[PIMD: Quick thanks to Paul Sundin, CPA who was gracious enough to review some of the numbers in this post with me.]
The recently passed Tax Cuts and Jobs Act is controversial to say the least. However you feel about it though, the fact is it’s here to stay, affecting everyone by 2018. We’ve already heard from Physician on Fire on how the new bill will affect him (spoiler: his taxes are going down) and a great summary of the new bill from the White Coat Investor.
However, in looking at our own situation as a two physician couple (purely from the medical income standpoint), at first glance it seems as though our taxes would actually go up. In addition, if it’s going up for us, it surely must be increasing for some other physicians. To answer this, I decided to take a closer look.
I’ve analyzed our situation ad nauseam, and I realized that when I factor in our other businesses and passive income sources, it gets extremely complicated very quickly. Since TurboTax isn’t going to cut it, I will definitely be relying heavily on a professional to do the job as I've always done in the past. However, I tried to come up with a basic, useful model on my own.
My wife and I are both physicians in higher paying specialties. I operate under an S Corporation and she receives both a 1099 and W-2 from working at multiple places. But to keep things simple, I’m going to assume we receive everything through one S-Corp and I'll assume a single 401k deduction ($18,500) so it makes sense for the married physician with a single income household. We’re fortunate that we have some ability to work more or less to adjust our incomes, therefore I decided to play out a couple different scenarios to see how things might turn out.
I’ve taken the liberty of a few assumptions:
- Married couple with two young children
- Home recently purchased with a mortgage of $1,500,000
- S Corporation
- Assume half of S-Corp income taken as a salary, half as distribution (benefit is to avoid paying some employment taxes)
- Charitable donations are 10% of gross income
- Couple lives in California
- Disregarded AMT which is a complicated calculation based on hypotheticals. Shouldn’t be a huge factor in these higher brackets
Some Important Elements of the Tax Cuts and Jobs Act
- Taxpayers who itemize can deduct at most $10,000 in State and Local income and property taxes.
- Federal child tax credit of $2000 per child starts phasing out at $400k income.
- Pass-through entities can now deduct 20% of taxable income under $315,000 with a scaled phase out up to $415,000.
- Personal exemptions have been repealed until 2025 so you'll see them missing from the NEW calculations.
How Some Physicians' Taxes Might Look
Here’s what I found for physicians making from $400,000 to $700,000. For the punchlines, look for the TOTAL TAX line in each section.
For the 400k and 500k earning physician in a high cost of living state, with those assumptions, their tax burden may actually decrease, even with state and local tax deductions & property tax capped at $10,000. This is possible because of the federal child credit, the 20% pass-through deduction on the S-corp, and the ultimate lowering of their federal tax bracket.
For the 600k and 700k earning physician, looks like their taxes increased. They do not qualify for the 20% pass-through deduction or child credit. The 700k earner will see their federal tax bracket drop to 35% from 39.6% previously. However, without some of the previous deductions they could take, their overall tax burden increased.
Thought I should at least mention a quick thought on the high-income W-2 employee. They will not be eligible to receive a 20% pass-through deduction in any category. Some other professions have talked about changing their designation by getting rehired as a pass-through corporation instead of as a W-2. Unfortunately for physicians, it's likely not a possibility to do this.
Ultimately, it is what it is. As always, people will adjust. With the caps on certain deductions and credits, knowing and predicting where you’ll land is important. For example, you may not want to take those extra calls knowing that it’ll make you ineligible for the child tax credit or less of a pass-through deduction. For some of your other businesses, you may want to change it from a pass-through entity to a C corp so it doesn’t affect your personal return.
According to Paul Sundin, CPA, “The cap on state and local taxes will hurt some folks. Self-employed taxpayers earning over $500,000 in high tax states could see their tax bill go up a little. But self-employed taxpayers earning less could see a slightly lower tax bill as a result of lower tax rates and the 20% pass-through deduction. We will see an emphasis on tax planning to keep taxable income below $315,000 which is where the 20% pass-through deduction starts to phase-out.”
Sounds like the IRS is still figuring out how to interpret and implement the new tax code so look for a good number of updates over the next few months. At the very least, your accountant should have a good handle on this and be up to speed on it all.
Obviously, everyone’s scenario is different. I am not a tax professional so please do not perceive anything in this post as tax advice. I recommend that you consult with an extremely knowledgeable tax professional for your particular situation.
[PIMD: Just as a quick note, I didn't write this to try to garner any sympathy for the high-income physician. It’s simply to report the repercussions of the new tax bill and how it may affect my family and many other physicians, lawyers, and other high-income service professionals.]
How do you expect the tax law to work out for you? Will it change how you work or practice at all?