Tax season is inching closer-Here's everything what physicians should do to prepare.
For the first 20 years of his private internal medicine practice, Marc Leavey, MD, took a pass on funding an IRA and obtaining the tax deduction that comes with it. The cost of raising four children and putting them through college simply demanded too many resources and there was little left for retirement.
“I basically said to myself I didn’t need to worry about IRAs and that it could wait,” says Leavey, who practices with Lutherville Personal Physicians in the Baltimore, Maryland area. “I’m paying for that now. If you’re just starting out, start planning for retirement on the first day you open your office.”
Leavey did see the light in 1995, when he merged the practice into a larger group The group had a 401k plan, and Leavey has been contributing, pre-tax, ever since. Now in his mid-60s, however, he knows his nest egg would have been much bigger had he started saving earlier.
Many physicians understand Leavey’s situation. As next month’s tax-filing deadline looms, however, there are a few steps physicians can still take to affect their 2015 returns, in addition to getting a jump on the 2016 tax year...
This story will also be featured in the March 10 issue of Medical Economics
1. Fund an IRA
“Once the year ends, the books are pretty much sealed except for a few provisions, and one of them is contributing to an IRA,” says Ed Slott, CPA, an author and speaker who trains financial advisers on IRA strategies. “You still have until early in the year to affect last year.”
For 2015, taxpayers can contribute up to $5,500 in a traditional IRA ($6,500 for those 50 and up). Anyone can make these contributions, regardless of whether he or she is covered by a workplace retirement plan, and they can be a good savings vehicle for medical residents or others who fit the income criteria.
Whether the contribution is tax-deductible, however, depends on a couple of numbers. Married taxpayers with modified adjusted gross income less than $118,000 ($71,000 for singles) can qualify for at least a partial deduction if they are covered by a workplace plan. If they aren’t covered by such a plan – say a solo practitioner without a qualified plan affiliated with a practice – then single taxpayers or married ones with neither spouse covered by a plan can get a full deduction regardless of income. If a physician is not covered by a plan but has a spouse who is, the couple can qualify for at least a partial deduction on income less than $193,000, according to 2015 IRS tables.
There is often confusion around whether contributions can be made to IRAs if someone has a 401(k) plan at a job, Slott says, so be aware that it is only the deductibility of the contribution that can be affected by 401(k) access.
2. Deduct equipment purchases
If a physician bought or leased equipment last year – or is planning to in 2016 – they should be aware that Congress in December made permanent business expensing under Section 179. The provision allows businesses to accelerate the deduction of the cost of equipment in the year of purchase, rather than over time. The bill was designed to encourage business owners to invest in new equipment, effectively lowering the sticker cost of a major purchase.
3. Double up to get ahead
Most taxpayers wait until April to make their prior-year IRA contributions, but Slott recommends making a 2016 contribution this year as well. “The better move is to fund the year prospectively. You can wait until April of 2017, but then you’re back in the same rut of not maximizing the tax deferral. Once you double up one year, then you’re ahead.” The earlier that contributions are made, he says, the longer the investments will have to compound before retirement.
4.…Unless you can’t
If you save for retirement in an IRA geared to small businesses, such as a Simplified Employee Pension Individual Retirement Arrangement (SEP-IRA), you may need to wait until early the following year to know how much of a contribution you can make. “It’s best to wait until you know your income for certain,” Slott says. “You can go back and fix excess contributions if necessary, but it gets complicated.”
Late-career physicians should be aware that in December Congress made a popular tax move involving charitable donations permanent. The IRA charitable rollover allows taxpayers who are at least 70 ½ years old to donate up to $100,000 from their IRAs directly to charity without including it in their taxable income.
By making the move permanent, taxpayers who don’t need their required minimum distribution (RMD) for income can devote their entire RMD to a charitable cause early in the year, Slott says, knowing that it will all go to a favorite charity. In previous years, Congress has tended to approve the deduction very late in the year, which meant that many people had already taken their RMD as income, even if they didn’t need the money, so any charitable donations weren’t satisfying the required distribution rules. Even physicians in their 60s should start thinking about this possibility now, experts say. Those years are often a time when people make decisions about large gifts to charity, but knowing in advance that a favorable tax treatment will be available could certainly make a difference in the timing of gifts.
6. Make a mistake? There’s a do-over
Savers who converted money from a traditional IRA to a Roth IRA last year may be regretting that move in light of this year’s early stock market declines. Take the example of someone who converted 1,000 shares of mutual fund ABC from a traditional IRA to their Roth IRA last year. At the time of the conversion, the share price was $10, so the saver would owe income taxes on $10,000 that was transferred from one account to the other. Then, as market volatility spiked in the new year, those shares might now be worth just $8 each. Even though they are now worth just $8,000, the saver will owe income taxes on the original $10,000 that was transferred. Not a problem, Slott says. By recharacterizing the contribution, taxpayers can undo the move.
“This is one of the great second chances,” Slott says. “You have until October 15, 2016, to undo all or any part of a 2015 conversion. It’s like betting on a horse after the race is over.” Keep in mind that an amended tax return may need to be filed, however. So should physicians just wait until late in the year to see how markets perform before making a conversion? Slott still generally recommends making the conversion earlier in the year rather than later because getting the money into the Roth sooner means more time for tax-free growth (Roth contributions go in after tax, but grow and are withdrawn in retirement tax-free). Physicians can try to market time a conversion, of course, but in typical markets it may not be worth the hassle, Slott says.
7. Start early
Sometimes, a medical practice’s accountant needs a nudge to do more tax planning during the year rather than waiting until tax preparation the following spring, says Joel Greenwald, MD, CFP, a financial adviser to physicians in the Minneapolis, Minnesota area. He sends his clients’ accountants estimates before year-end on income, taxable gains and losses, and any major status changes. “We’re trying to prompt the CPA to be more proactive, and they often find some good ideas. I have a client who took a year-long sabbatical, so we alerted the CPA about doing a Roth conversion in that year with no income. Then the accountant suggested taking some capital gains that year,” he says. “If we had waited until February to talk, we would have missed the opportunity.”
Waiting until the very end of the year to do tax planning is problematic for other reasons, says Ike Devji, JD, a Phoenix, Arizona-based tax attorney. “Many physicians want to swing into action the last month of the year on something they’ve ignored for 11 months,” Devji says. “Advisers take holidays, too, so you’re either going to get help from someone trying to squeeze too many people into the last few weeks of the year” or from someone who doesn’t have much business, both of which can lead to bad outcomes, he says. Year-end is also a time when tax scammers prey on physicians with fraudulent “last-minute” schemes, but the physician isnin such a hurry to beat the tax deadline that common-sense due diligence is overlooked, he says.
Financial institutions processing end-of-year requests for retirement plan contributions can also become overwhelmed and make mistakes, Slott says. At the very least, physicians should keep records of the transaction to prove the request.
8. Check for errors
Greenwald says he discovers a surprising number of clients who previously were not maxing out their retirement plan contributions, not because they couldn’t afford to, but because they didn’t realize they were leaving money on the table when a plan provider failed to withhold salary up to the full dollar amount allowable. “Either there was a plan mistake or a vendor changed and there was a slip-up,” he says. “It happened a few times so now we check all of our clients’ contributions each year.”
9. Consider a pension
Physicians are beginning to consider individual defined-benefit pension plans, particularly late-career doctors who may have new income streams from consulting or involvement in a side business, says Greenwald. Annual fees on these plans are typically significantly higher than for IRAs because of the administrative requirements, however, so they don’t make sense for small amounts. Greenwald helped set one up last year for a client with about $70,000 in side income. Start-up fees are typically about $1,500, with ongoing maintenance fees of about $1,000, he says. The upside: The physician was able to shelter about $55,000 of that side income in the pension. And it doesn’t affect contributions made to defined contributions plans, such as 401ks.
10. Shelter a windfall
Another way to avoid a big tax hit on extra income this year is to open a donor-advised fund to hold charitable contributions. Greenwald did this for a few physician clients in 2015 who had unplanned increases in income. Donors contribute to a donor-advised fund held at a financial institution, take a tax deduction for the year the gift was made, but then can determine later which charity will receive the funds. As with other charitable giving tax moves, this one makes sense only if a client is charitably inclined, he says.
11. Fund a college savings plan
Funding a 529 college savings plan also can be a place to park additional income this year, experts say. In addition to a potential state tax deduction for the year the money is contributed, there are estate-tax breaks. A total of five years’ worth of maximum contributions for gift-tax purposes can be made in a single year, allowing each spouse in a married couple up to $70,000 in contributions for a single beneficiary.
12. Watch out for scams
Particularly around tax-filing season, physicians are routinely pitched with tax-saving strategies that sound – and are – too good to be true, says Devji. Among the most popular scams doctors are pitched is the use of complex trusts with names like “Admiralty Trust,” he says. Often these are accompanied by non-disclosure agreements made to convey an air of exclusivity to a client, when in fact they are designed to protect the sellers from prosecution, he says. Greenwald agrees. “Whenever a client tells me about an offshore or complex trust opportunity, I refer them to an attorney for a second opinion,” he says. “Every time they have done that they end up not taking the opportunity because of the hassle and expense.”
13. Consider a new IRA
If a SEP-IRA is right for a physician’s situation, it can be set up for 2015 anytime before the tax-filing deadline for the practice, including extensions. Other types of plans for small businesses, such as a Solo 401(k), need to be established by year-end.
Finally, even though it won’t mean a deduction now, Slott recommends contributing to a Roth IRA to diversify tax liability in retirement. Physicians with incomes exceeding $193,000 if married or $131,000 if(single can’t contribute to a Roth, but they can contribute to a non-deductible IRA, then convert that IRA to a Roth IRA later on. The couples’ income limit also applies to spousal IRAs, but taxpayers who find themselves below the thresholds should take advantage, Slott says.
Diversifying retirement accounts by their tax status creates options in retirement, he says. For example a physician who retires in her 50s and has all of her retirement money in a regular (pre-tax) IRA, won’t be able to access the funds, generally, until age 59 ½. On the other hand, money from Roth IRA contributions (other than earnings) can be withdrawn any time, subject to a few rules.
A Roth IRA also provides flexibility in managing tax brackets in retirement, experts say. Taxpayers in the 15% tax bracket with $75,300 or less in taxable income this year, for example, might pull just enough from traditional IRAs so as not to jump into the next-higher bracket. If they need more income, they can take what they need from Roth IRAs, which aren’t taxed at distribution, or from other sources, such as home equity.
Having the diversification of a Roth account is so valuable, in fact, that for some clients Greenwald suggests it might not be beneficial to recharacterize them this year given the recent stock market declines, even if it means paying slightly more taxes because the accounts were worth more at the time of conversion than they are today.
“Sometimes the timing is just so good that it just doesn’t justify” a recharacterization, he says. A physician taking some time off who falls into a lower tax bracket for a year or two, or who retires later in the year and thus will be in a lower bracket because of the loss of income, or just retires and has not yet started collecting Social Security or other income withdrawals for a few years all might be candidates for keeping the conversions intact, he says.
“We’re not undoing many of these because it’s such a great tax situation that some clients are in,” he says. “We’d rather not lose a year of conversions unless there is a more dramatic drop in the market.”