COMMENTARY

12 Important End-of-Year Tax Tips

Carolyn Yun, CPA, CFP

Disclosures

October 21, 2020

COVID-19 has had a huge impact on every aspect of physicians' medical practice, incomes, and business. Although this will probably not end soon, there are some key tax strategies that can help your financial position if you take some important actions by the end of the year.

Some of the ways in which physicians were hard hit include:

  • Physicians who are self-employed are facing increased costs for personal protective equipment, cleaning protocols, and new telehealth infrastructure. Many are also facing staffing shortages as employees fall to part-time work or take time off work to care for family members.

  • Even physicians working for large hospitals are not isolated from the financial impact of the virus. A recent survey conducted by Medscape concluded that over 60% of physicians in the United States have experienced a decrease in income since the start of the pandemic.

  • Saving and investing have been affected: Physicians may expect to see that companies in which they are invested are cutting dividends. Interest rates (CDs, bonds) are lower, and capital gains distributions are reduced this year. Overall, that makes for a fairly grim financial picture.

While taxable income this year has mostly declined, the applicable tax rates overall are low. However, federal, state, and local budget deficits have been skyrocketing owing to the demands of the pandemic. That means, in all likelihood, there will be tax increases in the coming years to cover spending. However, this year's financial challenges could lend themselves to a unique tax planning scenario that could potentially benefit physicians as they make long-term plans for their investments.

Given these circumstances, these 12 tips can help you to lessen your tax bite this tax season. Many of these tips entail actions that you need to take before December 31, 2020.

1. Coronavirus Stimulus Rebates

If you have significantly depressed income this year or have lost your job, you may find that you qualify for an Economic Impact Payment, a refundable tax credit on the 2020 tax return. The credit is $1200 for individuals or $2400 for joint filers, plus an additional $500 for each qualifying child aged 16 years or younger. You begin to phase out of the credit at an adjusted gross income (AGI) of $75,000 for individuals and $150,000 for joint filers. People who had AGI below these thresholds in 2019 already would have received the credit in advance, but those who now find themselves qualifying will receive the credit when they file their 2020 tax return. No action is needed on your part; your tax preparer will calculate whether you are eligible for the credit when filing your return.

2. Look to Accelerate Income at Lower Brackets

With reduced earned income, many physicians will find themselves in significantly lower tax brackets this year. Once you fall below $200,000 for individuals or $250,000 for joint filers, you no longer trigger two additional surcharge taxes. The first is the additional Medicare tax, which is a further 0.9% applied to earned income above those thresholds, on top of ordinary income tax brackets. The second is the Net Investment Income Tax (NIIT), which is an additional 3.8% applied to your investment income on top of capital gains tax brackets.

If you are someone to whom the additional Medicare tax or NIIT no longer applies for 2020, you might consider generating income this year in order to realize the lower tax rates. You could consider selling highly appreciated investments in your taxable portfolio and reinvest the proceeds by repurchasing the same securities, thereby receiving a step-up in cost basis. Remember, when you go to sell securities in retirement, you are only taxed on the gain on the security over your cost basis. By bringing the cost basis up to today's fair market value, you could be greatly reducing the future tax applied on a sale.

For those with IRA or inherited IRA accounts who also have required minimum distributions (RMDs), you might consider making voluntary withdrawals this year and then reinvesting the proceeds into a savings or taxable account for when you need it. Keep in mind that under the CARES Act, you are no longer required to take RMDs for 2020. However, this action would help avoid being forced to withdraw the amount when you may be at a higher tax bracket. You would need to do this before December 31.

3. Build Roth Assets Strategies

With reduced incomes and lower marginal tax rates applying to the last dollar of income this year, physicians should carefully consider how to take advantage of current tax rates by building Roth assets. There are a few strategies, including switching 401(k) or 457 contributions from pretax to Roth or performing a backdoor Roth IRA contribution. However, neither is as powerful as converting IRA assets to Roth assets because there is no restriction on conversion amount or income cutoffs.

The goal is to convert enough assets to fill up lower applicable marginal tax brackets while avoiding tax surcharges, where possible. Roth IRA conversions can get you in trouble if you don't know what to expect, so it's best to work with a financial advisor or tax professional to give you guidance. For example, Roth conversions can trigger some tax surprises, such as the phaseout for the 199A qualified business income deduction, increased taxation on your Social Security benefits, or higher IRMAA surcharges on Medicare Part B and Part D premiums.

Bear in mind that Roth conversions generate taxable income and cannot be undone once completed. However, paying the lower marginal tax rate today may be a big win when RMDs could push physicians into tax brackets as high as or higher than during their working years.

4. Coronavirus-Related Distributions

New this year is a penalty-free way to withdraw qualified retirement plan funds for those who are not yet eligible to make penalty-free withdrawals.

Congress introduced the Coronavirus-Related Distribution under the CARES Act. It allows individuals who have been affected by the pandemic to withdraw up to $100,000 before December 31, 2020, without paying the 10% early withdrawal penalty. If you are considering an early retirement because of the pandemic, it may make sense to take this withdrawal while the option lasts and keep the cash available to help fund the gap before the remainder of your retirement plan assets are available penalty free. Keep in mind that this withdrawal generates taxable ordinary income, even though the early withdrawal penalty does not apply. Taking this withdrawal can boost your taxable income bracket, so calculate carefully before you do this.

5. Charitable Donations for 2020

There is no shortage of people in need owing to the pandemic. For those who continue to be charitable-minded, a decrease in income may mean you have more opportunity for your regularly recurring charitable donations to decrease your taxes this year. Normally, charitable donations for itemizers are limited to 60% of AGI. However, the CARES Act increased the charitable deduction limit to 100% of AGI for 2020. Even those who claim the standard deduction can take advantage of a new "above-the-line" deduction worth $300 for individuals and $600 for joint filers by making qualified cash donations in 2020. Take special note that the contributions do not apply to donor-advised funds or nonoperating private foundations.

6. Noncash Charitable Donations

Many physicians are working longer and harder than ever, and for many, that means vacation plans have been placed on hold for the remainder of the year. Don't let your paid-time-off days go to waste! The IRS now permits leave-based donation programs, which allow employers to make deductible charitable donations for the relief of victims of the COVID-19 pandemic on the basis of the value of the sick, vacation, or personal leave that employees voluntarily forgo. The value of the donation will not be treated as compensation for the employee and will be free of any otherwise applicable FICA taxes, and the employer can deduct the donation as ordinary and necessary business expenses if they meet certain requirements.

7. Claiming 2020 Losses on Prior Tax Returns

For self-employed physicians, a wealth of tax planning strategies are available. One of the most significant may be the new provisions under the CARES Act that allow 100% of net operating losses (NOLs) for 3 calendar years of losses — namely 2018, 2019, and 2020 — to be carried back to the prior 5 tax years. Using these NOLs, you may be able to claim a refund for tax returns from prior tax years when there was otherwise a limit on NOLs at 80% of taxable income. If you think this applies to you, it's wise to meet with your accountant or financial professional to discuss this.

8. Delay Payroll Taxes Where Possible

For physicians with employees looking for some cash flow relief, a new payroll tax deferral is available to you this year. Under the CARES Act, employers can delay payment of their 2020 employer payroll tax, namely the 6.2% Social Security tax, with 50% not due until December 31, 2021, and the remainder due December 31, 2022. The deferral will not incur any interest or penalties and is also available to those who are self-employed.

On top of that, a new payroll tax credit was created under the Families First Coronavirus Response Act. Eligible employers can receive this tax credit for the amount of wages they pay to eligible employees who are taking pandemic-related paid family leave or paid sick leave this year. The credit is also available to those who are self-employed. If you think this credit may be applicable to you, it's worth speaking with your tax preparer about it.

9. Increased Business Property Deductions

The nature of many physician business operations has drastically changed this year. For physicians who already have invested in and implemented new telehealth infrastructure, this can create valuable tax deductions to offset their ordinary income. Businesses may take 100% bonus depreciation on the cost of qualified property both acquired and placed in service after September 27, 2017, and before January 1, 2023. In general, during the last quarter of the year, you should look to decelerate business purchases until after January 1, 2021, to get a deduction in 2021 at a higher marginal tax bracket.

10. Switch to Cash Accounting Instead of Accrual Accounting

With higher expenses and lower profits, some large practice groups may take a second look to see whether they qualify to switch to cash accounting from accrual accounting to defer taxes. This rule change was adopted back in 2017 to allow small-business taxpayers with average annual gross receipts of $25 million or less in the prior 3 years to use the cash method of accounting. Ultimately, this switch should allow practices to owe the IRS money only after invoices were paid.

11. Physicians Looking to Sell Their Unprofitable Practice

For physicians looking to make a quick exit from their practice in response to the pandemic, there is some tax relief in the event of a sale at a loss. Certain business owners who sell failed businesses will be able to use up to $50,000 of net losses as individuals or $100,000 as joint filers from the sale to offset ordinary income, current or future, under Internal Revenue Code (IRC) Section 1244. Remember that ordinary income tax rates are much higher than capital gains rates, so you could see some tax relief through a sale. The provision covers shareholders of domestic small-business corporations, both C or S corporations, but not partnerships. You would have to sell the business before December 31 to get this deduction in 2020.

12. Physicians Looking to Sell Their Profitable Practice

Even self-employed physicians who have managed to maintain profitable practices may be looking for early retirement after the exhaustion of the pandemic. If you own stock in a C corporation engaged in an active trade or business that has not had assets of more than $50 million at any time, you can take advantage of the IRC Section 1202 exemption. Section 1202 provides an exclusion from gain from the sale of stock of either $10 million or 10 times the adjusted basis of the stock, owned at least 5 years, in corporations regarded as "qualified small businesses." This means you may be able to sell your practice at a gain with a handsome tax shield. Again, to get this tax benefit for April's tax return, you'd have to engage in this activity before year end.

Regardless of whether the pandemic has placed financial constraints on you this year, tax-savvy opportunities are available to capitalize on your reduced income and lower tax rates. It's always important to keep in mind not just your taxes in any one given year, but your lifetime tax obligations. Financial advisors and tax planners can perform multiyear tax calculations and recommend ways to manage your tax bracket and help lower your overall lifetime tax obligations.

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