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Category Archives: Tax Planning

Physician Tax Returns Could Present Challenges

We’ve all felt that time crunch as tax deadlines approach. In addition to being complex, tax code is subject to change at any time. Doctors are among the busiest of professionals and have little spare time to learn about the latest developments in tax law. In preparing your own taxes, you run the risk of missing out on potential tax deductions for doctors that could reduce your taxable income or unknowingly exposing yourself to an audit from the IRS.

Income and Material Participation

It’s important to recognize commonly used tax terms due to the nuances unique to physician tax returns. Having a good understanding of how income is defined will help clarify some of the more complicated tax concepts and strategies. Active income (sometimes called earned income) is what is reported on W2 and 1099 documents. This income is derived from your labor and is the most heavily taxed form of income. In addition to Federal and state income taxes, you’re also subject to Social Security and Medicare taxes also known as FICA witholdings. You may also be obligated to pay local income taxes depending on the municipality in which you practice or live.

Physician Tax Deductions

Passive income (or unearned income) is income derived from your assets instead of your labor. One example of this would be any income from your investment portfolio such as interest, dividends or capital gains. On the federal level, you could be subject to either long-term or short-term capital gains depending on how long you’ve held an investment. You may be responsible for paying taxes at your state’s rate as well. The cost of acquiring and selling an investment will affect your cost basis, so accurately tracking this information may lower your overall tax consequences. For tax purposes, cost basis is defined as the original value of an asset (usually the purchase price) which can be adjusted for stock splits, dividends, commissions and return of capital distributions. (1)

Passive income or losses are defined as activities in which the tax payer does not materially participate. There are several criteria for defining material participation, and you only need to meet one to qualify (2):

  • Does the taxpayer and/or spouse work more than 500 hours a year in the business?
  • Does the taxpayer do most of the work? Even if 500 hour test is not met, is his or her participation the only activity in the business? (ex. Sole proprietor with no employees)
  • Does the taxpayer work more than 100 hours and no one works more hours?
  • Does the taxpayer have several passive activities in which he participates between 100-500 hours each and the total time is more than 500 hours? Cannot include rental activities or activities involving portfolio or investment income.
  • Did the taxpayer materially participate for any 5 out of the 10 preceding years (need not be consecutive)?
  • Did the taxpayer materially participate in a personal service activity for any 3 prior years (need not be consecutive)? Personal service activities include fields of health, law, engineering, architecture, accounting, actuarial science, performing arts and consulting.
  • Do the facts and circumstances indicate taxpayer is materially participating? Test does not apply unless taxpayer worked more than 100 hours a year. Furthermore, it does not apply if any person other than the taxpayer received compensation for managing the activity or if any person other than the taxpayer spent more hours managing the activity.

Tax Deductions for Doctors

Did you know that many of the professional expenses that are required of you as a physician are tax deductible? Continuing medical expenses, medical malpractice insurance and membership dues for professional and public service organizations can be deducted. (3) There is also physician tax deductions for practices that have incurred losses or damages due to a natural disaster. You automatically qualify for this deduction if your practice is located in an official federal disaster area. (4)

For self-employed doctors and practice owners, travel related to the operation of your practice is fully deductible. However, typical commuting expenses are non-deductible. Keeping adequate travel records may allow you to qualify for a $0.55 per mile deduction. Most business meals and entertainment expenses are only partially deductible. To account for these, you should keep a log noting the amount spent, date, time, place of expenditure and business purpose.

There are numerous options for structuring your business from a legal and tax entity standpoint such as sole proprietorship, partnership, or limited liability company. Each form has advantages and disadvantages, and your choice will impact how you pay your taxes and the amount that you’ll owe.

Rental Income

Real estate investments and rental properties are a popular source of alternative income. Historically, real estate has been an attractive investment by providing 11.22% annualized returns over the past 15 years, according to the S&P Global REIT Index. However, it should not be assumed that past performance is indicative of future results, and fluctuations do occur up and down. As you can imagine, there are quite a few guidelines in regards to claiming rental properties on your tax return.

With real estate, your basis in a property is not fixed. (5) This also applies to your personal residence as well, but rules regarding taxation of a personal residence differ from rental property. The cost basis of a property can typically be reduced by items that represent a return of your cost, including an insurance payment you receive as a result of a casualty or theft. (6) Remember, it’s important to keep track of any renovations or improvements you’ve made that could affect the value of your property.

One important distinction to be aware of in the context of adjusted cost basis is the difference between property expenses and depreciation. According to IRS.gov, “depreciation is an income tax deduction taken against expenses that allows a taxpayer to recover the cost basis of a property. It is an annual allowance for the wear and tear or obsolescence of the property.” This mainly applies to tangible property like machinery or furniture but there are some intangible properties such as patents or computer software that are depreciable as well. In order to be eligible you must own the property and use it for a business, and it must have a determinable useful life of more than one year. (7) For example, having a new roof put on your practice’s building is depreciable whereas repairing an existing roof is classified as an expense.

When selling business property, you need to be aware of potential recapture situations where you would have to add back the deduction from a previous year to your current income. You can defer paying taxes on any gains under IRC Section 1031, allowing you to reinvest the proceeds in a similar property as part of a qualifying “like-kind” exchange. (8) To qualify for this exchange, you have to identify at least three “like-kind” properties within 45 days of the transaction, and then close on one of these properties within 180 days from the date of sale. This can be tricky due to the complex nature of real estate transactions, so professional assistance is often necessary.

This is just scratching the surface of the tax code as it relates to physicians. There are countless exceptions and minutiae that have to be considered on a case-by-case basis. You shouldn’t make decisions based solely on the recommendations of your colleagues or from articles you have read. Getting assistance from a trusted professional can reduce the uncertainty regarding these decisions.

Have Questions?

Advisory Services offered through Larson Financial Group, LLC, a Registered Investment Advisor. Securities offered through Larson Financial Securities, LLC, Member FINRA/SIPC. Medical Malpractice Insurance offered through Larson Financial Brokerage, LLC

Larson Financial Group, Larson Financial Securities, and their representatives do not provide legal or tax advice. Please consult the appropriate professional regarding your legal or tax planning needs.

(1)http://www.investopedia.com/terms/c/costbasis.asp
(2) http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Passive-Activity-Loss-ATG-Chapter-4-Material-Participation
(3) http://www.ventocpa.com/about_us/
(4) http://www.physicianspractice.com/blog/income-tax-deductions-commonly-overlooked-doctors
(5) http://www.investopedia.com/terms/a/adjustedbasis.asp
(6) http://www.investopedia.com/articles/investing/060313/what-determines-your-cost-basis.asp
(7) http://www.investopedia.com/walkthrough/corporate-finance/2/depreciation/other-considerations.aspx
(8) http://www.investopedia.com/terms/s/section1031.asp

Tax Season: 8 Questions to Ask Your CPA

By Debra Taylor, CPA/PFS, Esq., CDFA

Preparing tax returns is rarely fun, but it’s important. A good discussion with your tax preparer and financial advisor can help you manage your tax bill for both this year and next.

For many of us, meetings to prepare a tax return are like a trip to the dentist—we want to get in and out as quickly and painlessly as possible.

Physician Tax Deductions

However, there are many new rules to consider and questions to ask your tax preparer and your financial advisor to make sure you’re getting the best guidance possible. Use this list of questions to get the discussion going:

1. How will major life events and changes in my personal life affect my taxes?

Many people don’t realize how certain life events and milestones can affect their tax situation. That’s why it’s important to make your tax preparer aware of any life events or changes to your tax situation.

If any of your children matriculated to a college in 2014, they may qualify for up to $4,000 in deductions for education costs, the American Opportunity Tax Credit, or the Lifetime Learning Credit.

If you purchased a second home, you may qualify for a second set of home deductions for real estate taxes and mortgage interest.

If you got married this year, had a child, got divorced, or lost a loved one, your filing status may have changed as well as your deductions.

2. Should I have my employer make adjustments to my withholdings?

If you have had children, gotten married or divorced, or can no longer claim your adult children as dependents, consider making changes on your W-4 Forms to adjust your exemptions.

In addition, if you are receiving large tax refunds (or are saddled with a large tax bill in April), you may want to adjust your withholdings in an effort to smooth your cash flow.

3. Should I increase my retirement plan contributions?

Retirement plan contribution limits have been raised for 2015. Contributions to retirement plans and IRA’s accomplish two things. First, they may reduce your taxable income, thereby lessening your tax burden, and second, they can help you fund retirement and stay on track to meet your financial goals.

Retirement Plan Contribution Limits

Tax Deductions for Doctors

If you are changing jobs in 2015, coordinate with your new company’s human resources department to ensure that you do not exceed the maximum contribution to your 401(k) during the year due to making 401(k) contributions from both jobs.

Also consult with your tax professional regarding making contributions to a traditional or Roth IRA, in addition to your contributions to employer-sponsored plans. Contributions to an IRA are allowed regardless of income level and are not limited by contributions to an employer-sponsored plans (though the deductibility of contributions may be affected).

4. Should I consider a conversion to a Roth IRA?

 

A Roth IRA conversion allows you to move assets from a tax-deferred IRA to a potentially tax-free Roth IRA. You would incur a tax liability for the amount you convert in 2015. However, the assets held in a Roth IRA are not subject to a required minimum distribution and can eventually be withdrawn tax-free.

Ask your CPA to prepare a projection of the tax liability of a partial (or total) Roth IRA conversion. Roth conversions have tax, investing, and retirement considerations and the decision whether or not to convert should be made after a discussion with your tax professional and financial advisor.

5. How has the Affordable Care Act (ACA) affected my taxes?

Last year, you may have been subject to the 3.8% Medicare surtax on net investment income over $250,000 for those married filing jointly ($125,000 if married filing separately and $200,000 for all other filers). This year, you will need to provide proof that you were insured for the entire year, or pay a penalty.

If you secured coverage through a health care exchange, you will receive Form 1095-A. If your employer provides coverage, you will receive Form 1095-B or 1095-C (depending on whether the employer self-insures or provides a group plan).

For some individuals, the ACA may be a net positive when it comes to taxes paid. Small business owners may qualify for tax credits up to 50% of the premiums paid for their employees’ health insurance premiums. If you pay all, or part, of your employees’ health insurance premiums, consult with your tax professional to determine if you qualify for a tax credit.

6. Can you help me to estimate my 2015 tax bill?

Review your projected income, deductions, and planned sales of assets and other contemplated financial events with your tax professional. Ask your CPA to prepare a projection of your 2015 tax bill and help you strategize how to reduce your tax liabilities for the coming year.

If you are self-employed, ask your tax professional if your quarterly payments will fall within the safe harbor to avoid paying penalties and interest for any additional tax you may own in 2015.

7. How can I lower my tax bill for next year?

Taxes are on the rise. After you receive your projected 2015 income and tax liability, ask if there is anything you can do throughout the year to reduce your tax burden. Your CPA can help you maximize your deductions, properly manage (and hopefully maximize) your retirement plan contributions, and take advantage of any tax credits that may be available to you.

8. Is there anything that I should be reviewing with my financial advisor about my investments?

Various tax code changes including the 3.8% Medicare surtax, changes to capital gains tax rates, and compressed tax brackets for trusts are making tax considerations an increasingly important part of investments decisions.

Ask your CPA about the effectiveness of tax-loss harvesting throughout the year. Or if you have a large IRA, you may want to pay fees using non-retirement funds in an effort to maximize your deduction for investment management.

Don’t waste a good meeting!

Tax time is an opportunity to open the lines of communication between your tax professionals and your financial advisors. A good working relationship between all of your trusted advisors will help ensure you are getting tax-efficient management for all of your investments and financial affairs.

Have Questions?

Debra Taylor, CPA/PFS, Esq., CDFA, writes on tax and retirement planning for Horsesmouth, an independent organization providing unbiased insight into the critical issues facing financial advisors and their clients.

Debra Taylor is not affiliated with Larson Financial Group.

IMPORTANT NOTICE: This reprint is provided exclusively for use by the licensee, including for client education, and is subject to applicable copyright laws. Unauthorized use, reproduction or distribution of this material is a violation of federal law and punishable by civil and criminal penalty. This material is furnished “as is” without warranty of any kind. Its accuracy and completeness is not guaranteed and all warranties expressed or implied are hereby excluded.

Advisory Services offered through Larson Financial Group, LLC, a Registered Investment Advisor. Securities offered through Larson Financial Securities, LLC, Member FINRA/SIPC.

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