With possible tax increases looming, what can physicians do to safeguard their hard-earned income?
With possible tax increases looming, what can physicians do to safeguard their hard-earned income?
The federal government has committed more than $11 trillion to bail out the US economy (http://hcp.lv/dtgKNe). The good news is that only $3 trillion of it has been spent so far. Of course, somebody has to pay for this, and the burden will fall heavily on high-income taxpayers.
Let’s examine facts about the taxes for high-income Americans and corporations, and see how much of this burden will really fall on doctors and similar-earning taxpayers. According to the Internal Revenue Service, more than 140 million tax returns were ï¬ led in 2009 (www.gao.gov/htext/d10225.html). Of these taxpayers, 70 million people pay more than 97% of the total income tax in the United States. That means, the bailouts will cost each of those 70 million taxpayers an average of $157,143.
According to The Tax Foundation (www.taxfoundation.org), a Washington, DC think tank, the tax burden of the top 1% of earners exceeds that of the bottom 95% of earners (http://hcp.lv/c9bn96). As a physician, you can expect to be in the top 1% if your adjusted gross income is over $410,000, or in the top 5% if your income exceeds $160,000, according to most recent statistics from the IRS (http://hcp.lv/aikNcA). If needed changes to the tax code are not enacted, the top 5% of taxpayers, or 1.4 million people, will be expected to pay for 60.63% of this bailout in taxes, an average of $952,757 per taxpayer (http://hcp.lv/aikNcA). The numbers don’t lie.
Corporate tax loopholes and a “progressive” personal income tax structure mean hefty tax bills for high-income earners
In 2009, Exxon Corp. reported $45 billion in proï¬ts and yet had zero US income-tax liability (http://hcp.lv/c6K5Kn). During the same time period, General Electric Corp. ï¬ led more than 7,000 tax returns in various jurisdictions. GE’s total US tax bill? $0! This was on a global proï¬ t of $10.8 billion (http://hcp.lv/9Pskvc). Did the ï¬nancial collapse and need for bailouts hurt the incomes of chief executive ofï¬cers of top ï¬nancial institutions? Hardly, if Citigroup Inc.’s CEO, John Havens, is any indication. He received total compensation of $11.3 million in 2009 while his company received $5 billion in bailout funds (http://hcp.lv/bdUEaG).
Although many large corporations can get away with paying little or no income tax, the same cannot be said of individual citizens at the top of the income scale. According to the Tax Foundation, the “average” adjusted gross income (AGI) of a member of the top 0.1% of taxpayers is $7.4 million (http://hcp.lv/aikNcA). If you are looking for a goal, you should note that it only takes an income of $2,155,365 (the low end of the top 0.1% of earners) to claim a seat within this group. Compare this to the rest of the top 1% of taxpayers. This group has AGI over $410,000, but less than $2.155 million.
Consider this troubling statistic: The rest of the top 1% pay 22.56% as an average income-tax rate, while the top 0.1% of earners pay a lower average tax rate of 21.46%. The group with income between $410,000 and $2.1 million pays more tax as a percentage of income than the group with “average” income of $7.4 million. How can that be? One reason is that higher-income taxpayers often receive better ï¬nancial advice and more careful tax, retirement, and investment planning.
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Some middle-income taxpayers will lose and some may win under new income tax rates proposed by the Obama administration.
Need to Pay Your Taxes Late?
If you can’t get your return ï¬nished by April 15, you can ï¬le IRS Form 4868 to request an automatic extension, which gives you until October 15 to get your act together.
Putting Your Tax Refund to Work
You’ve ï¬ led your tax return and you’re now expecting Uncle Sam to reward you with a nice fat refund check. There are tax advisors who will tell you this isn’t a good thing; that you should tweak your withholding so you don’t get such a big refund. So, what do you do with the cash?
Before too long, your taxes may actually end up even higher
There has already been passage of legislation with a Medicare surtax of 3.8% on all investment income for taxpayers who earn more than $250,000 (http://hcp.lv/cGPRJ6). The cost of this tax increase is going to vary, based on the amount of your investment income. If you consider that the long-term capital gains tax on investments is only 15% (for now; there has been talk that Congress may allow the Bush-era reductions in capital gains taxes to expire and revert to previous levels), this surtax represents an increase in investment income tax of 25.3%.
If this tax-rate increase on capital gains and dividends comes to pass, it could be as high as 33% of the existing tax rate (if the tax rate increases from 15% to 20%). These two taxes combined could represent an increase in taxes on investments of more than 58%. The dollar impact of this increase will depend on the value of your appreciated assets and income-producing assets (such as real estate, equipment, etc). Needless to say, this tax increase may hurt a little, even for doctors who utilize smart asset-protection strategies, and separate assets from the operating practice.
Right now, the Social Security tax stands at 12.4% for self-employed individuals, but it only applies to the ï¬ rst $106,800 of income. What would happen if Congress successfully legislates away many of the tax beneï¬ ts of S-Corporations (as it attempted to do recently with the American Jobs and Closing Tax Loopholes Act of 2010), and every dollar of income is subject to Medicare’s new 3.8% tax? What happens if the law is changed so that the maximum amount of wages subject to the social security tax is increased from its current cap of $106,800? For doctors making $500,000 to $1 million per year, these hypothetical changes could represent up to $110,000 of additional taxes. The Medicare payment increase alone for a $1 million-earner who currently takes half of his or her income in salary and half in S distribution could be as high as $23,500 per year.
Another possible tax increase that has been discussed is to raise the highest marginal income tax rate back up to 39.6%, from the current 35% (http://hcp.lv/alpCD6). This would apply to income of approximately $400,000; for a doctor earning $600,000, this could cost another $9,200 a year. Finally, the estate-tax repeal that was enacted under former President George W. Bush is going to “sunset” on Dec. 31, 2010. This means that if you don’t die this year and lawmakers don’t extend or make the repeal permanent before it expires, all those big nasty estate taxes (up to roughly 55%) are back on the table. Now, assuming you are not interested in dying this year to avoid estate taxes, or to save the time and aggravation of doing income-tax planning, there are some strategies you can implement to prepare for the potential for higher taxes in the coming years.
Pay as much tax as you can right now
Yes, you read that correctly. It is crucial to get as much money as possible out of taxable environments and into tax-free environments. This is necessary because it’s extremely likely tax rates are going to have to increase substantially to pay for the bailouts, healthcare reform, and other federal programs that are on the agenda. Here are some examples of ways to accomplish this goal:
If you have the liquid cash available to pay the income tax, convert all of your individual retirement accounts to Roth IRAs in 2010.
If you have property with capital gains (especially gains that are the result of a number of 1031 tax-free exchanges), sell it and pay the taxes now.
If you have appreciated stock of public or private companies, explore ways to sell so you can trigger capital gains taxes in 2010.
Increase the amount of money you invest into tax-free vehicles, such as cash-value life insurance. Under the current tax regime, the beneï¬ts of tax-savings outweigh the costs of the insurance. In a higher-tax environment, the beneï¬ ts will only be enhanced.
Tax Break on Health Insurance
Health insurance expenses are 100% tax deductible. Right now, individuals can’t deduct health-related expenses until the costs exceed 7.5% of adjusted gross income. One bill under consideration right now would raise this threshold to 10% of AGI, unless the individual is eligible to take a self-employed health-insurance deduction. For a doctor earning $600,000, the ï¬rst $45,000 to $60,000 of health expenses are not deductible individually, but are 100% deductible through a C-Corporation.
Long-term Care Insurance
Long-term care insurance is treated like health insurance. While you are in your peak earning years, you can pay these premiums for a limited time (say, over 10 years) and be eligible for a full income-tax deduction while doing so. So beneï¬ts are tax-free, if and when you and your spouse need them. The deductible amounts for long-term care insurance are very low for individuals.
There are ways for a C-Corporation to tax-efï¬ciently purchase life insurance. If you can get a partial deduction for putting money into a vehicle that grows tax free, allows you access to the funds in the policy tax free, and provides some protection for your family, why wouldn’t you do it?
There are tax-saving strategies that exist that allow successful doctors to take annual deductions that can be in the hundreds of thousands of dollars or more under the umbrella of a C-Corporation.
Pay no more tax than absolutely necessary
On items you’ll eventually be taxed on, no matter what, you want to pay the tax now while rates are still relatively low. But on future income, you need to be smart and maximize tax deductions any place you can. If Congress passes the bill to reduce or eliminate the tax beneï¬ts of S-Corporations, savvy doctors will take advantage of the beneï¬ts offered by C-Corporations (see sidebar).
The best offense is a good defense
Not knowing exactly where the tax increases will fall is no excuse for inactivity. In all likelihood, tax rates are going to increase for high earners. By the time tax increases go into effect, it may be too late to act. And if, by some chance, tax rates go down, at least you’ll have invested the time to lower the overall rate of tax you will ultimately have to pay, so there will still be some beneï¬t.
Oh, and the answer to the question posed in the title of this article is a quadrillion (that’s a 1 followed by 15 zeroes). At the rate the national deï¬cit is ballooning, many taxpayers may learn the answer to that question the hard way.
Christopher Jarvis is an MBA with more than 15 years of consulting experience. Carole Foos is a CPA with more than 20 years of experience. They are both part of the consulting ï¬rm, OJM Group (www.ojmgroup.com), with ofï¬ces in Cincinnati, Fort Lauderdale, Austin, Phoenix, and New York City. They welcome questions at (877)656-4362.
This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized tax advice. There is no guarantee that the views and opinions expressed in this article will come to pass or that they will be appropriate for your particular circumstances. US tax law changes= frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax, ï¬nancial planning, and legal advice before implementing any strategy discussed herein. For additional information about the OJM
Group, including fees and services, send for our disclosure statement as set forth on Form ADV using the contact information herein. Please read the disclosure statement carefully before you invest or send money.