Reducing tax liabilities: Don't wait until April 15th to protect your income

Key Points

As a physician, do you realize that you spend 40 percent 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.

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 that one of these strategies might 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.

Share income wealth

Congress changed the rules on sharing income with lower-income family members 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. This technique is recommended by many CPAs and can work well for practice-owned real estate in a lease-back arrangement.

Cash-value life insurance

Under realistic assumptions, a $500,000 mutual fund portfolio may generate an annual tax liability of $10,000 to $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.

There is even an employee benefit plan that allows you a partial tax deduction if you properly structure your insurance purchase through your corporation.

Investment managers

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; however, unlike a mutual fund, with which 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 have often outgrown mutual funds and need to explore IMAs.