Let's plan for your 2022 taxes.
Taxes are inevitable, but proper planning can protect against an outsized portion of your income going to taxes. Recent changes to the tax code have made some past strategies outdated and new possibilities available. With inflation at the highest it has been in four decades, the need for physicians to utilize these strategies has gained outsized importance.
The first part of developing an effective tax strategy is determining which tax bracket you fall into and how much more you can earn before you move up to the next bracket. Based on experience, most doctors will find themselves paying around 35% and possibly up to 37%. If you have a C-corporation, the tax is a flat 21%, whereas self-employed physicians have a 12.4% and employed physicians have a 6.2% Social Security tax. Physicians should also factor in their capital gains taxes, as well as state income and corporate tax liability.
President Joe Biden has proposed increasing taxes, but legislators are running out of time to make the changes into law before the end of this year. Auer does not believe taxes on the highest earners will rise to the historical high of 94%. Depending on what state you live in and what other taxes you might be subject to, (your tax rate) could very well be into the 60% to 70% range, and that becomes very important when it comes to tax planning.
Doctors should maximize their retirement plan contributions, which lowers their taxable income and moves them to a lower tax bracket. Also consider a Roth conversion, which involves rolling over transferring funds from a traditional IRA or plan funds to a Roth IRA. This maneuver can be done by individuals who own a traditional IRA, a SEP IRA or those who have had a SIMPLE IRA for at least 2 years. It is also available to those with a 401(k), 403(b), or a government 457(b) plan eligible for distribution.
Roth IRA funds can be withdrawn tax-free so long as the funds have been held for at least 5 years and the holder is at least 59.5 years. There is also no lifetime required minimum distributions for Roth IRA owners.
Also considering funding a “back door” Roth IRA and a Mega Roth 401(k) to further lower taxable income. If properly utilized, these can enable physicians to put away an additional $66,000 and lower their taxable income.
When it comes to investments, harvesting capital losses is a good plan, as it can offset current and future capital, plus an addition $3000 a year. However, beware of the capital wash rules that say you cannot buy the same assets, which leads to the initial loss for 30 days.
Physicians should also consider converting W-2 income to 1099 income either in part or entirety. This is helpful, especially if the physician has locum tenens income in addition to their regular job. This also adds the ability to claim business expenses as deductibles.
For those physicians who already have Schedule C/1099 income, consider converting that income to an S-Corporation LLC. This will lower self-employment taxes and reduce the risk of an audit. Based on the most recent published statistics the IRS has provided, generally speaking, if you have a Schedule C income of over $250,000, you currently have about a 2.5% chance of an IRS audit. If you have that same income going through an S-Corporation, statistically, that drops your audit risk down to 0.7%—a fairly significant drop in the risk of an audit, everything else being the same”
With an S-Corporation in place, consider employing family members by putting them on the payroll and assigning responsibilities. This shifts income from being subject to your tax bracket to being subject to their tax bracket.
A physician can also maximize their home office and automobile deductions. There are acceptable ways to do this; physicians should work with a tax planner to ensure they are getting the most out of the vehicle and workspace. Physicians should also consider the per diem allowances for lodging and meals as opposed to the actual expenses.
Finally, physicians should consider making a pass-through entity (PTE), such as an S-Corporation or partnership, to pay individual state income taxes at the PTE level, which enables the clinician to deduct the cost of that tax dollar for dollar. This is available in 40 states.
Mr Auer is the president and founder of Physician Tax Solutions.
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