Strategies for Reducing Your Effective Tax Rate
Posted on February 21, 2017
As winter gives way to spring, many physicians are finding themselves in the familiar position of preparing their tax returns in advance of the April filing deadline. Compounding the stress is the complex tax code. Doctors tend to be among the busiest of professionals, making it a challenge to keep up with all the rules and nuances of tax code.
In short, tax planning is all about using legitimate and legal methods to pay as little in taxes as possible. An effective strategy will do one of the following:
- Reduce your taxable income
- Reduce your actual taxes owed
- Defer taxation to a future year
Reducing Taxable Income
Federal Income tax seems to hit high-income wage earners the hardest. Plus, it gets proportionately higher as income increases. Therefore, a major area of focus in strategic tax planning tends to be reducing taxable income. Unfortunately, many high-income wage earners, physicians included, do not take advantage of the deductions which can reduce taxable income which results in paying more Federal Income tax then necessary. Here is a partial list of items that tend to be available to most wage earners:
- Charitable Contributions
- Mortgage Interest
- Property Taxes
- State Income Taxes
- Student Loan Interest
- Retirement Plan Contributions
- Miscellaneous Deductions: Such as Professional fees that exceed 2% of your adjusted gross income, including legal, accounting, investment, and financial planning fees.
- Capital Losses
- Travel expenses in connection with a job search are potentially deductible.
- Continuing education expenses are potentially deductible.
- Medical expenses above 10% of your adjusted gross income.
- Long-Term Care Insurance Premiums
- Pre-school or childcare expenses paid for your children so that both spouses can work.1
For self-employed doctors and practice owners, travel related to the operation of your practice tends to be fully deductible. However, typical commuting expenses are not. Most business meals and entertainment expenses are only partially deductible. To account for these, you should keep a log noting the amount spent, date, time, place of expenditure and business purpose.2
Note: The preceding list of available tax deductions is only a partial representation. It is not comprehensive and varies from person to person. Please consult a tax professional with knowledge about your specific needs.
Reducing Actual Taxes Owed
In addition to tax deductions, physicians and other high-income wage earners should try to fully leverage all tax credits for which they are eligible. Because tax credits actually reduce your tax bill dollar for dollar, they are even more advantageous than a tax deduction. That said, quite a few tax credits have income caps that make it hard for physicians to qualify.
The following is a partial list of tax credits:
- Higher education expenses
- International or domestic adoptions
- Energy-efficient home improvements (Ex. High-efficiency furnace, Solar power, etc.)
- Each child that you have
- Childcare so that you and your spouse can work
Delaying the Due Date
One final tax planning strategy is to delay the due date on taxes owed for as long as possible. Though this is sometimes appropriate, it can be risky for high-income professionals because they could potentially be delaying their taxes to an even higher bracket later on. Taking advantage of tax-deferred savings vehicles or utilizing 1031 exchanges in a real estate transaction are good examples of the deferral strategy.3
When seeking out a tax professional, it’s recommended to find one willing to meet with you throughout the year to help implement proactive strategies. If you wait until after the year is over to sit down with a professional and dissect your tax situation, your options for reducing your tax burden may be extremely limited.
Many doctors assume that reducing their tax burden can be achieved by finding the right accountant to prepare their taxes, when in reality it’s small changes in the way you live your financial life that can really move the needle. Rules are in place to promote home ownership, business ownership and support for charities to name a few examples. By understanding how the tax code works, you can keep more of what you earn, now and in the future.
- Credits and Deductions for Individuals. Department of the Treasury, Internal Revenue Service. Washington, D.C. : Internal Revenue Service, (January 18, 2017)
- Ike Devji, JD, “Income Tax Deductions Commonly Overlooked By Doctors” (February 18, 2014). http://www.physicianspractice.com/blog/income-tax-deductions-commonly-overlooked-doctors
- Robert W. Wood, “Ten Things to Know About 1031 Exchanges” (January 26, 2010). https://www.forbes.com/2010/01/26/capital-gains-tax-1031-vacation-home-personal-finance-robert-wood.html
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Larson Financial Group, Larson Financial Securities, and their representatives do not provide legal or tax advice. Please consult the appropriate professional regarding your legal or tax planning needs.
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