bulk of taxes you would owe as a private doctor.
In some cases, you may also get exempted from state and local states if you reside in the bond’s issuing state. While municipal bonds generally offer lower yields compared to taxable bonds, the after-tax returns often make them a more lucrative option for high earners.
Another option for you is to consider real estate investments. While this type of investment requires a more substantial investment amount, it can be a great way to build wealth and minimize tax liabilities. Doctors can take advantage of depreciation, a non-cash expense that allows them to deduct a portion of the property’s value annually, effectively reducing taxable income.
If you plan on diversifying your real estate investments, you can also consider a 1031 exchange, which allows you to defer capital gains taxes (that can be substantial) by reinvesting the funds from the sale of one property to another. A key requirement for this is that both properties need to be “like-kind” properties.
If mutual funds and real estate don't sound appealing to you, you could also have the option of index funds and exchange-traded funds (ETFs). These investments are considered tax-efficient because they typically have low turnover rates, meaning there’s minimal buying and selling of assets within the funds. This means you can enjoy tax efficiency, diversified investment exposure, and the flexibility to tailor your portfolio to match your financial goals.
While there are many strategies for you as a private doctor to reduce the income taxes you pay, you need to ensure you’re following the law and don't make any mistakes that result in fees or charges that offset the benefits. Therefore, it’s best to seek assistance from a professional tax consultant or financial expert in wealth management for doctors. They can assess your case and guide you on your best options to make your doctor’s income more tax-efficient.
