Each year, our physician wealth advisors meet with doctors who have missed out on valuable income and savings due to avoidable tax errors. Over the years, simple oversights and filing mistakes can accumulate tens of thousands of dollars in lost income. With pressing financial priorities like disability insurance and student loan repayments, no physician should forgo a portion of their income because of costly tax errors.
As you prepare for this tax season, here are seven ways you can avoid simple tax errors and put more money towards your long-term financial goals:
1. Make sure you maximize contributions to employer-sponsored retirement plans
Each year, physicians should make the maximum contribution to any available retirement plans sponsored by their employers. Physicians can deduct contributions to plans such as 401(k)s, 403(b)s, 457(b)s, or 401(a)s up to a specified annual amount. For example, as of 2020 the annual deductible contribution amount for a 401(k) is $19,500 for physicians aged 50 years or younger, and $26,000 for physicians older than 50.
In order to minimize taxable income and bolster retirement savings, doctors should take full advantage of available deductions from employer-sponsored retirement plans. Some employers also offer contribution matching programs, which essentially provide free money towards your retirement savings. If your employer sponsors more than one retirement plan, you may be able to maximize contributions to more than one account to make an even bigger dent in your tax burden.
2. Use a Health Savings Account (HSA) to save for medical expenses
It’s always a good idea to set aside money for unexpected medical expenses, however, your savings can go even further with a Health Savings Account. Physicians with a high-deductible health insurance plan are eligible for HSAs, which offer three different tax advantages. First, physicians can make pre-tax contributions to an HSA to reduce taxable income. Second, HSAs allow for tax-free withdrawals for qualifying medical expenses. Finally, the funds within an HSA accrue tax-free interest.
This quiz can help you determine if you qualify for an HSA. If you are eligible, explore different HSA offerings from major banks and brokerages to compare interest rates and fees. With triple tax savings, HSAs are a savvy tax reduction strategy for qualifying physicians.
3. Explore all possible deductions for 529 plans
A 529 plan is a specialized savings account that allows doctors to make tax-free withdrawals for qualifying education costs. Each year, physicians can withdraw up to $10,000 from a 529 plan to pay for elementary, secondary, or higher education costs.
In addition to tax-free withdrawals, many states offer state income tax deductions for 529 contributions. Each year, many physicians miss out on tax savings because they fail to explore their state’s 529 tax perks. Double-check your state’s specific plan to see what additional tax advantages may be available, and consider investing in a 529 plan to create a tax-advantaged nest egg for future education expenses.
4. Document and claim all charitable donations
Oftentimes, doctors make various charitable contributions throughout the year but fail to claim itemized deductions for donations on their tax returns. Whether you make cash or non-cash donations, you could potentially save hundreds or thousands of dollars on your tax bill by recording and claiming your qualifying donations. By keeping track of the value of your annual Goodwill donations, for example, you can shave money off your taxable income.
Various apps can help you track and calculate the cost of commonly donated items.
If you plan to itemize your deductions, follow the IRS guidelines to provide proper records for your charitable gifts. For example, a cash donation of less than $250 can be verified with a receipt, canceled check, or credit card statement, while larger donations require written acknowledgment from the recipient. Expensive items (such as a vehicle) may need evidence of a professional appraisal to claim a deduction. With planning and documentation, you can claim valuable tax write-offs for all of your charitable contributions and donated goods.
5. Consider filing jointly if you are married
Many married couples who choose to file separately are losing out on deduction opportunities. When physicians file individually, they are limited in their standard and itemized deductions. Additional savings are available to physicians who file jointly, including child tax credits and student loan deductions. Many of our clients have been able to save thousands of dollars by filing together with their spouse.
6. Categorize your active and passive income strategically
One common error committed by physicians is mislabeling their passive and active income sources. Doctors who own their own practices should always code business income as active income because there are stricter limits on how much you can claim in losses from passive income sources.
Income from real estate can also present an opportunity for additional tax relief. In most cases, rental property income is listed as passive income. However, in many states, you can actually claim rental property income as active income if you actively participate in the management of the property. By taking advantage of this nuance in the tax code, you may be able to claim up to $25,000 of real estate losses on the current year’s tax returns. Consult with your tax professional to make sure your income sources are properly classified as active or passive to maximize your tax savings and avoid a costly penalty.
7. Track depreciation on real estate rentals
Many doctors who own rental properties do not record any depreciation on their property value. This mistake can end up costing you dearly over the years, as you will end up overpaying in taxes based on the value of your property. When it comes time to sell, a taxpayer is required to include depreciation in their calculation of the property value, however, they can only retroactively amend their property value for the previous three years of taxes. Thus, if you own a rental property for many years, but never record depreciation, you will pay an inflated rate on the cost basis of the property.
In conclusion
A robust tax strategy is the difference between building wealth versus simply earning money. This tax season, steer clear of expensive tax mistakes that can undermine your savings and jeopardize your financial priorities. By coordinating your tax plan with both a physician-specific wealth advisor as well as a qualified tax professional, you can develop a long-term tax savings strategy that will bring you closer to your goals.
Want to learn more about these tax-savings strategies or others? The Physicians Thrive team of financial advisors offers physician-specific tax planning services as well as comprehensive financial planning services. To reduce your tax burden, avoid costly tax mistakes, and plan for your financial future, contact one of our trusted advisors today.
Physicians Thrive is a dynamic, full-service financial planning company helping doctors take control of their finances. From student debt repayment plans for new doctors to retirement security planning for seasoned physicians, doctors at all stages of their career can make the most of their money by collaborating with our experts. As a certified B Corporation, Physicians Thrive donates a portion of our profits to Give Sight Global to restore sight to someone in need. Contact one of our trusted advisors today.