Tax Planning for Physicians: Concepts You Need to Know

When thinking about your personal finances and annual financial plan, you should not overlook tax planning. Tax planning is the process of analyzing your personal finances from a tax perspective and understanding how your income, expenses, purchases, and other financial transactions will affect how much tax you pay.

This includes understanding concepts such as knowing the difference between tax credits and tax deductions, how the sale of your personal residence affects your taxes, why you should contribute to tax-favored accounts, what marginal tax rates are, and many other topics.

In the Public Service Loan Forgiveness Program and want to know how it affects your taxes? I go toe-to-toe with John McCarthy, Co-Founder of Physician Tax Advisors, about it in this show:

When done properly, tax planning can help you save hundreds or even thousands of dollars on your tax bill.

When not done at all, it can be costly, stress-inducing, and lead to unnecessary run-ins with the IRS.

In this article, we will cover many of the basic concepts that physicians should know when it comes to tax planning as well as a few of the special rules that only apply to high-income earners like you.

How to Get Started with Your Tax Planning

Start with understanding your current situation. Once you know your current tax situation, you can start making adjustments and better plan for the upcoming year.

The best way to understand your current tax situation is to look at your prior-year tax return. Last year’s tax return will give you tons of good information on how your tax situation played out.

It will show you how much money you made, whether you took the standard deduction or itemized your deductions, how much tax you owed or refund you received, and what deductions and credits you took.

The tax year starts on January 1 and ends on December 31, so any changes to your financial situation starting January 1 will affect your current year taxes.

If you received a raise in February, plan to sell your home in June and are getting married in September, then you know your tax situation will likely be very different this year than it was last year, and you will need to make some adjustments.

Know How Your Individual Tax Return Works

Knowing the general layout of your individual tax return will help you see the bigger picture when thinking about your tax plan. Your individual tax return is filed using IRS form 1040 and follows these steps to calculate your taxes:

1. Accounts for all the income you earned throughout the year.
2. Gives you certain deductions to reduce your taxable income.
3. Uses the IRS tax rates to determine the amount of tax you owe.
4. Compares the amount of tax you owe to the amount of tax you paid throughout the year.
5. If you owe more than you paid in, you must pay additional taxes.
6. If you paid in more than you owe, you will receive a refund.

Your tax return is due the following year on April 15. For example for the tax year from January 1, 2020, to December 31, 2020, your tax return is due on April 15, 2021.

Good tax planning will help you estimate the above information prior to when you file your tax return, so there are no surprises when it is due on April 15.

Understanding Marginal Tax Rates

No tax planning conversation is complete without talking about marginal tax rates.

The United States operates on a progressive tax system which means the more you earn, the higher your marginal tax rate. What does that mean?

This means that portions of your income are taxed at different rates (i.e. marginal) instead of one flat rate. These rates depend on your filing status and your taxable income. The chart below shows the marginal tax rates for 2020.

Let’s walk through an example.

You are a single physician whose taxable income for 2020 is $150,000.

This puts you in the 24% marginal tax bracket. However, you do not pay 24% on your entire $150,000. This is what it means to operate on a marginal tax rate system.

Using the graphic above, you can see that you are only taxed at 10% for your first $9,875 of taxable income and will owe $987.50 in taxes for this portion of your income.

Next, you will only be taxed at 12% for your income between $9,876 and $40,125. This comes to a tax owed of $3,629.88 ($30,249 x .12).

This is followed by a 22% tax on your income between $40,126 and $85,525. This comes to a tax of $9,987.88 ($45,399 x .22).

Finally, you land in the 24% tax bracket where your remaining taxable income above $85,526 will be taxed at 24%. This comes to a tax of $15,473.76 ($64,474 x .24). The $64,474 comes from subtracting $150,000 from $85,526. This is the only portion of your income taxed at 24% because of the progressive nature of the United States tax system.

Adding up your taxes from above, you would pay a total of $30,079 in taxes for 2020 with a taxable income of $150,000.

One thing I would like to mention is don’t let anyone tell you that you should earn less because you will owe more in taxes. That is bad advice, but advice that a lot of people hear. Would you rather make $100,000 and be taxed in the 24% bracket or make $70,000 and be in the 22% bracket?

If your taxable income is $100,000 you would owe $18,079 in taxes and take home $81,921. If your taxable income is $70,000 you would owe $11,190 in taxes and take home $58,810.

Who would you rather be?

Yes, earning more means you have to pay more taxes, but it also means you will be taking home more to support you and your family and let you live the life you want to live.

Marginal tax rates are one of the building blocks when it comes to tax planning. Understand this concept, and you will know how to plan your own taxes or ask informed questions when working with your financial planner or tax advisor.

How Your Filing Status Affects Your Tax Planning

Another concept to understand when it comes to tax planning is your filing status. There are five filing statuses to choose from, and they have a direct impact on the amount of tax you pay each year. Understanding which filing status you should choose is essential to paying the correct amount of tax on your income.

Let’s compare a single person to a married couple to illustrate this concept.

A single person with a taxable income of $100,000 falls into the 24% tax bracket. A married couple with the same $100,000 income falls into the 22% tax bracket.

As you can see, a single person will owe 24% on additional income up to $100,000 while a married couple will only owe 22% on additional income up to $100,000. Selecting and planning for the right filing status will help you accurately estimate and pay your taxes

What Filing Status Should You Pick?

There are five filing statuses to choose from when filing your tax return. We will outline each one below.

Single

To qualify for the Single filing status, you must be not married or legally separated as of the end of the tax year.

Married Filing Jointly

To qualify for the Married Filing Jointly (MFJ) filing status, you must be married as of the end of the tax year. You can also qualify for MFJ if your spouse died during the tax year, and you did not remarry during the year of your spouse’s death.

You and your spouse are both fully responsible for the tax liability on your joint return if you file MFJ.

Married Filing Separately

To qualify for Married Filing Separately (MFS), you must be married and decide to file a separate return.

Head of Household

To qualify as Head of Household, you must be unmarried at the end of the tax year and meet one of two criteria:

Criteria 1

You paid over half the cost to maintain a home for your parents. You must be able to claim this parent as a dependent on your return, and the parent does not have to live with you to qualify under these criteria.

Criteria 2

You paid over half the cost to maintain a home for you and for a qualifying person whom you can claim as a dependent. This dependent must have lived in your home for more than half the year. A qualifying person can be your son, daughter, grandchild, father, mother, or other close relatives. The key is you must be able to claim them as a dependent on your return.

Qualifying Widower

To qualify as a Qualifying Widower, you must fully meet all the following criteria:

1.   Your spouse died in one of the past two years, and you did not remarry by the end of the current year.
2. You had the choice to file a joint return in the year your spouse died, even if you did not actually file jointly.
3. You can claim a child as a dependent, and this child lived with you for the entire tax year.
4. You paid more than half the cost to maintain your household for the tax year.

The Relationship Between Total Income, Adjusted Gross Income and Taxable Income for Tax Planning

If you have ever looked at IRS form 1040, you will notice that there are three different lines for income on the front page. There is total income (line 7b), adjusted gross income, or AGI as it is commonly referred to (line 8b), and taxable income (line 11b). Each of these lines plays off the other, and it is important to know what financial activities go into each line.

Total Income

Your total income on line 7b is a total of all the income you received for the year from all sources. This includes from your salary, retirement plan distributions, interest payments, dividends, capital gains from stocks and bonds, capital gains from selling your home, side gig income (i.e. moonlighting & locum tenens), and income you received for operating a business or being paid as an independent contractor. All this income is combined to arrive at your total income number on your tax return.

Knowing all the sources of your income when you start your tax planning will help you understand how much money you are expecting to make this year and allows you to plan appropriately for the taxes you will owe.

Adjusted Gross Income

To arrive at your adjusted gross income (AGI), you subtract all your deductions from your total income. This gives you your AGI. These deductions come from IRS form Schedule 1 and include deductions for student loan interest, traditional IRA contributions, and a portion of your self-employment tax if you are self-employed.

Taxable Income

Finally, to arrive at your taxable income, you will subtract either the standard deduction or your itemized deductions from your AGI. Itemized deductions are calculated on the IRS form Schedule A and include deductions for medical expenses, state and local taxes, and gifts to charity. If you own a business, you may also qualify to subtract the Qualified Business Income (QBI) deduction to arrive at your taxable income.

Your taxable income is the number you use to calculate your tax based on the IRS tax rate tables. As you can see, the total money you make from your job or your business is not necessarily the amount you will pay tax on. There are a lot of adjustments and deductions to help lower your taxable income.

What’s the Difference Between Tax Credits and Tax Deductions, and How Do They Affect Your Tax Planning?

Tax credits and tax deductions help reduce your total tax, but they do so in different ways.

A tax deduction reduces your taxable income which decreases your total tax by your marginal tax rate multiplied by the deduction you are taking.

A tax credit reduces your total tax dollar-for-dollar by the amount of the credit.

Let’s compare three physicians to see how tax deductions and tax credits differ in real life.

In the chart below, all three physicians are married, have a total income of $100,000, and take the standard deduction of $24,800 for the 2020 tax year.

Physician 1 can’t take any other deductions or credits and ends up paying $8,629 in tax.

Physician 2 can take the student loan interest deduction which reduces her AGI and taxable income by $2,500. She now only pays tax on $72,700 which is $2,500 less than Physician 1. Since she pays tax based on her marginal tax rate, this deduction decreases her total tax by $300 ($2,500 x 12%).

Physician 3 is like Physician 1 and doesn’t take the student loan interest deduction, so his tax is the same as Physician 1. However, Physician 3 has a qualifying child and can take the child tax credit for $2,000 in 2020. This reduces his total tax by $2,000, so he only pays $6,629 in tax (the lowest of all three physicians).

So which would you rather have? A deduction or credit?

Tax credits are much more beneficial as they decrease your actual tax. Deductions are still good, just not as good as tax credits.

The thing to remember is deductions reduce your income before you calculate your tax while tax credits reduce your actual tax after you calculate it.

Common Deductions and Credits to Know for Your Annual Tax Planning

Now that you know the difference between tax credits and tax deductions and how they affect your taxes, you probably want to know what they are and if you qualify for them. In this section, we will give you an overview of some of the most common deductions and credits that you should know.

Traditional IRA Deduction

The IRA deduction is available to taxpayers who contribute to a traditional IRA. For 2020, you can contribute up to $6,000 and deduct this amount on your tax return. This amount is limited if you are covered by a workplace retirement plan and your modified AGI is above $65,000 for Single taxpayers and $104,000 for Married Filing Jointly taxpayers.

Student Loan Interest Deduction

You can deduct up to $2,500 in student loan interest on your tax return in 2020. This deduction is also limited based on your modified AGI.

Deductible Part of Self-Employment Tax

If you are self-employed, you are on the hook for the employee and employer portion of your self-employment tax calculated on Schedule SE. The IRS offers a tax break to self-employed individuals by allowing you to deduct the employer portion of your self-employment tax on your tax return.

American Opportunity Credit (AOTC)

The AOTC is a tax credit available to taxpayers who are in the first four years of their higher education and have paid qualified education expenses. The credit is for a maximum of $2,500, and if it brings your total tax liability below $0, you may be eligible to receive a refund. You are not eligible for this credit while in medical school, but if you are a parent who has kids in their undergraduate years, you are likely eligible to take this credit on your tax return. You can take the credit for each eligible student you claim as a dependent on your tax return, and can only claim it up to four times per eligible student.

If you claim the AOTC, you must fill out IRS form 8863.

Lifetime Learning Credit

The Lifetime Learning Credit is available to students who are in their undergraduate years and can no longer claim the AOTC, or students in their graduate studies. This credit is for a maximum amount of $2,000 and may be limited based on your income and the amount of your expenses.

You can claim both the AOTC and the Lifetime Learning Credit on the same return, but you can’t claim them for the same student.

You must also fill out the IRS form 8863 if you take the Lifetime Learning Credit.

Child Tax Credit

If you have a qualifying child whom you claim as a dependent, you may be eligible to claim the child tax credit for up to $2,000. A child is a qualifying child if they meet all the following seven criteria set out by the IRS:

1. The person you are claiming as a child/dependent is your son, daughter, stepchild, sibling, half-sibling, or any descendants of these people such as your grandchild.
2. The child was under age 17 at the end of the tax year.
3. The child provided less than half of their own support for the year.
4. The child lived with the taxpayer for more than half the year with exceptions for temporary absences such as schooling, vacations, military service, medical care, and others. Additionally, if your child was born during the last half of the tax year (including December 31), then they qualify as a child for the child tax credit.
5. You can claim this person as a dependent on your tax return.
6. The child does not file a joint return with someone else for the tax year.
7. The child is a U.S. citizen, U.S. national, or U.S. resident alien.

The child tax credit is limited if your modified AGI is above $400,000 for MFJ taxpayers and $200,000 for all other filing statuses.

Credit for Child and Dependent Care Expenses

This tax credit is often overlooked when it comes to tax planning. This credit is available to taxpayers who pay for someone to care for their dependent, while the taxpayer works or looks for work. The dependent must be a child under the age of 13 or a dependent who can’t take care of themselves.

This credit is limited to 35% of the qualifying expenses you incurred, and this percentage changes based on your AGI.

The IRS defines a qualifying expense as one that allows you to work or look for work and is used for your dependent’s care. IRS publication 503 outlines all the rules around qualifying expenses. Some expenses that do qualify are nursery school or preschool expenses and even day camps. If you are sending your kids to soccer camp in the summer while you are at work, the camp fees may qualify you to take this tax credit.

There are plenty of other deductions and credits you can claim. The ones mentioned above are some of the most common and will help you reduce your tax liability if used appropriately.

What You Need to Know about the Standard Deduction and Itemized Deductions Regarding Your Tax Planning

When you file your individual tax return, you will have a choice to either take the standard deduction or itemize your deductions to reduce your taxable income. You can pick one or the other, and you will normally pick the larger deduction.

The standard deduction amount is set by the government, usually increasing annually for inflation. This gives everyone a chance to reduce their taxable income by the same amount. In 2020 the standard deduction was increased to the following amounts for each filing status:

• Single – $12,400
• Married Filing Jointly – $24,800
• Married Filing Separately – $12,400
• Head of Household – $18,650

If you would like to itemize your deductions instead, you can fill out IRS form Schedule A. Itemizing your deductions allows you to track certain personal expenses, and deduct those expenses on your tax return if the total is more than the standard deduction.

Expenses you can itemize on your Schedule A include medical and dental expenses, state and local taxes, mortgage interest you paid, gifts you gave to charity, casualty and theft losses, and certain other expenses.

All these expenses have certain limitations and rules, so you likely won’t be able to deduct the full amount of your expense. To learn more about Schedule A, itemized deductions, and the limits for each category, you can reference our IRS publications article.

Understanding whether you are going to take the standard deduction or itemize your deductions plays a big role in your tax planning. The standard deduction requires no additional work on your part. You just fill out your tax return, enter the standard deduction amount for your filing status, and move on.

On the other hand, itemizing your deductions requires a lot more tracking, planning, and preparation. When you itemize your deductions, you need to keep track of all your expenses and receipts, so you can reference them when you fill out your Schedule A. You will also need to keep these records in case the IRS doesn’t agree with a deduction you took, and you need to prove it to them down the line.

How Social Security Tax, Medicare Tax, and Other Paycheck Deductions Play into Your Tax Planning

Whether you work for an employer or are self-employed, you will need to prepare for your social security tax, Medicare tax, and other paycheck deductions when you start tax planning for the year. As high-income earners, physicians also have some additional provisions to understand.

How the Social Security Tax Works for Physicians

Social Security is a government program that provides benefits to retirees and certain other individuals who can’t work and is funded by the general, working public through the social security tax.

Every employee and employer in the United States must pay a portion of their income into social security through the social security tax. You may also hear this called the FICA tax. When people reference FICA, they are referring to both the social security tax and the Medicare tax.

Each employee pays 6.2% of their income into social security and each employer pays 6.2% of the employee’s income into social security coming to a total of 12.4%. If you are a self-employed individual, you are responsible for both the employee and employer portion of the social security tax. This is why the IRS gives self-employed individuals a tax deduction for the employer portion of self-employment taxes.

The good thing about the social security tax is that you are only taxed on 6.2% of your income up to a certain limit. For 2020, that limit is $137,700. This means you will only have to pay 6.2% of your income into social security for the first $137,700 you earn each year. After that, each additional dollar of income you earn will not be subject to the social security tax.

You might notice on your W-2 tax form that your wages in box 1 are different from Social Security wages in box 3. That’s because the IRS calculates your social security tax based on your gross income whereas box 1 of your W-2 is the income you report on your tax return for federal income tax purposes.

Box 1 will be your gross income less any pre-tax retirement contributions you made throughout the year. Box 3 (Social Security wages) will be your total gross income, so your retirement contributions are not subtracted from this number.

There is not much tax planning you can do to decrease your social security tax unless you are certain self-employed individuals, but that is beyond the scope of this article.

How the Medicare and Additional Medicare Tax Works for Physicians

Medicare is another government program that provides health insurance for people over the age of 65 and other qualified individuals. Like social security, Medicare is funded through taxes.

Unlike social security, there is no limit to the amount of your income subject to Medicare taxes. In fact, if you earn more than certain thresholds, you will owe additional Medicare taxes.

To start, every employee and employer will pay a portion of the employee’s income to fund Medicare. The employee will pay 1.45% of her wages, and the employer will pay 1.45% of the employee’s wages for a total of 2.9%. Again, self-employed individuals are on the hook for both the employee and employer portion.

Similar to social security, your Medicare tax is based on your total earned income, not reduced for retirement contributions. However, unlike social security, you will owe Medicare tax on all your income. There is no wage limit like there is for social security.

Additionally, if you earn more than the following amounts, you will owe an extra .9% for your Medicare taxes. The thresholds are:

• $200,000 for Single taxpayers
• $250,000 for Married Filing Jointly taxpayers
• $125,000 for Married Filing Separately taxpayers

Your employer is required to start withholding this additional .9% once your wages exceed $200,000 each year. If you are Married Filing Jointly, and you have the additional tax withheld even though you never earn more than $250,000, then you will receive a tax credit on your tax return to offset the amount that was withheld from your paycheck, even though you didn’t actually owe it.

Other Common Paycheck Deductions You Should Know

Aside from FICA taxes (i.e. Social Security tax and Medicare tax), you will likely see a few other deductions from your paycheck, depending on your circumstances.

If you enroll in health insurance through your employer, your premiums will be deducted from your paycheck on a pre-tax basis. That means your wages for federal tax purposes are decreased by the amount of your health insurance premiums.

You will also see withholdings on your paycheck for federal, state, and local income taxes. The amount that is withheld from your paycheck is based on how you fill out your W-4 tax form which we covered in detail here. When you file your tax return each year, these withholdings are the amount you will use to determine if you paid too much or too little tax throughout the year.

Updating your W-4 is one of the first things you should do every year when starting your tax planning. You can account for changes to your income, life-changing events such as marriage or having a child and possible deductions and credits when completing your W-4. The way you fill out your W-4 has a direct impact on the amount of federal taxes withheld from your paycheck, and filling it out correctly will help you accurately plan out your tax situation for the current year.

If you contribute to a workplace retirement plan, you will also see your regular retirement contributions listed on your paystub. When you contribute pre-tax dollars to your retirement plan, you decrease your income that is subject to federal income taxes. This is a great way to reduce your current year taxes.

You might also hear about FUTA and SUTA which stand for Federal Unemployment Tax Act and State Unemployment Tax Act respectively. As an employee you do not pay into these programs, but your employer does on your behalf. These funds are then used to support unemployed individuals.

What Self-Employed Physicians Need to Know about Tax Planning

Small business owners and self-employed individuals have a lot on their plate from running a business and working with patients to tracking their income and expenses and paying their own taxes throughout the year.

Self-employed individuals include freelancers, moonlighters, small business owners and independent contractors, and they are both the employee and the employer in business. That means they are solely responsible for making quarterly estimated tax payments throughout the year. Doing diligent tax planning as a self-employed individual will help you stay current on your tax payments and avoid any unwanted check-ins from the IRS.

Since you are both the employee and the employer, you are responsible for both the employee and employer portion of the FICA tax. This is in addition to your federal and state income taxes.

Schedule SE is the IRS form you will use to figure out the total self-employment tax you owe for the year. The United States runs a pay-as-you-go tax system, so you will need to send quarterly payments to the IRS for your self-employment taxes and your federal income taxes. If you forget to do this, you will receive underpayment penalties from the IRS when you file your tax return.

Any time we talk about taxes on self-employed individuals, the tax is on your net earnings from your business. That is your earnings after you deduct all your business expenses from your income. You can figure out your net earnings by completing IRS form Schedule C and by keeping good records of your income and expenses throughout the year.

Your net earnings then flow from Schedule C to your individual tax return where you will calculate how much federal income tax you owe based on your net earnings. You will compare this tax number to the amount of the estimated payments you sent in for the year.

Self-employed individuals have some unique tax advantages that traditionally employed people don’t have which is why tax planning for the self-employed can lead to big tax savings. Self-employed people can deduct most expenses related to their business thus reducing their taxable income and total tax owed. These are expenses that are normal to running the type of business you operate can include office expenses, scrubs, technology, and other related expenses. This also includes being able to deduct expenses for having a home office and for car mileage related to your work.

Using Tax Favored and Tax Deferred Accounts When Tax Planning

A big part of tax planning is using tax-favored and tax-deferred accounts to help you accumulate wealth in a tax-efficient manner. What does it mean for an account to be tax-favored or tax-deferred and what accounts are we talking about?

Tax-deferred accounts are accounts where you contribute money on a pre-tax basis and let the money grow tax-free until you withdraw the money at a later date. The withdrawals are then taxed at your ordinary marginal income tax rate. Examples of tax-deferred accounts include workplace retirement plans like 401(k)s and 403(b)s, and traditional IRAs.

Another example of a tax-deferred account is the health savings account (HSA) which is often known for its triple tax savings. With an HSA, you put money in tax-free, let it grow tax-free and withdraw the money tax-free if you use the funds for the qualified health expenses.

A tax-favored account is an account that gives you favorable tax treatment either by contributing to the account on a pre-tax basis or being able to withdraw funds without paying tax on them.

A good example of a tax-favored account is the Roth IRA. You pay tax on the money you contribute to a Roth IRA and let it grow until you reach age 59 ½. Once you reach age 59 ½, you can withdraw all your contributions and any gains you accumulated tax-free.

Tax Planning for Major Events

Getting married, having kids, and selling a home for a profit are all things to celebrate. All these events also come with differing tax implications that you should consider when thinking about your tax planning.

Getting Married

When you get married, you and your spouse will want to adjust your W-4 to update your paycheck withholdings and reflect your new tax filing status. You will also want to know what financial transactions your spouse made before you became married, especially in the year you got married. If your spouse sold a bunch of stocks at the beginning of the year, then you get married and file a joint tax return, you will want to know about the sale of those stocks. That sale will impact your tax return since you will be filing your taxes together moving forward.

Having Kids

When you have kids, you will want to adjust your W-4 to update your withholdings. You will also want to consider what tax credits you may now qualify for. These credits include the child tax credit and the child and dependent care tax credit. If you adopted a child, you should also consider the adoption credit.

Kids are expensive, so make sure you take any help you can get from the IRS to help your personal financial situation.

Selling a Home

There are a lot of things to consider when selling a home. From a tax perspective, if you sell a home for a gain you will owe capital gain tax on the profit you made. You need to plan for this if you intend to sell your home. This could be a large amount of money depending on your original purchase price and your selling price

Thankfully, the IRS has a generous tax break when it comes to selling a personal residence for a profit. Under section 121 of the tax code (outlined in IRS publication 523), you may be eligible to exclude $250,000 of gains ($500,000 if MFJ) on the sale of your home if you meet both of the following conditions:

1. You owned the home for at least two out of the last five years. If you are married, only one of the spouses must meet this requirement.
2. You lived in the home and used it as your personal residence for at least two of the last five years. This can be any two year period from the last five years and does not need to be continuous. If you are married, both you and your spouse need to meet this requirement, otherwise, you will only be eligible for a partial exclusion of the gain.

Depending on how you fall into this criteria and why you are moving, you may be eligible to claim a partial amount of this exclusion.

Regardless, selling your home has major tax implications, and you should understand the tax and financial implications before you decide to sell your home.

Filing Your Tax Return after Tax Planning

Once you have finished your tax planning for the year and implemented the various strategies, the last step is to file your tax return using IRS form 1040.

One way to file your return is through paid software like TurboTax. For simple tax situations, this is a great, low-cost way to file your tax return. TurboTax will ask you a series of questions regarding your personal situation, and then ask you to input the information from all the tax forms you received from your employer, clients, and banking and financial institutions. From there, they will put together your federal and state returns.

If you file local taxes, you will need to file those with your local municipality outside of TurboTax.

You can also file your taxes by hand and mail in your tax return. However, this is not a recommended option since it is highly prone to error.

Another option is to file your tax return for free using one of the IRS free e-file services. You can find these services here. If your adjusted gross income is below a certain threshold ($69,000 for 2019), you can use one of these free, online filing services to file your tax return.

Another free option is to seek out one of the IRS Volunteer Income Tax Assistance (VITA) sites and have IRS certified volunteers help you file your tax return. The VITA program offers free tax preparation for people who make less than $56,000, so you will likely only be eligible to use this program while you are a resident or in medical school.

A final option is to find a tax advisor you trust to help you file your tax return. Tax advisors are well-versed on the tax code and stay up-to-date on the most recent changes. A good tax advisor will provide value beyond just filing your tax return. They will get to know you and your tax situation, help you understand the implications of your financial transactions and help you put together a tax plan that lets you use your financial resources in the most tax-efficient way.

What Records Should You Keep When Tax Planning

Keeping records is not glamorous, but it will save you tons of headaches if you ever need to reference them in the future. Thankfully, you don’t need to keep your tax records forever. In this section, we will overview what records you should keep, how long you should keep them, and give some examples of filing systems you can use.

What Records Should You Keep?

The short answer is it depends.

In general terms, you will want to keep anything that helps you verify any income, deductions or credits you reported on your tax return.

If you itemize your deductions, then you will have more documents to keep than someone who takes the standard deduction. More specifically, whatever expenses you itemize on your Schedule A, you will want to keep the receipts and documentation that verify you were eligible for that deduction.

Keeping old tax returns is also good practice.

They give insight into your prior financial life and can be a good starting point when starting your tax planning for the current year. You can also amend prior returns up to three years after you filed your original return, so if someone reviews your return and comes across a mistake or realizes there was a credit you could have taken that you didn’t, then you can use your prior return as a starting point for the amendment.

The IRS will also want to see prior tax returns if they ever decide to audit you.

You will also want to keep any items of income such as your W-2 or 1099s that verify the accuracy of what you reported on your tax return. The same goes for documents verifying credits and deductions you took such as your 1098 mortgage interest statements and 1098-E student loan interest statements.

If you run a business, you will want to keep your old income statements and balance sheets to show the legitimacy of the income and deductions you reported. If you are taking deductions for things such as your car mileage, having records of that will also be useful.

How Long Should You Keep Records?

Different documentation requires different retention periods.

For tax returns and related records (W-2, 1099, 1098, etc.) the IRS recommends you hold on to these documents for three years. Once three years is up, you can get rid of your returns and related documents. Personally, I would recommend holding on to these documents digitally rather than fully getting rid of them. Digital records take up no space in your home, and it’s easy to file them in a folder on your computer. Why not keep them just in case you need them down the line?

If you are a small business owner, the IRS recommends you keep all employment tax-related documents for up to four years after your fourth-quarter filing. This includes:

• Your EIN
• Wages paid to employees
• Employee W-4s
• Dates and amounts of tax deposits you made

You can check out a full list of this documentation here.

You will want to keep any records for property you own (date of purchase, purchase price, date of sale, etc.) until three years after you dispose of the property. This aligns with your personal tax return retention.

If you failed to report some items of income, the IRS has up to six years to assess additional tax on you. Keep records for six years if you are in this scenario.

For people who didn’t file a return or filed a fraudulent return, the IRS can assess additional tax on you whenever they learn this information. There are no limitations under these circumstances, so if you know you didn’t file a return or filed one fraudulently, you will want to keep these records forever.

What’s the Best Way to File Your Records?

Some people like to keep paper while others prefer a more digital approach. When deciding how to keep your records here are some tips to keep in mind.

If you like to keep your files in a digital format, keeping them secure is a top priority. Services like DropBox and Google Drive are great options to keep your information secure, all in one place and readily available no matter where you live.

If you prefer to keep old fashion paper records, you will want to keep them in some sort of storage that will survive disasters such as a house fire.

Whether you store your records digitally or physically, the same retention periods and requirements pertain.

Since your tax year is the same as a calendar year, creating different folders for different years will help you stay organized and be able to easily find your information if you are ever asked for it. Separating items by income, expenses, deductions, and credits could also be useful if you have enough documents to keep track of.

Tax planning is more than just figuring how to save money on taxes. It requires some grunt work such as retaining records and getting rid of them when they are no longer needed. Take the time to properly file your records in whatever format you prefer and know your future self will thank you for it.

Tax Planning by Quarter: Super Easy Ways to Keep Your Taxes Organized All Year

Tax planning is a year-round endeavor, and knowing what to do and when can help you stay on top of your tax situation throughout the year. In this section, we will breakdown the year and give you tax planning insights to know depending on the time of year.

Year-Round Tax Planning: January 1 – December 31

Like most plans, tax planning is not a one and done thing. It is constantly changing as your life changes. When thinking about your tax plan, here are some things to keep in mind throughout the whole year.

• Adjust your W-4 for raises, life events (i.e. marriage, kids), when selling assets or earning a side income. You can update your W-4 whenever you want, so make sure you update it whenever your income increases or decreases significantly.
• Make quarterly estimated payments if necessary. See our article, Tax Due Dates for 2020 for when the quarterly due dates are.
• Keep receipts and documentation for possible itemized deductions such as medical expenses and charitable contributions.
• Keep receipts and documentation for possible tax credits such as the child and dependent care tax credit which might qualify you to deduct summer camp costs for your kids.
• Before you make major financial decisions like buying or selling a home, selling stocks or bonds, starting a business or moonlighting, make sure you understand the tax implications.
• If you are running a business, keep track of your income and expenses using accounting software like QuickBooks.

January to March Tax Planning

The first quarter of the year is a busy time of year. You need to gather your documents to file your tax return and think about the year ahead. Here are some tips to keep in mind as you plan the first quarter of your year.

• Gather all tax documents from your employer and financial institutions, so you can file your individual tax return by April 15. These tax forms include your W-2, 1099, 1098 mortgage interest statement and 1098-E student loan interest statement.
• If you are in a partnership or have an S-Corp, your business return is due by March 15. Don’t let this deadline creep up on you.
• If you are eligible and haven’t contributed to an IRA for the previous tax year, you have until April 15 to contribute to your prior year IRA. Make sure you contribute if you are able to!
• Set your current year retirement contributions. This will help you reduce your taxable income and give you a better idea of what your taxable income will be at the end of the year. This goes for both workplace retirement plans and IRAs.
• If you are interested in meeting with a tax advisor, now is probably not the time to do it. They will be swamped with their current clients. It never hurts to call, but be ready to pay a premium for last-minute advice and tax return filing. Tax planning with an advisor should not be a one and done sort of thing. You should build a relationship with a trusted advisor and talk about your tax situation more than one time a year during the tax filing season.

April to September Tax Planning

After the mad dash to April 15, tax-related items settle down for a bit. Here are some things to keep in mind during the summer months.

• File your federal, state and local individual tax returns by April 15
• If you need to file an extension, file that by April 15. This extends your tax filing deadline to October 15, however, you still need to pay your taxes by April 15
• Once you file your return, file your tax documents in your physical or digital filing system
• Review your current year tax plan and make any adjustments as necessary
• Now is a good time to interview new tax advisors if you are interested in working with one
• Summer wedding? Make sure you adjust your W-4 withholdings
• Selling a home for a profit? Make sure you know if you need to pay tax on any portion of the gain and set aside the appropriate funds.

October to December Tax Planning

The last quarter of the year is another busy time for tax planning purposes. Doing some planning and preparation during this time will help the first quarter of the following year go much smoother.

• File your extended tax return by October 15
• Gather all your receipts and documents for items you may be able to deduct on your tax return. Whoever prepares your return will thank you for this
• Make any year-end decisions that might help you reduce this year’s taxable income. See our next section on various year-end tax planning tips.
• Check your eligibility for deductions and credits
• Estimate your tax liability and make sure you have paid in enough tax to avoid underpayment penalties when you file your tax return. This includes your paycheck withholdings and any tax payments you have made as a self-employed individual. Send in payments or increase your withholdings if you need to true up your taxes.
• If you are working with a tax advisor, meet with them and make sure everything is in line for the current year and start talking about what you should do at the beginning of next year while they are working through their clients’ tax returns.

Year-End Tax Planning Tips for Physicians

As we have mentioned, tax planning is a year-round activity, not just a once-a-year thing. However, when the end of the year approaches, you will want to consider some of the following items before the tax year ends.

Retirement Planning

Are you looking for an easy way to reduce your taxable income as the end of the year approaches? Contributing additional funds to your pre-tax retirement accounts is a great way to capture additional tax savings without putting forth too much effort. This can be to your workplace plan or to your IRA.

One great thing about IRAs is that you have until April 15 to contribute to it for the previous tax year. For example, you have until April 15, 2021 to contribute to your IRA for the tax year 2020.

This concept does not apply to workplace retirement plans. Once the tax year is over, you can’t contribute any more funds to your 401(k) or 403(b).

Itemized Deductions

If you are close to being able to itemize your deductions, there are a few things you can consider to put yourself over the edge and capture a deduction larger than the standard deduction.

The most common thing to do is give money to a charity. This will do good for the organization you support and increase the amount of your itemized deductions.

You should also consider if there are any medical procedures or expenses you can pull forward into the current year. There are limits to the medical expense itemized deduction, but if you can prepay a medical procedure for the following year or have a procedure in the current year and pay for it in the current year, then you will increase the likelihood of being able to itemize your medical expenses.

Capital Gains and Losses

Have you sold assets such as stocks and bonds for a gain or loss this year? If you sold assets for a gain, you will likely owe tax on this money. Make sure you have some money set aside to cover this additional expense.

You can offset your capital gains with capital losses, so if you are holding assets that you no longer want, and they are in a loss position, then you can sell those assets for a loss and reduce the amount of your capital gains and pay less tax.

Even if you don’t have any gains, you can consider selling assets you have in a loss position if you no longer want to hold them. You can offset your ordinary income with up to $3,000 of capital losses each year, thereby reducing your taxable income and the amount of tax you will owe.

Contribute to a 529 Plan

Do you have a 529 plan for your kid’s education? While you can’t deduct contributions to 529 plans on your federal tax return, some states will allow you to deduct some of your contributions on your state return. This is a great way to fund your kid’s future and possibly receive a tax break. This varies by 529 plan and by state, so you will need to research your own specific plan and state to see if you can deduct your contributions.

Roth IRA Conversion

Depending on your current tax bracket and what you expect your tax bracket to be in the future, converting funds from a traditional IRA to a Roth IRA could be beneficial. When you convert funds from a traditional IRA to a Roth IRA, you pay tax on the money you convert at your current marginal income tax rate. The benefit of converting these funds to a Roth IRA is that once you convert these funds and pay the tax, the money is now in a Roth IRA which will grow tax-free and you can withdraw all of the gains tax-free once you reach age 59 ½.

For people in low marginal tax brackets who expect to be in higher marginal tax brackets when they retire, this is a great option to capture some future tax savings.

If you are considering this option, please make sure you understand all the implications before making the decision. There are additional forms you need to fill out (IRS form 8606), and a lot to consider when thinking about converting from a traditional IRA to a Roth IRA.

Special Tax Planning Concepts for Physicians

Being a high-income earning physician means you need to know a few additional concepts when it comes to your tax planning. Here are three concepts to consider as a high-income earner.

Additional Medicare Tax

We talked about this earlier when we talked about Medicare, but as a high-income earner, you will owe additional Medicare tax for any income you make over a certain threshold. The additional tax is .9% of your wages over the following thresholds:

• $200,000 for Single taxpayers
• $250,000 for Married Filing Jointly taxpayers
• $125,000 for Married Filing Separately taxpayers

Net Investment Income Tax

The net investment income tax is an additional tax that applies to your net investment income if your modified adjusted gross income is over a certain amount. The tax is 3.8% of your net investment income or the excess of your MAGI over the applicable thresholds, whichever is lower.

Your net investment income is income you receive in the form of interest, dividends, royalties, rents and some passive activities.

You will owe this additional 3.8% tax if your MAGI is over the following thresholds:

• $250,000 for Married Filing Jointly taxpayers
• $200,000 for Single taxpayers
• $125,000 for Married Filing Separately taxpayers

Doing some advance tax planning will help you understand if you owe this additional tax, and help you see if there are ways you can decrease your MAGI throughout the year to avoid paying the additional 3.8%.

Backdoor Roth IRA

Once you reach certain income levels, you will likely not be able to contribute to a traditional or Roth IRA to save for retirement.

Luckily, there is a way around this by doing what is called a backdoor Roth IRA conversion.

If your income is above the applicable thresholds, you can still make a non-deductible contribution to your traditional IRA. This means you pay tax on the money you put into the account and will pay tax on any gains you accumulate when you take the money out. Instead of paying tax on the way in and on the way out, the goal of the backdoor Roth is to eliminate the taxes on the gains when you pull the money out.

Once you contribute to the non-deductible traditional IRA, you convert these funds to a Roth IRA. Your contributions are now in a Roth IRA where you will grow tax-free and can be withdrawn tax-free once you reach age 59 ½. You paid the tax on your initial contributions, and that is it.

Wrapping-Up Your Tax Planning

Tax planning plays an essential role in your overall financial plan. Especially for high-income earners, taxes are a large expense that can be managed with some careful planning. Understanding the basic concepts, educating yourself, or working with an advisor will help you plan your finances in the most tax-efficient way possible and possibly save you hundreds or thousands of dollars over the long-run.