Four Tax-Saving Ideas You Can, and Should, Do Now

As a physician, your income likely puts you in the top marginal federal income tax bracket. This means that after the new tax increases for 2013 — 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. Meaning you truly don’t “take home” income until July or August … before then, you are working just to pay taxes!

Given this climate, your advisors should be providing you creative ways to legally reduce your tax liabilities. How many tax-reducing ideas does your CPA regularly provide you? If you are like most physicians with whom we speak, you get very few tax planning ideas from your advisors.

Given these sobering facts, the purpose of this article is to show you four ways to potentially save taxes and possibly motivate you to investigate these planning concepts now, before the end of the year approaches, when it is too late. Let’s examine a few possible tactics here:

1. Use the right practice entity/payment structure/benefit plans

These areas are where the vast majority of tax mistakes are made by physicians 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:

• Using the legal entity with maximum tax/benefits leverage — whether that is an S corporation, C corporation, LLC taxed as S or C, partnership or disregarded entity

• Using a multi-entity structure to take advantage of two types of entities and their tax/benefit advantages

• Managing the payment of salary, bonus, distribution and partnership flow-through to take advantage of maximum retirement benefits and minimize income, Social Security and self-employment taxes

• Consider benefit plans beyond the typical profit-sharing/401(k) with which most medical practices start and end their benefit planning

2. Explore investment managers who manage with taxes in mind

It is generally 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.”

Obviously, over 20 or 30-plus years of retirement savings, losing one-sixth to almost half of your returns to taxes can be devastating to a financial plan. Nonetheless, too many physician-investors settle for this awful taxation.

While a 17% to 44% tax bite is dreadful, these numbers will likely be worse in 2013 and beyond, as federal capital gains and dividend rates now reach 20% for some taxpayers (where they were 15% before), and the new Obamacare tax on investments adds another 3.8% for high income taxpayers as well. Of course, state taxes are an addition. 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 only have “one way” communication — the fund tells you what your return is and what the tax cost is. Working with an investment management firm, you may get “two way communications” as the firm works with you to maximize the leverage of different tax environments, offset tax losses and gains, and other tax minimization techniques.

Your investment firm might also employ “tax diversification” as part of their strategy. Tax diversification dictates the use of various “buckets” to hold investment assets — each with its own tax treatment.

Some buckets enjoy tax-free growth but will be subject to ordinary income taxation upon liquidation, like a 401(k). Some grow tax deferred and are subject to various types of tax treatment on exit, like an annuity. Other buckets grow with little tax but are subject to capital gains upon liquidation (like growth stocks); while others may grow tax free and can be accessed without tax (Roth IRA).

These are just a few examples of strategies that a tax-forward investment firm may implement for its clients.

3. Gain tax-deferral, asset protection through cash value life insurance

Above, you learned about the 17% to 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. Finally, if managed properly, one can access the cash values of the policy without tax as well.

Perhaps no asset class is as misunderstood by all types of physicians as cash value life insurance. Certainly, it is not simple to implement properly because product design and customization is crucially important — and a long-term investment perspective is equally important. However, with these elements in place, and a proper advisor guiding you, a cash-value life policy may be an excellent tax-favored wealth accumulation tool.

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.

Another effective, but little-known, tax-planning tool in this arena is the conservation easement. Donors may take a deduction for a “qualified conservation contribution” to a qualifying organization. In effect, a taxpayer can donate land for preservation and take a charitable deduction for the value of the land at its “highest and best” use. A valid qualified appraisal is required. The taxpayer can acquire a membership interest in an LLC which owns property eligible for a conservation easement.

The taxpayer can then take part in the contribution of the easement and the tax benefits surrounding such a transaction. As above, proper design and implementation is crucial.

Conclusion

This article gives you a few ideas for how to save taxes. For larger practices with $3 million to $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 may be the subject of future articles.

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 next April 15 … and next April 15 … and the one after that.

David B. Mandell, JD, MBA, is an attorney and author of five national books for doctors, including For Doctors Only: A Guide to Working Less & Building More, as well a number of state books. He is a principal of the financial consulting firm OJM Group, where Carole C. Foos, CPA works as a tax consultant. David can be reached at (877) 656-4362 or mandell@ojmgroup.com. You can also call for a free (plus $10 S&H) hardcopy of For Doctors Only: A Guide to Working Less & Building More. If you would like a shorter free E-book download of our “highlights” version, you can download it here.

Disclosure:

OJM Group, LLC. (“OJM”) is an SEC registered investment adviser with its principal place of business in the State of Ohio. OJM and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisers by those states in which OJM maintains clients. OJM may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. For information pertaining to the registration status of OJM, please contact OJM or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).

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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.