physician tax planning, doctor tax planning, tax cuts and jobs act summary

What Physicians Should Know About the Tax Cuts and Jobs Act

The Tax bill is final; did you get a tax cut?

What is the Tax Cuts and Jobs Act (TCJA)?

The Tax Cuts and Jobs Act (TCJA) that was signed by President Trump on Dec 15, 2017, and there has been a lot of confusion around what changed and how that will affect the taxpayers.

On today’s show, I talk with John McCarthy CPA, as we do a high-level walkthrough on the tax bill and highlight some of the important things physicians need to be aware of right away. While the list isn’t exhaustive, it would be hard to summarize 1100 pages of tax law into one podcast, we give you the cliff notes version to jump-start your knowledge on some of the key points.

Did the Tax Cuts and Jobs Act make taxes simpler for physicians?

Unfortunately, the passing of this bill did not make the tax code simpler, and we can’t do our taxes on a postcard like President Trump campaigned on. We still have 7 tax brackets, even though the rates were reduced, AMT still exists and personal exemptions are a thing of the past. The majority of the TCJA is set to sunset after 2027 and rest assured, it will take many months, probably years, for the CPA’s to find out all the tax strategies.

How Does the Tax Bill Affect Physicians?

In this episode, you will learn:

  • What is a standard deduction and why do some physicians itemize vs taking the standard deduction on their tax return?
  • The concept of Qualified Business Income (QBI) and how that relates to your income as a physician.
  • Who qualifies for the child tax credit?
  • The BIG changes to 529 plans (from a tax perspective) and potential tax strategies that physicians can use in 2018.
  • The changes in the tax bill that affect student loan repayment and/or forgiveness.
  • What physicians can do in 2018 to get ready for all of these changes.
  • If the backdoor Roth strategy removed or changed.

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Full Transcript: What Physicians Should Know About the Tax Cuts and Jobs Act

Ryan

Did you read the eleven-hundred-page tax bill that was just passed? No? Well, lucky for you, John McCarthy and I just created the cliff notes version for you.

Ryan

What’s up everyone? Hope your New Year is off to a great start and treating you right. I’m sure that the majority of you have heard that the final version of the major tax reform, called the Tax Cuts and Jobs Act, was signed by President Trump, on December 15, 2017. This is the largest change in the tax code since the Bush tax cuts of 2001 and 2003. While we were told during the campaign that this would simplify the tax code and provide tax benefit to everyone, this bill did not make things simpler. It’s going to take some time to really go through the bill and receive guidance from the IRS for more clarification, but one thing that’s glaringly obvious, this was not simpler. AMT still exists for individuals; although, it was repealed for corporations; and corporations do have a flat tax now. But, individuals, we still have seven tax brackets.

The Tax Cuts and Jobs Act is the largest change in the tax code since the early 2000s.

Ryan

The rates were reduced, and after all the changes, they aren’t even permanent. That’s the kicker, is that these changes can’t last beyond ten years, the way it was written; and they’re due, actually, legislation is due to sunset after 2025. So, ultimately, it’s going to take months, and probably years, for CPA’s to go through everything to find out all the tax strategies; and then, they’re going to potentially expire in 2025, unless some fiscal cliff thing comes out and they end up having to make some of this permanent. Basically, it’s going to take months or years to go through this and find all the strategies. Be sure to keep up with all the news surrounding this new tax bill. On today’s show, we’re going to be talking to John McCarthy, from McCarthy Tax Prep. John has been a CPA for over fifteen years and he works with well over four hundred clients nationwide.

Ryan

He’s been a tremendous resource to me, personally and professionally; and I’m really grateful that he’s taking the time out today to talk with us on the major changes that were presented in the bill. So, that brings me up to today’s digestible tip.

Here is this week’s digestible tip.

Ryan

Make sure that you sit down this month and organize all of the documents needed to file taxes. Get it all organized, all in one place, to make tax prep easier for 2017. Going forward, if you do your own taxes, make sure you read up on all these changes that were put in place. There’s eleven-hundred-pages of reform that just were approved. There’s a lot in there. So, make sure you keep up with the changes and one other little tidbit was, the tax rates, even though your tax rates were just lowered, it’s more than likely the payroll services haven’t been able to catch up and adjust. So, you may be over withholding in 2018. So, make sure to check up throughout the year to make sure that you’ve corrected that. Now, let’s jump into the interview with John McCarthy.

Ryan

John, thank you so much for joining us. I really appreciate you being here and taking out the time to talk with all of us and educate us a little bit more on this tax bill.

John

Yeah, sure. Happy to be here, Ryan.

Ryan

So, I first just, kind of, want to start out with just a high-level of what did you see change with all these taxes and where do you think we maybe should be highlighting throughout our discussion today?

John

Yeah, sure. There was a number of significant changes. Congress gave us quite the Christmas present. So, we have about one thousand pages of tax law with various changes through them. We’ll go through a few of them here, but the key thing to remember is that a lot of this information is still waiting on IRS guidance at this point. So, while we have some answers for some things, we still are waiting for a lot of clarification from the IRS at this point.

A lot of changes to the tax law are still waiting on IRS guidance.

Ryan

If you could just explain that really quick. So, the tax bill came out, it got put into law and then we’re waiting for additional guidance. Can you just explain that to people really quick?

John

Yeah, sure. Congress gives us, kind of, a blueprint for what they intended these tax law changes to be; but, unfortunately, congress people aren’t always tax experts. What we end up with is some ideas on how they would like these things to work; but, really, the nuts and bolts of how tax preparers and tax professionals will apply these rules, is really not settled until the U.S. Treasury Department and the IRS issue some additional regulations, and help define some of these new terms and new ideas that we have in the tax law. So, you know, it can be several months before we have really final ideas on how all of these things will work going forward.

Ryan

So, if you could, just go into a little bit more on the tax bill and what we’re looking at now.

John

So, one of the biggest changes that we saw was in the standard deduction area, and itemized deductions, and how those work with exemptions as well. In the past, folks could choose the higher of their standard deduction, or itemized deductions. So, everyone was allowed a standard deduction, and it varied depending on your filing type. It could be sixty-three fifty for single folks, in 2017; and twelve thousand seven hundred for married folks. So, you could either take that or if your itemized deductions were higher, you were able to take your itemized deductions; and your itemized deductions are things like mortgage interest, real estate taxes, state and local income taxes, medical expenses, and things like that. One of our biggest changes with the tax law, is that it completely redesigned this area for us. So, we used to be able to take exemptions for the number of people that you were claiming on your return.

John

So, for yourself and your spouse and kids, exemptions are now gone; and they’ve included them with the standard deduction now, going forward. So, the standard deduction amount has gone up to twelve thousand for singles and twenty-four thousand for joint, to help compensate for the loss of exemptions. Then, we’ve also had a number of changes in the itemized deductions that people are able to take too. This has gotten a lot of press, over the last several weeks, as people were quickly trying to make some payments towards the end of the year. That’s mainly because state and local income taxes, as well as real-estate taxes, are now limited to ten thousand dollars in a year. So, that’s quite a bit of a change from the past. That ten-thousand-dollar amount is the same, whether you’re single or married filing joint; which does catch people by surprise a little bit.

Expect changes to the exemptions you’ve become accustomed to.

Ryan

Yeah, and that really punishes people that live in high-cost-of-living areas, like California or New York, or somewhere like that; where you might have an expensive house, which might be an affordable house in the Midwest, but you’re paying all of your property tax and insurance and all this stuff, and now you can’t look at…it’s basically capped at ten thousand.

John

Correct.

Ryan

And, is that capped with the taxes that you’re paying through your state and…is it ten thousand each or is it ten thousand together?

John

Yeah. So, if you’re filing a joint return, it’s ten thousand dollars for both of you.

Ryan

John, when do people look at itemizing versus taking a standard deduction? How does one, if they’re looking at their financial life, and they’re looking at everything, and they’re trying to do tax prep on their own; when should they look at itemizing versus the standard deduction?

John

Sure. The 2017 year, you would want to look at itemizing, if you think that your itemized deductions are going to be higher than your standard deduction. For 2017, those amounts were sixty-three fifty, for individuals; and twelve thousand seven hundred for married filing joint. What you would do, is look, you normally, if you own a home, you’re going to have a Form 1098 come out in the mail here soon. That will list your mortgage interest and sometimes it will also list your real-estate taxes on it. So, you would add those things up, as well as the state income tax withholding and any city tax withholding that you might have on your W-2’s. You add those together with any charitable contributions that you have, and if that number is greater than your standard deduction, then you would want to consider itemizing.

Ryan

That’s perfect. You know, looking at the standard deduction, I know we talked about it doubling, and that the idea that you no longer can take these personal exemptions; does that end up hurting bigger families, or does this new…I know that we’re probably going to get into here, is the child tax credit. Does that end up offsetting this? How does it end up working?

John

For most folks, going forward, the child tax credit benefits to the new law, is going to help to offset the loss of those exemptions. That’s because they’ve increased the child tax credit now, from one thousand dollars, how it will be here in 2017; to two thousand dollars going forward. Part of that credit is also refundable for lower-income taxpayers. So, even if you don’t have a tax liability, there’s a chance you can still get a refund from some of that, from that child tax credit.

The Child Tax Credit was increased and part of it is also refundable for lower income tax payers.

Ryan

Will that factor into whether they itemize or take the standard deduction?

John

Yeah. The child tax credit is completely independent of whether you take the standard deduction or you itemize. So, as long as you’ve got kids, you’re eligible to take the child tax credit.

Ryan

And, there’s no phase-out, or is there a phase-out with that?

John

There is a phase-out, still. This is the area that’s really going to help a lot of tax payers, where they weren’t able to take a child tax credit in the past. So, the phase-out used to be between seventy-five thousand of taxable income and one hundred and ten. That has been greatly increased to two hundred thousand dollars for single individuals and four hundred thousand dollars for married filing joint. So, a lot more people, starting in 2018, are going to be able to take the child tax credit.

Ryan

So, assuming that you, let’s say, have a household income of under four hundred thousand, you’ll be able to actually take advantage of this two-thousand-dollar tax credit, in addition to the expanded standard deduction. That should help offset to where families, without taking these personal exemptions on multiple kids and themselves; like, that should offset what happened. Right? Like mathematically? I’m trying to think about it in my head.

John

That’s what we’re seeing in practice, is that for the vast majority of people, I think they’re going to see a tax reduction. There are certainly pockets of folks that could potentially pay more with the new tax law, but I think for most people, they’re going to see a tax reduction.

Ryan

I mean, that’s the whole point of this. I don’t know, I feel like they introduced more tax planning complexity; and they didn’t really simplify the tax code. It just feels more difficult to understand.

John

Yeah. There were pockets of simplification, but overall, I would say that, while CPAs might not have necessarily been excited to have this tax law dumped on them here at the last minute, it does provide a lot of job security for us going forward; especially for helping out our small business customers.

The new tax law provides CPAs with job security going forward.

Ryan

Yeah. So, you mentioned small business, and I do want to jump into the QBI in just a minute; but keeping with the child tax credit, and the theme here, the 529’s got a little benefit through this tax bill. Can you explain how that ended up changing?

John

Yeah. So, we got a couple of new wrinkles in the 529 plan availability. The biggest thing, is that they opened up 529’s to be so you’re eligible to pay expenses for primary and secondary education for your kids. Folks are allowed to distribute up to ten thousand dollars, per year, per beneficiary, for primary and secondary education costs; whereas before, it was limited to college costs.

Ryan

What about home schooling?

John

Yeah. At the last minute, they ended up taking out the home schooling availability. So, in the earlier versions of the bill, they were going to include home schooling and education costs as potentially in there; but it did not meet some of the restrictions to pass the bill, so they were stripped out at the last moment.

Ryan

Yeah. I mean, with a thousand-page bill and so many, like, you know…this is what they’re planning to do and then this is what they actually did; it’s hard to keep up with what actually got signed in over the holidays. So, I appreciate the clarification there. So, John, if your state has a deduction for contributing to a 529 plan, and you are already putting your kids into a private school; essentially, instead of just paying the school, you could fund the 529 and then have that come out and pay the education costs. Correct? Now that they’re able to pay the primary schools?

There are two main benefits of the 529 plan.

John

Yeah. It’s a good planning tool, and one that we’re seeing our advisors really key in on. Really, there’s two main benefits of the 529 plan. With college, when it was only eligible for college costs, the main benefit was putting away money in a tax-deferred manner, meaning that you wouldn’t have to pay taxes on those earnings, while that money sat there, until your kids got to college. But, now that we’re able to use those funds for primary and secondary education, you know, for the states that allow a tax deduction for contributions to a 529; there’s nothing preventing you from making a contribution on December 31st to get your state tax deduction, and then pulling that money out on January 2nd to pay directly to the kids’ education costs. So, it’s a great way to get a state tax deduction.

John

There are a few states that don’t have that benefit, so you’re going to want to check with either your state’s tax websites, or there’s some good 529 websites out there that detail which states have those benefits and how much the benefits might be.

Ryan

Yeah, because one of the things, when I’m looking at 529 plans and analyzing which plans are good and bad and all that, is sometimes these things are like bloated with fees and terrible investments and all that. So, if your state had the deduction, but it had a terrible plan; then you would end up going somewhere else, like Utah or New Hampshire, or Nevada’s plan. You’d end up choosing something different, but this, to me, opens up the idea that, while maybe you’re 529 that your saving for college has opened up at, let’s say Utah, and going through there; but you can fund your state’s crappy plan to get that deduction and then immediately move it out. It just seems like a weird loophole around bad plans.

John

Yeah. That’s a great point, Ryan. That’s something that, it is always good to take advantage of making sure that your state plan is reasonable in terms of fees. That’s something that an advisor, like you, can help clients with.

The episode with Abby Chow from College Backers sheds light on the 529 plan.

Ryan

Yeah. It just seems like I get the 529 question a lot and I just did an episode with Abby Chow, from College Backers. So, if you haven’t listened to that, go back and check out that episode. They’ve got a great product around 529 plans that I have actually been using for my kids now. Yeah, it just looks like if your state had a bad plan…now, I know states like, I think it’s like Minnesota, where you can put it into any plan and still get the state deduction; but there’s some states out there that say “no, it’s our plan and you need to put in to get that deduction.” It seems just like a little loophole around being able to fund it there and then pay for your kids’ tuition. So, I like that. Keeping along this same line here, was there anything in the bill that would help or hurt with respects to student loan repayment or forgiveness on student loans?

John

Yeah. There were a few new changes in the student loan area. For a while, we thought the student loan interest deduction might go away. That one did survive the writing process. So, student loan interest is still deductible. It phases out based on income, though. So, depending on your income for 2017, it phases out for singles between sixty-five thousand and eighty thousand dollars; and for married filing joint, it phases out between one thirty-five and one sixty-five thousand. So, for the right person, student loan interest deductions are still there, up to twenty-five hundred dollars. On the student loan discharge fronts, there was some changes made regarding student loans that are discharged due to death or disability. Those are no longer going to be considered taxable income in the unfortunate event that we have somebody in that situation.

John

There were no changes to the discharge previsions around folks that are in IBR, or pay, or repay programs. So, we still need to do planning there and if we think that’s going to be a situation, because there could be still some taxable income implications for those.

Ryan

Okay. So, I mean, that’s nice that they helped out people through disability or death, that it’s not taxable inside of there. So, switching over to what we eluded to, how you can look at deductions for QBI. So, if you don’t mind, could you explain QBI, what it actually is, and the deduction now that it has gotten the press of the bill?

John

Yeah. So, this is one of the biggest changes with the tax bill, because they’re opening a whole new area of tax law; and it’s something that is completely different than what we’ve experienced in the past. From a legislative standpoint, the QBI that we’re talking about, this Qualifying Business Income deduction, was really a response to try to help put small businesses on the same type of tax advantage that they were newly giving to large C Corporations, or large multi-national companies, that have a new lower tax rate as well. The Qualified Business Income deduction, from a very high level, is basically offering up to a twenty percent deduction for business income that comes straight on the individual’s return and helps reduce their tax liability. The Qualified Business Income deduction, it has to have a business associated with it.

John

So, the IRS, I should say when Congress wrote the rules, they were really trying to make sure that people are not abusing this particular provision of the tax law. So, it’s not going to include folks that are W-2 employees. So, there’s no deduction for them. The other thing to keep in mind too, is that it doesn’t include your wages, even if you’re working for a small business. Let’s say you’re working for a partnership, or an S Corporation, or some other type of small business; and you’re getting paid a salary or guaranteed payments from that company. The deduction is not going to apply to that. It’s only going to apply to the other business income that passed through to your return.

The IRS is trying to make sure that people are not abusing the Qualified Business Income deduction with these requirements.

Ryan

So, the distribution is over and beyond your given salary for your work and compensation?

John

Yeah. Correct.

Ryan

So, how does the twenty percent deduction actually work, maybe one level down from a high level? Is it above the line? Is it below the line? How does it actually work flowing down through the…I guess explain more on how this twenty percent deduction works.

John

From a tax return standpoint, it’s going to be a deduction after adjusted gross income. So, you can kind of think of it on the same lines of where itemized deductions today are deducted on the return. That’s kind of how this Qualified Business deduction is going to work. So, it’s not going to directly reduce your adjusted gross income, which does come into play quite a bit in other areas of the tax computation.

Ryan

Perfect. Well, is there anything else that we’re missing out on this new tax bill? I know there was a ton of stuff in there and I just wanted to highlight this conversation on the big key points. Is there any other big key points that you think we’ve kind of missed out on talking about?

Big key points to the new tax bill include these things.

John

Well, I’ll go back really quickly to the Qualified Business Income deduction, just as it pertains to your audience a little bit. One of the things to keep in mind with this, is that congress has designated health professionals, as well as tax accountants, lawyers, and a few other groups that they are excluded from some of the benefits from this Qualified Business Income deduction. So, there’s a lot we don’t know about how it’s going to work yet. If you are going to be making above one hundred and fifty-seven thousand as a single person, or three hundred and fifteen thousand jointly, in 2018, and you are part of a small business of health professionals; this is one where you’re probably going to want to see your CPA or your tax professional, going forward, to see if this applies to you and how you can take advantage of it.

John

This is one of the areas that’s so new that we don’t know a lot about how it’s going to work at this point. So, we’re waiting for some additional guidance. It’s one definitely to keep an eye on for next year.

Ryan

Yeah. That’s a great little disclaimer or disclosure here, is we don’t know exactly how all this is going to play out. So, we could have torn apart more into the bill and went into the nitty gritty details; but it wouldn’t have made sense, because we still don’t have the guidance to go through it. So, maybe, John, we’ll have you back on towards the end of the year to go through, once further guidance is out; maybe to explain a few extra things and see if there’s any loopholes or anything that all the CPA’s have found. I know that it’s going to take them months to figure out what we can do and not do.

Curbside Consult

And now it’s time for the Curbside Consult.

Ryan

So, my first question is around 1099 income and the physicians that earn it. Is there anything in the tax bill that would cause them to change how they would either form their practice or, basically, how would they make changes around their practice to minimize their taxes?

John

At this point, with the information that we know, I’m not advising any clients to make any business entity changes based solely on the new law that we have; just because we don’t know enough yet to make these decisions. The Treasury Department is definitely going to have to write some regulations here, or there’s going to have to be some technical fixes to the bill, in order to get this all to work out correctly, I think, the way congress intended. So, at this point, I would say it’s premature to make any business changes, unless you have some other things going on in your business that makes sense to address at this point. If you have a tax professional that you’re working with, then I would certainly talk to them about that; but, right now, I wouldn’t advise any changes until we get a little bit more information.

With physicians earning 1099 income, it’s premature to make any business changes unless you have to.

Ryan

And based on what you’re reading with that, again, good disclaimer of saying “let’s make sure we know what’s actually going to happen;” but, based on what you’ve read and what you’ve seen, is there anything that would cause you to lean one way or another in terms of how they would organize?

John

Most of the tax experts that I’ve read, at this point, have advised that we think the S Corporation is still going to become the vehicle of choice; which it has been for a number of years. The thing that we’re waiting on some additional guidance for, right now; is the plain letter wording of the law, right now, seems to put sole proprietors that are filing their income directly on their return as a schedule C, at a little bit of an advantage the way the laws are currently written. There’s some technical reasons for that, but we think that’s going to be addressed through some fine-tuning of the legislation, here within the next couple of months. Really, until we have that final answer, we don’t know for sure.

This is why the S-Corp continues to be a vehicle of choice.

Ryan

Yeah. That makes complete sense. I want to ask you one more quick question on this one and then we’ll move to the next one. You had mentioned S Corp and that it’s been kind of the vehicle of choice. Can you just explain a little bit about why it’s the vehicle of choice and maybe even what is an S Corp. An S Corp is a legal entity type for tax purposes that we can elect into. The primary advantage for it, is that we can have some of the earnings from the S Corporation paid out as wages, and subject to self-employment taxes; and then part of the earnings come out just as distributions that are still subject to income tax, but they’re not subject to employment taxes, like Social Security and Medicare. So, there’s generally a little bit of an advantage to an S Corporation over a sole proprietorship that would pay self-employment taxes on all of their income.

Ryan

Perfect. So, the second question I have for you, John, is what can physicians do right now, in 2018, to get ready for filing their taxes, either for 2017 or in prep for all the changes in 2018?

John

Yeah. The first thing I always mention is just to get organized this time of year. This is a great time to set aside a little bit of time, go through your financial transactions with an eye towards looking at it from a tax perspective. Look through everything and make sure you’re keeping track of all of your mail that comes in over the next month or so, as you get tax documents in, and just set that aside in one place, so that you have one central location to look for all those documents. As we move forward into next year, depending on your situation, you know, if you’re in a relatively small business; I think you’re going to want to see your CPA early and often. It’s not just an advertisement for CPA’s everywhere, but I think it’s really going to be important this year with all of the tax law changes. Don’t contact them before April 15th with your tax planning.

John

But, shortly after that, I would say that’s a good time to get in touch with your CPA, go over your tax situation, and see if you can’t bend some of these new laws to your benefit.

Ryan

That’s great advice. I kind of chuckled when you said “don’t do it before April 15th.” For those that just think that CPAs do taxes and they’re only busy from January 1st to April 15th, can you kind of just tell people from a general standpoint…when should they contacting CPAs to look at general planning advice for that current year? When are the best times?

John

Yeah. The best time really starts in May, after the CPA’s have gotten a couple of weeks’ breather after tax season. Then, all the way up until September, generally, is a good time to reach out. That’s in-between a lot of our tax filing deadlines and that’s time where we really have some time to sit back and actually do some tax planning for folks.

Ryan

Perfect. Well, John, thank you so much for being on the show. I really appreciate it. If you could, just tell people where they can find you.

John

So, I’m available online, at johnmccarthycpa.com. That’s my main website. We’re available, we’re taking a few more clients here for this tax season. You can schedule directly online on our website. We’re a totally virtual firm. So, we work out of multiple states, but we use a lot of technology to meet with clients and we work with folks all around the U.S.

Ryan

Perfect. Well, thanks John, again, for being on the show. I appreciate it.

John

Sure. Thanks, Ryan.

Ryan

Alright. Well, thank you again, John, for being on the show. Listeners, I know that taxes are not the most favorable thing to listen to in here, but this stuff was really important. There’s so many changes, it affects all of us. So, John, thanks again for being on the show. One thing I didn’t mention, and John and I didn’t talk about on the show, was the concept of the backdoor Roth. I know that this is a very popular strategy, for very good reasons, throughout the Physician Finance community. I wanted to let you guys know that this was left untouched in the final legislation, so we can continue doing our backdoor Roth’s. Next week’s show is going to be a Curbside Consult, but it’s a little bit different. I was honored to be one of the expert panelists for the New England Journal of Medicine’s Financial Planning 101 series. In that series, there were so many great questions, that I feel like I should highlight some of them on the show.

Ryan

So, I’m going to pick out four or five questions from that series; and then, I’m going to give you guys my answers. I’ll also link to it in the show notes of next week’s show, so you guys can go read all of the questions. There were a lot of great questions asked. Yeah, next week we are going to be doing a Curbside Consult with several questions from that New England Journal of Medicine’s Financial Planning 101 series. So, have a great rest of your week and I’ll see you guys next week. Take care.

 

Ryan Inman