Between income, capital gains, Medicare, self-employment and other taxes, physicians spend up to 50 percent of their working hours laboring for the IRS and the state. Here are four tax-savings strategies that may help ease the burden.
Doctors, do you realize that -- between income, capital gains, Medicare, self-employment and other taxes -- you spend 40 percent to 50 percent of your working hours laboring for the Internal Revenue Service and your state? That is a lot of time with patients for someone else’s benefit.
Given the significance of this fact, shouldn’t you be looking for creative ways to legally reduce your tax liabilities? How many tax-reducing ideas does your accountant regularly provide? If you are like most physicians, you probably get very few tax-planning ideas from your advisors.
Given these sobering facts, here are four ways to potentially save -- and hopefully motivate you -- to investigate these planning concepts before the end of the year:
1. Choose 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”, or partnership;
• Using a multi-entity structure to take advantage of two 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; and
• Having a game plan in place in the event of federal tax increases.
2. Don’t Lose Up to 44 Percent of Your Mutual Fund Returns to TaxesMost investors in mutual funds have no control of the tax hit they take on their investments. What you might not know is how harsh this hit can be. Over the past 20 years, the average investor in a taxable stock mutual fund gave up the equivalent of 17 percent to 44 percent of their returns to taxes, according to fund tracker Lipper Inc. Obviously, over 20 or 30-plus years of retirement savings, losing one-sixth to roughly half of your returns to taxes should be unacceptable to you. Nonetheless, too many physician investors settle for this awful taxation.
Even worse is what fund investors experienced on April 15th 2009: Many paid significant taxes on transactions within their funds, even though the funds lost 30 percent or more of their values. Is there anything worse than seeing your mutual fund decimated by more than a third of its value and then getting hit with a tax bill on “gains” inside that fund?
How to avoid this problem? Work with an investment advisor to design a tax-efficient portfolio and communicate with you during the year to minimize the tax drag on your portfolio. In a mutual fund, you have only “one-way communication”: The fund managers tell you how the investment has performed and what you’ll owe in taxes. Working with an investment advisor, you get “two-way communication,” maximizing the leverage of different tax environments, offsetting tax losses and gains, and other tax-minimization techniques.
3. Cut Taxes by Protecting Your Practice’s Most Valuable AssetAs a physician, you face malpractice liability as well as general business risks (employee liability, etc.). What you may not realize is that a claim by a patient or employee will likely threaten all of your practice’s accounts receivable, including those you earn. Typically, this is a medical practice’s most valuable asset.
For this reason, physicians implement strategies for protecting their receivables. While the details of the options go beyond the scope of this article, it should be mentioned here that one of these strategies may allow the practice to reduce its income tax burden as well.
4. Gain Tax-Deferral, Asset Protection through Cash Value Life InsuranceAbove you learned about the 17 percent to 44 percent tax hit most investors take on their investments in mutual funds. Similar funds held 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 of the value is shielded.
This article gives you a few ideas for how to save taxes. For larger practices with $3 million to $5 million or more of revenue, there are additional techniques that could offer significantly greater deductions. 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 when tax season rolls around again.
David B. Mandell and Jason O’Dell are principals of the financial-consulting firm O’Dell Jarvis Mandell LLC, where Carole Foos works as a CPA and tax consultant. The authors welcome your questions. You can contact them at (877) 656-4362 or through their website.
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