Tax Deductions for Physicians

Common Tax Deductions That Will Save You Money

Common Tax Deductions That Will Save You Money

As a high-income earning physician, you will want to know the common tax deductions and credits that are available to you. These deductions will help you decrease your taxable income and pay less tax. The good news is that these common tax deductions are available to any U.S. taxpayer. The bad news is that most of these deductions have income limitations that could limit the amount of the deduction you can take on your tax return. In this article, we are going to outline some of the most common tax deductions and credits available to you as well as how being a high-income earner affects your ability to take the deduction.

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Tax Deductions vs. Tax Credits

Before we talk about these common tax deductions it is essential to understand the difference between a tax deduction and a tax credit.

A tax deduction reduces your taxable income, thus lowering the total tax bill. Your total tax is calculated based on your taxable income, so a lower taxable income means a lower tax bill.

A tax credit reduces your total tax bill dollar-for-dollar by the amount of the credit. Tax credits do not affect your taxable income. They affect your total tax after you calculate your tax based on your taxable income.

Credits are typically more beneficial than deductions as you can see in the simple example outlined below.

Deduction vs. Credit $10,000 Deduction $10,000 Credit
AGI $150,000 $150,000
Deduction ($10,000)
Taxable Income $140,000 $150,000
Tax Rate 25% 25%
Calculated Tax $35,000 $37,500
Tax Credit ($10,000)
Total Tax Bill $35,000 $27,500

 

With that understanding of a tax deduction vs. a tax credit, let’s dive into the common tax deductions and credits available to you.

Common Tax Deductions You Should Know

Workplace Retirement Plan Contributions & Deductions

If you work for an employer that offers a workplace retirement plan such as a 401(k) or 403(b), you can contribute a portion of every paycheck to these plans. These contributions go into your retirement account tax-free and reduce your taxable income by the amount of your contribution. In 2020, you can contribute up to $19,500 into a 401(k) or 403(b) to save for retirement and reduce your current year taxable income. If you are over the age of 50, you can contribute an additional $6,500 to your retirement account, thus increasing your total possible contribution to $26,000.

IRA Deduction

Another common tax deduction related to your retirement is the IRA deduction. You can contribute up to $6,000 ($7,000 if over age 50) to your individual traditional IRA and deduct it on your tax return if you meet certain criteria.

If you or your spouse are covered by a workplace retirement plan such as a 401(k) or 403(b) then you may be limited to the amount of the deduction you can take. These limits are based on your income and filing status which you can see below.

 

Filing Status Modified AGI Amount of Deduction
Single or

Head of Household

$65,000 or less a full deduction up to the amount of your contribution limit.
more than $65,000 but less than $75,000 a partial deduction.
$75,000 or more no deduction.
Married Filing Jointly or Qualifying Widow(er) $104,000 or less a full deduction up to the amount of your contribution limit.
more than $104,000 but less than $124,000   a partial deduction.
$124,000 or more no deduction.
Married Filing Separately less than $10,000   a partial deduction.
$10,000 or more no deduction.

 

Source: 2020 IRA Contribution and Deduction Limits Effect of Modified AGI on Deductible Contributions If You ARE Covered by a Retirement Plan at Work

If you or your spouse are not covered by a workplace retirement plan, then you can contribute the full amount to your traditional IRA and deduct that same amount on your tax return.

Student Loan Interest Deduction

Physicians who carry student loans might be able to deduct a portion of their student loan interest on their tax return. The student loan deduction is maxed out at $2,500 per year, and this amount could be reduced based on your income level and filing status. These income limits have not yet been released for 2020. Your student loan provider will send you a 1098-E tax form to show the amount of student loan interest you paid for the year.

Standard Deduction

The standard deduction is a common tax deduction available to all U.S. taxpayers regardless of their income level. You have the choice to take either the standard deduction or to itemize your deductions on your tax return. You will typically choose whichever gives you the highest deduction. The IRS sets the standard deduction amount each year, and the amounts for 2020 are listed below.

Single and Married Filing Separately – $12,400

Married Filing Jointly – $24,800

Head of Household – $18,650

Itemized Deductions

When you choose to itemize your deductions, you must use the IRS form Schedule A to track the deductions you take. There are multiple deductions that total up to your combined itemized deductions, and the main ones are listed below.

Itemized Deductions: Charitable Contributions

When you give money, clothing, furniture, or other property to your favorite charity, you can deduct these amounts on your tax return using Schedule A. This is a great way to support your community and get a tax break at the same time. Depending on the amount and type of gift, you may have to ask for certain documentation from the charity you donated to, so you can keep proper records for your tax return.

Itemized Deductions: Medical and Dental Expenses

You can itemize certain, qualified medical and dental expenses on your Schedule A. These include, but are not limited to, fees paid to doctors, surgeons, dentists, chiropractors, inpatient hospital care and many others. See IRS form Schedule A instructions for a list of more qualified medical expenses.

To deduct medical expenses on your Schedule A, your total medical expenses for the year must be more than 7.5% of your Adjusted Gross Income (AGI). If they are less than 7.5% of your AGI, then you can’t deduct any of them on your Schedule A. If your expenses are more than 7.5% of your AGI, then you can deduct the difference between your medical expenses and 7.5% of your AGI.

Itemized Deductions: State and Local Income Taxes

You can deduct state and local income, real estate and personal property taxes on your Schedule A tax form. This is great for physicians who live in states with a high state income tax or high real estate taxes. However, the deduction is limited to $10,000.

Itemized Deductions: Mortgage Interest

If you own a home, you might be able to deduct mortgage interest that you paid throughout the year. Your mortgage provider will provide you with a 1098-Mortgage Interest Statement that shows you the amount of interest you paid on your mortgage. You use this form to fill out your Schedule A.

To deduct your mortgage interest, your mortgage proceeds must have been used to buy, build or substantially improve your home. Additionally, if you took your mortgage out on or before December 15, 2017, you can only deduct mortgage interest on up to $1,000,000 of that mortgage. If you took your mortgage out after December 15, 2017, you can deduct mortgage interest on up to $750,000 of the mortgage.

With all your itemized deductions, it is a good idea to keep all the documentation and receipts that prove you were eligible to take the deduction. If the IRS has questions on your return, you want to be able to justify your deductions to them with clear documentation.

Another thing to consider before you itemize your deductions is that itemizing your deductions is way more time consuming than using the standard deduction. With the standard deduction, you don’t have to keep any receipts and can just select the standard deduction box on your tax return and move on. When you itemize your deductions, you need to keep track of receipts throughout the year, and you will spend more time filling out the additional form on your tax return.

Health Savings Account

A health savings account (HSA) is an account that allows you to contribute money to it for future medical expenses on a tax-free basis. When you contribute to your HSA, you can take a deduction on your tax return. The max you can deduct as an individual with self-only coverage is $3,550. The max you can deduct for family coverage on a high deductible health plan is $7,100. You can also withdraw money tax-free from your HSA as long as you use the money to pay for qualified medical expenses.

Self-Employed Deductions

When you are self-employed, you have many more deductions available to you than those who are traditionally employed. Self-employed people are those who run their own business or receive payment as an independent contractor rather than as an employee. Here are some of the most common tax deductions for the self-employed.

Self-Employment Tax Deduction

Self-employment tax is made up of the social security tax (12.4%) and Medicare tax (2.9%). The employee is responsible for half this amount, and the employer is responsible for the other half. Since you are the employee and employer of your own business, the IRS lets you take a deduction for half of your self-employment tax. This means you can deduct 7.65% of your net business income on your tax return.

Business Expenses

Since you run your own business or make money as an independent contractor, you can deduct expenses incurred related to your business or the work you perform. This means you can deduct expenses such as health insurance premiums, internet bills, office rent, uniforms, travel expenses, meals (limited), education, technology (computers, phones, etc.), business insurance, subscriptions, membership fees and any other expense related to running your business.

If you work from home, you can also deduct a portion of your home office. There are two methods to deduct expenses related to your home office. There is a simplified method and the regular method. For the simplified method, you estimate the square footage of your home office and multiply that square footage by $5. This is the amount of your deduction under the simplified method. The deduction is limited to 300 square feet, so your max deduction is $1,500.

Under the regular method, you calculate the percent of your home that was used for your business and use that percentage to allocate your home-related expenses to your business. For example, if your office makes up 5% of your house, and you pay $100 on the internet every month, then you can deduct $5/month for the internet related to your business. You would do this for all your home-related expenses.

Another perk of being self-employed is you can deduct vehicle expenses for business-related travel. Similar to the home office deduction, there are two methods to calculate this. You can use the IRS standard mileage rate and keep track of the miles you drive for the year. In 2020, you can deduct 57.5 cents per business mile from your travel. Or you can keep track of all your car-related expenses for the year (gas, maintenance, repairs, etc.) and allocate a portion of those expenses to your business. Depending on your situation, you might want to calculate both methods to see which one would give you a higher deduction.

One final thing to consider as a self-employed individual is setting up a retirement account for your business. A solo 401(k) or SIMPLE IRA could be a great option for you to reduce your taxable income and save for retirement while being self-employed.

Everything we just talked about was for common tax deductions that reduce your taxable income. In the following section, we will discuss some of the most common tax credits available to you.

Common Tax Credits You Should Know

Tax credits reduce your tax bill dollar-for-dollar by the amount of the credit. Here are some of the more common tax credits you should know as a physician.

Child Tax Credit

You can claim the Child Tax Credit for each qualifying child you claim as a dependent on your tax return. The credit is $2,000 per child and is limited based on your modified adjusted gross income. If your modified adjusted gross income is more than $400,000 as MFJ taxpayers or $200,000 for all other taxpayers, then the amount of the credit you can claim will be limited. A portion of this credit is also refundable meaning if you take this credit, and it reduces your tax bill below $0, then you will receive a refund (up to $1,400 per child).

Generally, your child is considered a qualifying child for the Child Tax Credit if they are under age 17, they did not provide more than half of their own support and they lived with you for more than half the year. If your child was born in the latter half of the year all the way up to December 31, they still qualify as a child under the Child Tax Credit.

Child and Dependent Care Tax Credit

The Child and Dependent Care Tax Credit is available to taxpayers who pay expenses for their child or dependent to be taken care of while the taxpayer works or looks for work. A child is a kid who is under the age of 13. You are limited to taking credit for $3,000 for one child or $6,000 for two or more children. The amount you can deduct is based on a percentage that is determined by your AGI. For example, if your AGI is over $43,000, then you can only deduct 20% of your qualifying expenses under this credit.

For an expense to qualify under this credit, it must be paid for someone to care for your child or dependent while you work or look for work. This is a rather broad definition by the IRS, but some examples of expenses include daycare expenses, babysitters, and even some summer camps.

Adoption Credit

The Adoption Credit allows you to reduce your tax bill for your out-of-pocket expenses related to adopting a child. The credit is limited to $14,300 in 2020 and is non-refundable, meaning if it reduces your tax bill below $0, then you will not receive a refund (but you will still not pay any tax). This credit is limited based on your modified adjusted gross income. Eligible expenses include adoption fees, legal fees, travel expenses, and other expenses directly related to the adoption.

There are some weird timing rules related to this credit. Before the adoption becomes final, any adoption-related expenses you pay cannot be used towards this credit until after the year of payment. Once the adoption is finalized, any expenses paid in the year of the finalization or after the year of finalization may be used toward the credit in the year they were paid.

Another nice thing about this credit is if your credit amount exceeds your tax liability for the year, you can roll the remainder over to following tax years for up to five years.

American Opportunity Credit

The American Opportunity Credit (AOC) is an education credit available to students who are in their first four years of undergraduate education and paid qualifying educational expenses. If you claim your kid as a dependent on your tax return, then you are eligible to take this credit. The maximum credit you can take is $2,500 per eligible student per year. This credit is calculated as 100% of the first $2,000 of eligible education expenses and then 25% of the next $2,000 of eligible expenses, giving you the max amount of $2,500. This credit is partially refundable to you if it reduces your tax liability below $0. To be eligible for this credit, you must support your credit calculation with a 1098-T tax form that will be provided by the educational institution you, your dependent or your spouse attends. Once your income is above $80,000 for Single filers or $160,000 for MFJ filers, the amount of this credit will be limited.

Lifetime Learning Credit

The Lifetime Learning Credit (LLC) is an education credit available to taxpayers who are beyond the first four years of their undergraduate education. That means it is available to people who are in their fifth year of undergrad, graduate school, medical school, or any other higher education beyond four years of undergrad. It is maxed out at $2,000 per tax return (not per individual) and is for eligible education expenses. The credit is calculated as 20% of the first $10,000 of qualified education expenses you incur for you, your spouse, or someone you claim as a dependent on your tax return. Again, you must receive a 1098-T from the qualifying institution showing your incurred expenses, and the credit is limited based on your modified adjusted gross income. Once your income is above $58,000 for Single filers or $116,000 for MFJ filers, the amount of this credit will be limited.

Use These Common Tax Deductions and Credits to Reduce Your Tax Bill

Through these tax deductions and credits, you will be able to lower your taxable income and total tax bill to help you pay less tax. As a high-income earning physician, reducing your tax bill is a great way to save money for your future and bring more money home to support your family and the lifestyle you want to live. Keep these deductions and credits in mind as you go through your annual tax planning and file your tax return. They could help you save hundreds or thousands of dollars every year.

Ryan Inman