Planning tips that could help alleviate a higher tax bill for high-earning physicians.
Today’s tax rates are among the lowest we have seen in many years, but President Biden made it clear in March of this year that he intends to change all of that. In order to fund his large-scale fiscal stimulus, infrastructure initiative, and economic reforms, President Biden is pushing to increase taxes that are targeted to disproportionately affect the wealthy. While some of the tenets of this proposal may be difficult to pass and the details may change as the legislation makes its way through Congress, physicians may want to consider the following tax planning strategies as they look ahead to their 2021 return.
Let’s take a look at the proposed changes on the table and explore some of the financial planning tips that could help alleviate a higher tax bill for high-earning physicians.
Biden has proposed a return to the top individual tax rate for individuals earning over $400,000 from 37% to 39.6%. This is essentially a reversion to the pre-2017 Tax Cuts and Jobs Act (TCJA) rates for this bracket, which we were expecting to see in 2025 when the bill was set to expire. There are still questions, though, as to whether the 400K threshold will be for a single taxpayer or for married filing jointly (MFJ).
Planning Tips: Lowering taxable income will be fundamental in offsetting this potential change. Consider escalating contributions to retirement plans, opening a profit sharing or defined benefit plan, or bunching deductions to counterweigh the liability in the year this provision is passed into law. You may want to speak with your advisor about decreasing income-producing investments or placing them in retirement accounts.
Charitable contributions, of course, are always a tried-and-true way to lower taxable income through the use of Donor Advised Funds (DAFs), Qualified Charitable Distributions (QCDs), or even donating appreciated stock to charity.
Some physicians may also want to consider increasing municipal bond holdings as they become more valuable when taxes and the tax-equivalent yield increase.
High-earning physicians may be the most challenged by Biden’s proposal to increase the capital gains rate on income over $1 million from 20% to 39.6%. Combined with the 3.8% Medicare surtax, you could potentially face a 43.4% federal tax rate on long-term capital gains. This is almost double the current top rate. In effect, high income earners would completely lose the tax benefits of holding capital assets for more than one year as short-term and long-term gains would be taxed at the same rate.
Planning Tips: You’ll need to keep a keen eye on managing capital gains. This could mean accelerating gains into the current year or gifting highly appreciated assets.
Biden is also proposing to assess Social Security taxes on wages above $400K. Currently, employees pay 6.2% toward Social Security and employers pay another 6.2% on the first $142, 800 of wages for each employee. Biden’s proposal would assess these two 6.2% tax rates again once wages exceeded $400K. This, of course, is in addition to the 2.9% and 3.8% Medicare taxes already paid on unlimited wages.
Planning Tips: Consider taking a close look at how your practice is structured tax-wise. If your practice is an S-Corp, you’ll want to minimize the amount of compensation you receive as wages while still remaining “reasonable” per IRS standards.
C-Corps may have a more difficult time, though, since C-Corp practices typically try and eliminate their net taxable income at the corporate level via bonus pay to the owners in the form of W-2 wages. C-Corps may consider a shift in business structure going forward to account for this new tax law.
The maximum amount of itemized deductions would be capped at 28% for those earning over $400K. It is unclear if this provision will be for individuals or those filing jointly. But essentially, these deductions will be worth less to the high-income physician in terms of reducing taxable income.
Planning Tips: It may be worthwhile to bunch deductions on property taxes, charitable contributions, and health expenses in order to increase your deduction.
The possibility for significant tax law changes on the horizon make forward-looking tax planning especially critical. Of course, this is complicated by the fact that we do not know with certainty when, if, or how these provisions will become effective. Could any of the laws be retroactive? Or could we be in the clear until later in 2022 or 2023? Only time will tell.
Although these tax laws are not a foregone conclusion, physicians would do well to fortify their tax planning strategies ahead of time to guard against some or all of these possibilities. By making small adjustments now, you can protect against being caught off guard as any new legislation moves into law.