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Tax-saving Ideas

Most physicians get few tax planning ideas from their financial advisers. Plan now and save next April 15th.

By david b mandell, jd, mba and jason m o’dell, cwm

Unique Opportunities, May/June 2008

As a physician, do you realize that you spend 40 to 50 percent of your working hours laboring for the IRS and your state? That is a lot of time with patients for someone else’s benefit. Given the significance of this fact, shouldn’t your advisers be giving you creative ways to legally reduce your tax liabilities? How many tax-reducing ideas does your CPA regularly provide you? If you are like most physicians, you probably get very few tax planning ideas from your advisers.

Given these sobering facts, the purpose of this article is to show you five ways to potentially save and possibly motivate you to investigate these planning concepts now, before the end of the year. Let’s examine them:

1. Asset-protect your practice’s most valuable asset and reduce taxes

As a physician, you face malpractice liability as well as general business risks (employee liability, etc.). What you may not realize is that a claim by a patient or employee will likely threaten ALL of your practice’s accounts receivable, including those you earn. Typically, this is a medical practice’s most valuable asset.

For this reason, physicians implement strategies for asset-protecting their receivables. While the details of the options go beyond the scope of this article, it should be mentioned here that one of these strategies may allow the practice to reduce its income tax burden as well. Thus, if asset protection is a concern of yours, in addition to tax reduction, we recommend that you investigate your practice’s options in this area.

2. Share income with lower-income family members

Congress changed the rules on this technique in 2006, by increasing the minimum age for children involved from 14 to 18 – and 24 if children are full-time students. Nonetheless, it still remains a viable option for many older physician families. Essentially, this is accomplished by what is called “income sharing.” This means spreading the income created within a family limited partnership (FLP) or limited liability company (LLC) to the limited partners or members who are in lower tax brackets. Since most of our physician clients are in a 40 percent tax bracket (state and federal) and many of them have children who are in either a 10 percent or 15 percent tax bracket, the LLC/FLP can save significantly on income earned by LLC/FLP assets such as mutual funds, rental real estate, stocks, and bonds. Typically, this is a technique recommended by many CPAs and can work well for practice-owned real estate in a lease-back arrangement.

3. Gain tax-deferral, asset protection through cash value life insurance

Under realistic assumptions, a $500,000 mutual fund portfolio may generate an annual tax liability of $10,000-$25,000. Similar investments within a cash value life insurance policy will generate NO income taxes—because the growth of policy cash balances is not taxable. Also, nearly every state protects the cash values from creditors—although there is tremendous variation among the states on how much is shielded.

4. Explore investment managers who manage with taxes in mind

One of the biggest complaints we hear from clients is about their tax burden on investment portfolios—especially when they are holding the portfolio for the long term. One option is to consider investment managers who manage clients’ portfolios to reduce income and capital gains taxes. Individually managed accounts (IMAs) can invest in the same securities a mutual fund holds but—as opposed to a mutual fund where you get no input on the timing of purchases or sales of those securities—with an IMA, the manager works with you individually to harvest losses and manage taxes. Doctors with six figures to invest often have outgrown mutual funds and need to explore IMAs.

5. Use charitable giving to reduce income taxes—the charitable remainder trust (CRT)

There are many ways you can make tax-beneficial charitable gifts while benefiting your family as well. The most common tool for achieving this “win-win” is the Charitable Remainder Trust (CRT). A CRT is an irrevocable trust that makes annual or more frequent payments to you (or to you and a family member), typically, until you die. What remains in the trust then passes to a qualified charity of your choice. A number of advantages may flow from the CRT.

First, you will obtain a current income tax deduction for the value of the charity’s interest in the trust. The deduction is permitted when the trust is created, even though the charity may have to wait until your death to receive anything. Second, the CRT is a vehicle that can enhance your investment return. Because the CRT pays no income taxes, the CRT can generally sell an appreciated asset without recognizing any gain. This enables the trustee to reinvest the full amount of the proceeds from a sale and generate larger payments to you for your life. Finally, the trust will be eligible for an estate tax deduction if it passes to one or more qualified charities at your death.

More money, different strategies

This article gives you a few ideas for how to save taxes. For larger practices with $5,000,000 or more of revenue, there are additional techniques that could offer significantly greater deductions. These are outside the scope of this article, but are mentioned in the articles on our website and are topics of our free e-newsletter. If you want to save taxes, the most important thing you can do is start looking for members of your advisory team who can help you address these issues in advance. Otherwise, you will be in this same position this April 15th…and next April 15th and the one after that. Feel free to contact the authors through www.ojmgroup.com if you have questions.

David Mandell is an attorney, lecturer, and author of five books for physicians. Jason O’Dell is a financial consultant, lecturer, and author of two books for physicians. They are both co-founders of the financial consulting firm O’Dell Jarvis Mandell, with more than 1,000 doctor clients nationwide. The authors can be reached at 800-554-7233.