After the tax increases of recent years - 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. Here are five creative ways to legally reduce your tax liabilities.
As a dermatologist, do you realize that, after the tax increases of recent years - 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? 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, early in the year when you can best take advantage of them. 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:
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 now and in the near future, as federal capital gains and dividend rates now reach 20% for some taxpayers (where they were 15% before) and the Affordable Care Act 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.
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
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.
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.
The authors welcome your questions. You can contact them at (877) 656-4362 or through their website www.ojmgroup.com.
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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. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.