134. Tax Secrets Every Doctor Should Know

Navigating the complexities of taxes can be daunting, especially for medical professionals with unique financial situations. From maximizing retirement contributions to understanding the benefits of Health Savings Accounts (HSAs), strategic tax planning is essential. In this episode, we explore various tax strategies that physicians can leverage to optimize their financial outcomes. Finally, we delve into practical tips for managing multiple income streams and setting up your business on the right side of the IRS.

Guest Bio: Alexis E. Gallati is the founder and Lead Tax Strategist at Cerebral Tax Advisors, Cerebral Wealth Academy, and the author of the book Advanced Tax Planning for Medical Professionals. She has over 20 years of experience in high-level strategic tax planning and multi-state tax preparation and has trained at the highest level, holding two master’s degrees. Alexis grew up in a family of physicians and is married to a private practice physician. That’s why she understands how hard medical professionals work to get where they are and why she provides simple and accessible tax solutions tailored to busy physicians.

Mentioned in this episode

• 1-On-1 Coaching is the fastest way to get unburnt and unstuck. Check out our Coaching FAQ Page
• Our free resources address common pain points of medical practice. Learn More Here

We Discuss:

Maximizing Retirement Contributions

• Many physicians overlook maximizing retirement contributions through employer-provided plans, missing out on potential tax savings.
• It’s important to read the fine print of employer-provided retirement plans to ensure full utilization.
• Health Savings Accounts (HSAs) can be used similarly to retirement accounts for tax advantages.

Understanding 403b and 457b Plans

• Nonprofit hospitals may offer 403b and 457b plans instead of 401k plans.
• Maximizing contributions to both plans allows for double the usual retirement contributions and can result in substantial tax-deferred savings.
• In 2024, $23,000 is the maximum contribution to 403b and 457b plans.

Why Health Savings Accounts (HSAs) are Tax Advantageous Compared with Flexible Spending Accounts (FSAs)

• HSAs act like pre-tax IRAs. They provide triple tax benefits: contributions are tax-free, growth is tax-free, and withdrawals for qualified medical expenses are tax-free.
• HSA contributions reduce taxable income immediately, providing tax savings.
• Unlike FSAs, HSAs are not “use it or lose it” and can roll over year to year.
• HSAs can be invested, allowing the balance to grow over time and providing a valuable retirement resource.

Immediate vs. Deferred Medical Expense Payments

• Some will fund their HSA every year but won’t use the funds until retirement.
• In this scenario, they pay current medical expenses out of pocket with post-tax money, allowing HSA funds to grow tax-free through compounding interest from investments like ETFs.
• If cash flow is needed, it’s fine to use HSA funds, but it reduces long-term growth potential.

How to Make Smart HSA Choices

• Evaluate your employer’s HSA plan compared to available independent plans. Some employer plans may have restrictive or less desirable investment options.
• If your employer’s HSA plan is not satisfactory, you can open your own HSA independently.
• Transferring funds from one HSA to another is possible if you change jobs or find a better plan.
• Consider reputable HSA providers like OptumBank, HSA Bank, and Fidelity.
• Ensure the chosen HSA aligns with your investment preferences and has manageable maintenance costs.
• Holding onto HSA receipts for future tax-free withdrawals is currently allowed by law. However, you should always keep an eye on potential legislative changes that could impact HSA benefits.

TurboTax: When to DIY and When to Go Pro

• TurboTax is suitable for simple tax situations, like W2 employees with basic investment income.
• As tax situations become more complex, especially with setting up entities or optimizing deductions, professional tax preparation can ensure accurate and optimized returns.
• Technology in tax preparation is advancing and is becoming more automated, but the expertise of a tax professional can still provide significant value.

A Primer on LLCs and S-Corps for Physicians

• Choosing between an LLC and an S-Corp depends on various factors, including specific state laws and individual circumstances. In some states, like Tennessee, S-Corps are treated like C-Corps, negating federal tax benefits due to additional state taxes.
• LLCs provide flexibility as they can be taxed as sole proprietorships, S-Corps, or C-Corps, making them versatile for various situations. 
• LLCs offer limited liability protection but do not shield against personal negligence; malpractice insurance is still necessary.
• For tax purposes, LLC income is fully subject to self-employment taxes, while S-Corp income can be split between salary (subject to employment taxes) and distributions (not subject to these taxes), potentially reducing overall tax liability.
• S-Corps require reasonable compensation to be paid to owners, with no clear IRS guidelines on what constitutes “reasonable.”
• Transitioning from an LLC taxed as a sole proprietorship to an S-Corp can be beneficial as income increases, offering tax flexibility and savings.
• Business expenses like flights for locum work are deductible regardless of entity type, but proper documentation and separation of personal and business expenses are crucial.
• Properly setting up and maintaining documentation for your business entity is crucial for tax optimization.

Balancing Multiple Income Streams

• Many physicians have income-generating side hustles, often from 1099 work, such as consulting, med-mal work, chart review, or telemedicine.
• Balancing multiple income streams from W2 and 1099 work requires strategic tax planning. Properly structuring business entities can maximize deductions and minimize tax liability. 
• Leveraging deductible business expenses, such as home office and travel, can reduce taxable income from side hustles.
• Setting up a retirement plan for side hustle income can further reduce tax liability and boost retirement savings.

The Benefits of 1099 Income

• 1099 income offers greater control over time and money compared to W2 employment.
• Physicians with 1099 income can deduct business expenses that are not available to W2 employees.
• Establishing an S-Corp for 1099 income provides additional retirement savings opportunities and tax benefits.

Retirement Plans for 1099 Income

• Solo 401(k) and defined benefit plans can offer significant tax advantages for 1099 income earners.
• Defined benefit plans differ from defined contribution plans like 401(k)s and 403(b)s, where the IRS sets annual contribution limits.
• With defined benefit plans, the IRS sets the total amount you can accumulate by retirement. These plans are more complex and involve determining your retirement age and desired benefit amount. An actuary calculates annual contributions based on various factors to reach the defined benefit by retirement.

SEP IRA vs. Backdoor Roth

• SEP IRAs are not recommended because they prevent tax-free backdoor Roth contributions.
• High-income earners cannot make direct Roth IRA contributions but can contribute post-tax funds to a traditional IRA.
• These funds can be rolled over immediately to a Roth IRA, where they grow and are withdrawn tax-free.
• SEP IRAs complicate this process because the IRS treats all pre-tax and post-tax funds proportionately, leading to unexpected taxes.
• To avoid this, use a 401(k) instead of a SEP IRA, and transfer pre-tax IRA funds into the 401(k) to maintain a zero balance by year-end.
• This strategy allows for seamless backdoor Roth contributions without additional tax liability.

Renting Your House to Your Business

• The Augusta rule allows you to rent your home to your business for up to 14 days tax-free.
• Proper documentation, including a rental agreement and comparable market rates, is essential. Payments should be made from the business account to the personal account to validate the transaction.
• This strategy provides a legitimate way to create additional deductions without incurring taxable income.

Can I Write Off My Vacation?

• Business-related travel and retreats must have a clear and documented business purpose to be deductible.
• Allocating expenses between business and personal use is necessary to ensure compliance with IRS regulations.
• Proper planning and documentation, including meeting minutes and evaluation sheets, can support the business intent of trips.
• Ordinary and necessary business expenses are deductible, but caution is advised to avoid excessive claims.

Starting a Business on the Right Side of the IRS

• Thorough documentation and research are key to starting a business correctly.
• The initial steps include obtaining necessary documents like articles of incorporation and an EIN and setting up a separate bank account.
• Regularly documenting business activities and keeping detailed records can help defend against IRS scrutiny.
• Utilizing professional resources, like tax advisors and educational platforms, can provide valuable guidance for new business owners.