On our communities, we often see physicians asking how they can save on taxes, or for recommendations on an accountant can help them save on taxes. The first response is usually, are you paid as a W2 or are you a partner or 1099? This matters a lot, because the tax code is set up very differently depending on the type of income. One of the reason many physicians love side gigs is because the tax code is set up to favor businesses and real estate, and therefore, these earners typically have more tax savings options than W2 earners. If you have any 1099 income, you should check out our blog post on tax deductions for the 1099 physician.
If you are an employed physician who is paid as W2 without alternative income streams, before you go out an hire an expensive tax strategist, this post goes over the most commonly suggested tax savings outlets for W2 physicians, and what to know about each.
Disclaimers/Disclosures: We do not provide individualized advice and are not formal financial, legal, or otherwise licensed professionals. You should consult these parties as appropriate and do your own due diligence before making decisions based on this page. This page may contain information about our sponsors or affiliate links, which support the group at no cost to you. These should be viewed as introductions rather than formal recommendations.
Quick Links
Resources
Basics of What Physicians Need to Know about Taxes: www.physiciansidegigs.com/taxes
Self Employed Finances Primer: This primer goes over popular tax strategy options for self-employed income
Real Estate Investing: This page connects you with avenues to learn more about real estate investing
TLDR on Tax Strategy Options for W2 Physicians
If your sole income source is W2, your options for tax savings and fancy tax strategy are limited, but you should do what you can to be smart about them.
Max out your basics.
Be wary of tax strategists or others that sell you very creative tax strategies. In particular, check out the IRS’s ‘Dirty Dozen,’ which they put out every year listing things that are high on their radar for fraud.
Retirement Accounts
For most W2 physicians, contributing to the retirement accounts available to you at work is the most straightforward way to reduce the taxes you owe today.
If you make contributions that are tax deferred (i.e. not the ROTH options on your 401k, but traditional 401k, 403b, 457, etc), those contributions are tax deductible for the tax year where they were taken out of your paycheck, meaning that they reduce your taxable income today. The maximum amount you can contribute can change yearly, so make sure you check and adjust your withdrawals at the beginning of every year to maximize this (and maximize your employee matching!). Remember you will pay taxes on that money when you take it out.
The theory here is that you’re in a higher tax bracket in the years that you’re working, so you would rather pay the taxes in retirement when you are in a lower tax bracket. Nobody has a crystal ball, but if for some reason you think that you will be in a higher tax bracket in retirement and have the option of investing in a ROTH 401k, then you could consider paying the taxes now and letting everything grow tax free going forward, with no taxes to be paid when you withdraw.
Learn more about choosing between a traditional 401k or Roth 401k.
If you are eligible for a traditional IRA, make sure you contribute to those as well (up to $6500 - or $7500 if 50 or older - annually as of 2023). NOTE: Many physicians will NOT qualify for this based on income. You can read more about IRA deduction limits here on the IRS page. Many high income professionals get around this by doing a backdoor ROTH contribution. You can read our guide to the Backdoor Roth here.
If your 401k plan qualifies and has the necessary special features, you may also be able to take advantage of the mega Backdoor Roth, which is a powerful option for physicians to put a significant amount of post tax dollars into a 401k plan and then roll it into a Roth (either a Roth IRA or Roth 401k).
Another option is a defined benefit plan, if you happen to have access to one as an employee. Most of the times when we are talking about defined benefit plans on the community we are talking about the huge tax savings you can get as an employER or partner in a practice, but just in case you hear about this, it can be a great way to put
More about retirement accounts - click on retirement accounts.
Other Tax Advantaged Accounts (HSA, FSA, 529)
If you’ve been on the groups for a while, you know we love the HSA if you’re eligible (i.e. have a high deductible health plan). The reason for this is because they’re triple tax free - you can contribute to them with pre-tax dollars, let them grow tax free, and then withdraw money tax-free (as long as you use that money for healthcare related expenses). These can be withdrawn whenever you want, even decades from now, so you should let them keep growing tax free or as long as possible. If you have a high deductible health plan, this is an obvious one to look into, and even if your job doesn’t offer it, you can do it separately. It doesn’t matter what your income level is to qualify. In 2023, you can contribute $3850 for an individual or $7750 for a family if you’re younger than 55, and an additional $1000 if you’re older as a catch up contribution. In 2024, this goes up to $4,150 for self-only coverage and $8,300 for family coverage.
Learn more about health savings accounts (HSAs).
If you have access to an FSA at work, you can contribute $3050 in pretax dollars for an individual to this account, but make sure that you have that amount in eligible healthcare expenses, since those don’t roll over to the next year if you don’t use them.
If your state gives you a tax deduction for 529s, you could also use this for your tax strategy. Even if you can’t deduct on your taxes, some people view 529s as tax advantaged as they do grow tax free. Lots of other great reasons to use 529s as well (but always take care of your own retirement first!). Visit our 529 plans page for more information.
Charitable Contributions
If you donate substantial amounts of money, it’s worth talking to your accountant about tax savvy ways to do it. These days, many people elect the standard deduction on their taxes as it is a large enough amount that many wouldn’t benefit from itemizing their deductions. However, there are some strategies such as ‘bunching’ your donations to be able to take advantage of deductions, as well as more complicated strategies that involve the creation of entities that are beyond the scope of this discussion. The rules are complicated and there are income restrictions on some deductions. Of note, some charitable trusts are more carefully scrutinized by the IRS (see below).
Tax Loss Harvesting
This isn’t a huge tax deduction, as it maxes out at offsetting $3000 on your income taxes annually, but it’s something you should consider if you have the opportunity. Essentially, if you have an investment asset that has lost value, you can sell the asset and buy something similar with a similar value, and then declaring the loss on your taxes against any capital gains that you have. Before you do this, make sure you look up the rules on Wash Sales from the IRS.
Real Estate Investing Options
This is a big topic, and if you’re very interested in it, you should make sure you’re signed up for our free real estate education event series, as we discuss it often there. There are several tax advantages to real estate investing that are inherent to the investments, but for most of those, the tax advantages are related to the income produced by the real estate investment itself, but not as deductions against your W2 income. There are two exceptions to this which are very powerful if used correctly.
1. Real Estate Professional Status This does not mean you have to be a real estate agent. If you, or if applicable, the person you file jointly on your taxes with, meet the criteria for real estate professional status (in the pictures below, please check for most current rules), you can actually deduct paper losses related to your real estate activity against your W2 income and potentially pay as little as $0 in taxes. Note that the person claiming this status has to do real estate more than anything else so in order to claim this, most physicians will actually have to cut down their clinical activity to qualify or have a spouse that is able to qualify. What happens here is that the IRS typically classifies rental income as passive income, and therefore the ‘losses’ incurred from depreciation on your property can only be used against your passive gains such as rental income, and is subject to limitations on loss deductions. Even if your property is actually increasing in value, the IRS has a scheduled depreciation on your properties that is spread out over the course of almost 3 decades, which often offsets the cash flow from the property. However, real estate professionals can treat their rental income as active income, allowing them to deduct ‘losses’ from their rental properties without limitation against their W2 active income as well. This is a complicated concept but one that many in our communities who invest in rental properties try and utilize because of its power. You should talk to an accountant experienced in real estate about this (which we are not!).
Learn more about real estate professional status.
2. Short Term Rental Tax Loophole This ‘loophole’ is a big reason investing in short term rentals has become popular amongst physicians. Unlike the REPS strategy used in longer term rental properties, where have to meet the REPS criteria above, you can qualify for this without having to do real estate “more than anything else” as long as you meet other criteria. Even if you work full time, you can take advantage of this. For those that buy and put into service rental properties that are rented out for short stays (<7 days average per IRS rules), as well as meet other criteria for material participation as defined here on the IRS website, it is possible to depreciate the value of the property against their W2 income over a defined period of time. Currently (phasing out gradually by 2027), you can even do something called bonus depreciation, where instead of spreading that depreciation over a larger period of time, you can take a large percentage of it in the first year. Again, the details of this require working with an accountant savvy in real estate who can ensure that you are in compliance with the guidelines set by the IRS. Visit our page on choosing an accountant to guide you through the process is you need to find a new accountant.
Beware of the IRS’ Dirty Dozen
If It sounds too good to be true, there’s probably a lot of research that needs to be done before going forward. People love to tax about tax strategy and share the unique things they’ve learned about, including tax strategists (hopefully well-intentioned), colleagues, and random social media accounts. Understand that while there are many loopholes within the tax code, some of them are more nuanced than others and more susceptible to fraud or inexperienced operators that could result in problems for you if they don’t follow the letter of the law exactly. Every year, the IRS puts out a list of things that are higher on their radar either because of fraudulent activity or schemes that take advantage of innocent taxpayers. Things that regularly show up on their list that are often suggested by tax strategists or others on social media:
Conservation easements
Oil and gas, mineral rights partnerships
Charitable Remainder Annuity Trusts
Monetized Installment Sales
Micro-captive insurance arrangements
As these things are more likely to result in an audit, make sure 1) that it feels legitimate and you’ve done your due diligence and 2) ask yourself whether you think the risk of an audit is worth it to you. Everyone’s aversion to being contacted by the IRS is different, even if what they are doing is completely legal, so make decisions accordingly. As with everything, the more you know, the better you can make a decision that’s right for you.
Conclusion
As discussed above, while there are less deductions for W2 earners without 1099 or partnership/business income, there are some tried and true (and less tried and true) options! It’s worth looking into these, but be careful if anybody promises you huge tax savings as a W2 only income earner, especially if they’re asking you to pay a lot for that advice. If you really want to pursue tax advantaged income, having a side gig is a great way to do it instead, as you really have more deductions available to you with self-employed income!