This transcript has been edited for clarity.
John Whyte, MD: Welcome, everyone. I'm Dr John Whyte, the chief medical officer at WebMD. I want to tell you about a recent survey that Medscape did on physician taxes. You need to check out this recent report. We talk to physicians about whether they're paying too much in taxes. I know you know the answer to that already, but also what contributions they're taking, and what's the chance of an audit?
Joining me today to dig a little deeper — and to talk about what deductions you may be missing, maybe how to pay less tax, and what the tax code of the future may look like — is Rob Scroggins. He's the principal at ScrogginsGrear. Rob, thanks for joining me today to discuss this important topic, and not necessarily one they want to talk about — taxes.
Robert C. Scroggins, JD, CPA, CHBC: That's right. Happy to be here.
Whyte: We found that doctors think they pay too much tax. That's not surprising. Everybody thinks they pay too much tax, don't they? But are there certain strategies to lower tax that physicians sometimes neglect? What do you recommend to your clients?
Scroggins: As we know, a lot of the deductions from decades ago are gone, as of the mid-1980s. So there's just not as much that can be done on a personal return. And hopefully doctors are taking advantage of everything they can. They're the obvious ones: mortgage interest, charitable contributions, the normal deductions where we find with our clients their biggest advantages as business owners. They are often able to take legitimate business deductions [outlined in] the Tax Cuts and Jobs Act of 2017.
But what we refer to is 2% items — those itemized deductions that were un-reimbursed, business expenses that were eliminated. Doctors were able to take those deductions in the past, but no longer. For those who are employees of health systems or otherwise incurred business expenses, those [deductions] went away. But doctors who have their own practices can certainly take advantage of anything that's a legitimate business expense: meetings, conferences, meals — expenses that they can run through their business.
Whyte: What about physicians who are employees of a health system? Can they still take some business deductions such as CME or other conferences? What are they perhaps missing that they're legally entitled to deduct?
Scroggins: They would be the ones who have lost the ability to take those deductions. Now, they were all always limited to or had a threshold of 2% of adjusted gross income, so often many of those expenses did not end up being deductible. But where they can really plan is as they take employee positions, they can work some of those expenses into their employment agreements so that their health system or their employer would agree to cover some of those, maybe in exchange for a slightly lower compensation. So that's where there are situations that are a matter of planning ahead.
Whyte: Do we spend too much time talking about federal tax as opposed to state and local tax? Is there not as much discretion in terms of local taxes?
Scroggins: We certainly focus on the federal. That's where most of the dollars go. It's the tax everyone understands because it's the same for all of us. The state and even local taxes do get overlooked, I guess, in favor of federal. But it is important because there are 50 different types of tax returns when it comes to the states. And then if you're where I am in Ohio, we have a municipal tax all over the state, which is really quite complicated. That can make a big difference because that can range from nothing in some areas to 3% in others. So that does add up. Also, as you know, some states don't have any income tax.
Whyte: Do we all need to move there? What's the value in the long run? There's a lot of debate about moving one's residence to avoid state tax. Does that really make a difference for most people?
Scroggins: It does. In Ohio, our top tax rate is 4%. You go to some of the states on the coasts and it's quite a bit higher than that. So it does make a difference. Being in the Midwest, we see a lot of our clients relocate to Florida in retirement. That's an income tax–free state. But a lot of our clients don't have that choice because they're working and they need to be where they have their practice.
Whyte: And there are strict rules on residency. I should point that out. And that sometimes leads to the next question.
When we talk about residency, really the most dreaded word, as you know, other than "tax" is "audit." Our survey showed that 18% of respondents said they were audited. So is there something about being a physician that makes one more likely to be audited or is it pretty arbitrary? What might trigger an audit for a filer?
Scroggins: I really don't believe that there would be a targeting of physicians as a profession or a certain type of taxpayer. What triggers the audits are figures on the tax return that are outliers. It may be very high contributions that are not typical.
Whyte: But how do you know what's an outlier? Is it your historical precedents? Is it that you can't really calculate necessarily what's an outlier?
Scroggins: That's right. I couldn't weigh in on how the IRS calculates that either, or what flags their system or jumps out. We've seen that when a taxpayer has a side business that's not making a profit, that can trigger an audit because that eventually becomes identified as a hobby in the eyes of the IRS. Any certainly there have been aggressive positions taken by a taxpayer that have been audited; the IRS is going to be more in tune with those individuals. But I don't really know what they do behind the scenes.
Whyte: A lot of physicians use accountants, right? Someone else prepares it and files it. So how do you know if your accountant is being too aggressive? Because that could trigger an audit as well. Are there any red flags in working with an accountant that readers should be aware of?
Scroggins: It's probably difficult for physicians, not being tax people, to understand the intricacies of what's considered income, what's a valid deduction, everything that needs to go into preparing the tax return. So I could see where it's difficult for them to notice something like a too-aggressive position. I think it's going to come down to their general discernment in terms of what kinds of questions their tax preparer is asking or not asking, or if there are suggestions of a potential gray area. So let's just question whether to say to the taxpayer that I want to make sure we're doing this properly and not being too aggressive. Now, most tax preparers are careful in that area because one that is too aggressive on one return puts all of their clients at risk.
Whyte: Everybody wants to save money, though. Nobody wants to give their money away. So how do they know if it's a gray area? You said if it's gray, I might be inclined to take gray. Someone else may say I don't want any gray.
Scroggins: Where most of the gray areas are going to show up is on the business side of tax filings. Like we were saying earlier, so many of the deductions of years past are gone now. So unless someone puts false information on a personal tax return, there's not a lot of wiggle room. And many gray areas show up mostly on the business side; the general tests there are whether deductions taken are customary, usual, ordinary, necessary — that type of terminology. So to take a deduction that's not related to the business, like extravagant, lavish trips, things like that are likely going to get denied. But those would be gray areas.
Whyte: What about the impact of investments? Do physicians think enough about the tax implication of capital gains mutual funds? How should they think about that and maximize what they're entitled to?
Scroggins: That's where they really need to lean into their investment adviser, unless they're doing that on their own, to watch the buys and sells throughout the year to make sure that they're washing out any gains perhaps by selling some investments that have gone down in value. A lot of times, investment advisors refer to that as tax loss harvesting. So there are gains coming through, and particularly with capital gains distributions or mutual funds.
When we have a stock market on the incline, which is not what we're experiencing this year, then those distributions can be substantial. So if there's an opportunity to offset those losses, that's certainly important. But I do think it's an area that can be overlooked unless they or their advisor is really watching over that. It certainly adds to the tax burden, especially as doctors near retirement; investment accounts are more sizable. Those gains can be more impactful.
Whyte: What should I be doing now if I'm thinking of retirement in 5 years? I should talk to you, but what are the general principles?
Scroggins: The most important is the planning piece of that — to really start doing some true, accurate projections and identify the income needs that are anticipated in retirement. Often that goes up in the early years of retirement. More money is spent than maybe anticipated. But really good planning is the priority. And hopefully the doctors have done a good job of saving into retirement accounts over the years, whether it's a 401(k) or, as many of our clients are now also adding on, a defined benefit plan.
So as those assets are put away and they've grown tax-deferred, that's going to be the income source in retirement. Also important is planning for how much needs to come out of those accounts and at what points in time. More than 5 years prior to retirement, the actual saving for retirement is in the rearview mirror at that point, for the most part, and now it's approaching the drawdown time. So hopefully the savings and the planning have gone well and physicians are well positioned to get the income they need in retirement.
Whyte: I hate to talk politics, Rob, but let's be realistic: Taxes are largely political and determined by Congress, in terms of what rates may be. Do you see any significant changes that you predict may occur in the tax code in the next 2 years, prior to the next election?
Scroggins: Well, I'm surprised that we haven't actually seen that in the first couple of years of the new administration. I would have suspected that was an action that would have been taken.
Whyte: Higher tax hikes for high income.
Scroggins: At the end of 2017 there was the Tax Cuts and Jobs Act, and a change to the AMT (alternative minimum tax) came with that. The marginal rate structure also changed, favorable to the higher-earning taxpayers. That's where normally we'd see Democratic administration come in, and I'd be in favor of raising rates. So I'm surprised that it hasn't happened. And if some of the political power shifts in Congress after the midterm elections, then the chance of taxes increasing in the remaining 2 years of the Biden administration is probably fairly slim.
Whyte: Do you agree with the conventional wisdom? People often say that doctors are not good money managers, they're not good accountants. Do you agree with that?
Scroggins: I think of those two questions separately. In our client base, I've noticed that some of our clients are quite good on the investment side. Perhaps just as the general population would be, doctors are very smart people. Often they get a bad rap as not being business people, and they don't have a lot of that in their education.
But what I've found is that they're very intelligent. They can absorb a lot of information and understand it quite well because that's what they do in their day job. And so with good advisors and good information, that leads to good decisions. I think they're probably also like the general population in terms of saving and planning for the future; some do a very good job, like others, and some don't do so well with that.
Whyte: Well, Rob, I'm going to end on a good note — that you don't believe that tax rates will increase. That is very encouraging.
Scroggins: I do not believe that they will increase, but none of us have a crystal ball for that.
Whyte: Thank you for taking the time today to share your insights in terms of how physicians pay tax and what might be some of those areas on their tax return that they want to pay a little more attention to.
Scroggins: You're quite welcome. Good to be with you.
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Cite this: John Whyte, Robert C. Scroggins. How Can Physicians Pay Less in Taxes? Expert Offers Tips - Medscape - Aug 18, 2022.