7 tax strategies for a low-income year

For many people, 2020 has been a tough year. The COVID-19 pandemic, business shutdowns, the general economic downturn, and layoffs may have all taken their toll on your finances. Many physicians and APPs have not only become overwhelmed by the stress of treating patients in this environment but may have become ill themselves or been exposed to the virus leading to time off of work quarantining. Others lost work time taking care of their children at home who have been schooling remotely or missing school altogether.

Yet in this dark cloud, there is at least one silver lining. Although your income for 2020 may be significantly lower than usual, that means your taxes and tax bracket may also be significantly lower as well. Now is the time to try to take advantage of this situation. The general idea is to take as much income as you can this year when you are in a lower tax bracket and defer expenses until a year when your income and tax bracket will be higher. Here are seven strategies you may be able to follow to help your tax situation this year, and possibly in 2021 if the pandemic and economy continue to wreak havoc on your finances.

1. Accelerate income into 2020

While there is only a short period of time left in the year, some techniques may still be available to you. First, contact all your patients, insurance companies, and anyone else who owes you money and encourage them to pay what they owe to you before year-end.

Second, if you are an employee or are working as a locum tenens and are entitled to a bonus for the year, ask your hospital or other employer to give you the bonus before year-end instead of in January or later. If you are honest and tell the employer that this is meant to help your tax situation, they may respond more positively than if it is just a random request.

Third, if you run your business as a professional corporation, there are other income-shifting strategies to consider. Generally, the goal of most physician’s corporations (PC) is to zero out the books for the year so the income matches the expenses and no corporate tax is due. If you know your PC is about to receive a large payment for services early next year, consider paying yourself the money out of the corporation this year when your tax bracket will be lower. This may result in a net operating loss (NOL) for the PC in 2020, so no corporate taxes will be due. The NOL can be carried forward to 2021 when the PC receives the large payment and the books will then balance for 2021. The same strategy can be used for other income that you would be receiving next year but for which the PC has yet to actually receive the money. While the PC will not necessarily be able immediately to honor the payment check to you unless it gets a loan (from you or someone else), that is not a problem unless you actually try to cash the check. Instead, simply hold onto the check until the PC has the funds to cover it. The check still acts as income to you whether it is cashed or not, since you are in constructive receipt of the income in 2020.

2. Defer expenses to 2021

In most years, the goal is to accelerate deductions to lower taxable income. But in a low-income year, the reverse is true since the goal now is to take income at a lower tax bracket and use the deductions in another year at a higher tax bracket.

In a low-income year, the best advice is that if you don’t need it, then don’t buy it. But if you do need to buy a deductible item such as a computer or piece of medical equipment for your business, defer the purchase until after the start of next year so the deduction applies to 2021.

If you are buying a business asset (computer, medical equipment, etc.) that you want to buy this year (for example, you’re getting a discount if you buy it before year-end), simply purchase the asset but do not put it into service until January. A business asset can only be deducted in the year it is put into service, not in the year it is purchased.

3. Take capital gains in 2020

If you are in a low tax bracket, this may be time to take any capital gains you have on stocks, bonds, cryptocurrency, real estate, etc. While the general strategy is to balance capital gains with capital losses, you may want to defer selling the losing assets until a year when the losses will be more valuable at a higher tax rate and take the gains at the current lower tax rate.

In addition to the lower ordinary tax rate in a low-income year, the capital gains tax rate also will be lower at certain income levels. Short-term capital gains will still be taxed at your ordinary tax rate level, but this is lower anyway with your lower income. Long-term capital gains will be tax-free if your income is $40,000 or less for an individual (or $80,000 or less for married filing jointly), 15% for income of $40,001 to $441,450 for an individual (or $80,001 to $496,600 for married filing jointly), or 20% for incomes above those levels.

physician and spouse meeting with tax advisor

4. Contribute to a Roth individual retirement account

The difference between a traditional IRA and a Roth IRA is that the money being contributed to a traditional IRA may be tax-deductible in the year it is contributed, but contributions and any accumulated growth is taxable at the ordinary income tax rate when it is distributed out of the IRA. With a Roth IRA, the contribution is not tax-deductible when it is contributed, but the contributions and any accumulated growth are non-taxable when withdrawn after 59 ½.

If you are having a low-income year, you are already in a low tax bracket, so it makes little sense to contribute to a traditional IRA since the tax saving will be small but the tax rate may be much higher when the money is distributed years from now (not to mention the tax on the accumulated growth inside the plan). Instead, it makes more sense to contribute to a Roth IRA when the contribution year tax rate is low.

At the time of withdrawal at retirement, the tax rate may be high but since Roth IRA distributions are tax-free, you do not have to pay at that higher rate. One caveat: a Roth can only be started or contributed to if your modified AGI is $139,000 or less for an individual in 2020 or $206,000 or less for married filing jointly for 2020, and the contribution limits are the same as for the traditional IRA. However, you can then immediately roll over that contribution to a Roth IRA and pay no tax on the rollover, since the contribution to the traditional IRA was taxable. This is called a “Backdoor Roth”. Use this link to learn more about “Roth IRA versus Traditional IRA: Which is Better for You?

5. Do a Roth IRA rollover

If you are in a lower tax bracket this year or next, and you have money in a traditional IRA or if you have access to money in other retirement plans, this may be the ideal time to do a rollover into a Roth IRA.

When money is taken out of a traditional IRA or another tax-deferred retirement plan, it is immediately taxable at the ordinary income tax rate. But if you are at a low tax bracket in 2020 (or 2021), the tax hit will be less than if you take that money out in a higher income year. And the money can be rolled over into a Roth IRA where it can then grow and ultimately be withdrawn tax-free when you need it after age 59 ½ (or you can leave it in the Roth and pass it along to your heirs tax-free).

Ideally, you would want to pay the tax on the rollover from funds not in the IRA but from other sources so that as much money as possible can be put into the Roth to grow tax-free.

6. Review relief grants and other income taxes

Many physicians received money from the Payroll Protection Program (PPP) and/or the Provider Relief Fund (PRF) authorized by the CARES act due to the COVID pandemic. The PPP money is in part or entirely tax-free if you seek forgiveness, so it does not in and of itself increase your taxable income for the year, possibly keeping you in a lower tax bracket. At the time of this writing, however, any expenses related to the PPP money (e.g. employees’ salaries, rents, mortgages, utilities) cannot be expensed, effectively making the PPP loan potentially taxable. Hopefully, Congress will rectify this problem.

In contrast, the PRF money is tax-free. While it is supposed to be used to pay business expenses, there does not appear to be the same issues as with the PPP, so it can be considered not to increase your table income.

Also, keep in mind that the net investment income tax of 3.8% applies only to taxable income above $250,000 and the extra Medicare tax (Obamacare tax) applies only to earned income for each individual above $250,000. While these grants and taxes should not alter the other strategies discussed here, they need to still be considered.

7. Get professional tax help

With the right help, you can execute the ideal plan to take advantage of your lower-income year. A tax strategist specializing in high income-earning healthcare professionals can help balance your needs and ensure that you reach the best financial outcome.

Cerebral Tax Advisors can help you with the guidance you need to lower your tax burden. Book a Tax Discovery Session now.