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Tax Planning Strategies

Proper tax planning can make a big financial impact on a pharmacist families bottom line every year. However, preparing a strategy that is both advantageous and tax-efficient might feel daunting at first. Tax rules and regulations are not getting any easier and they seem to be changing annually. But that shouldn't detract you from making the most of the opportunities you are afforded through the Internal Revenue Code.  Tax evasion is illegal but tax avoidance is fair game for everyone to pursue. Thankfully, there are some things you can do now to keep from overpaying this tax season and beyond. Just remember, you're never considered extra patriotic when you pay more to the IRS then you have to!

Key Takeaways:

  • Building your professional team
  • Tax-Focused Investment strategies
  • Tax Loss Harvesting
  • Shadow Tax minimization

Hold up! Before you go any further, check out our complimentary checklist:As-A-High-Income-Taxpayer-How-Might-President-Bidens-Tax-Plan-Affect-Me-2021.pdf

Is a blog post not your style? Do you prefer video instead? No worries, we've got you covered! Check-out this PharmD FP video about Child Care FSAs and Child Care Tax Credits.

Build Your Team of Professionals

Building a financial team to tackle your taxes may often mean talking to more than one person. A lot of the time, many people feel that their accountant or CPA is the only source they need to help guide them within the realm of tax planning. And that may be the case, but often times a single professional cannot be tasked with covering all your tax issues now and into the future. Having a trusted team of professionals working together on your behalf is a much better option. A financial planning professional may be one of those "teammates" you might consider hiring. The biggest reason for this is that taxes are connected to almost all of your other financial matters. There are very few instances when you are able to do something with your money or property and not cause a tax event (See the Augusta Rule for one of those rare such cases). This means that allowing a team of trusted professionals who help you manage the different area's of your financial life, should all be "in-the-know" when it comes to your tax situation.  

At PharmD Financial Planning, we require a copy of each clients tax returns every year. We overlay a clients current tax situation onto future opportunities we feel are attainable to lower their tax burden. When we think we have found unique tax planning opportunities, we always invite the opinions and expertise of that clients trusted accountant to CPA. Because we understand the value of having a team on your side, all working in your best interest. You should value that as well.

Tax-Focused Investment Strategies

Once you have the right team of financial professionals who understand your financial situation, there are some investment strategies you may consider using. 

Backdoor Roth IRA

If you are a high earner with an income above the IRS’s income limit for Roth IRA accounts, you still have the option to create a backdoor Roth IRA. Just as it sounds, this option allows high earners to bypass the income limits and still utilize the tax advantages of a Roth IRA account.

A backdoor Roth IRA may be beneficial for those whose income level is above the ceiling limit set by the IRS. Additionally, it’s important to remember that Roth IRAs do not have required minimum withdrawals, only traditional IRAs do.

When considering a backdoor IRA, evaluate the tax obligations you might pay today versus the tax benefits you may realize toward retirement. To learn more about Roth IRAs, check out Episode 5 of the PharmD Money podcast, Roth IRA Basics for Pharmacists.

Backdoor Roth IRA

Tax-Focused Gifting

Smart moves can help you manage your taxable income and taxable estate. For instance, if you’re making a charitable gift, giving appreciated securities that you have held for at least a year is one choice to consider. In addition to a potential tax deduction for the fair market value of the asset in the year of the donation, the charity may be able to sell the stock later without triggering capital gains. 

This discussion of tax-focused giving is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your financial, tax, and legal professionals before modifying your gifting strategy. 

The annual gift tax exclusion gives you a way to remove assets from your taxable estate. You may give up to $15,000 ($30,000 if you are married) to as many individuals as you wish without paying federal gift tax, so long as your total gifts keep you within the lifetime estate and gift tax exemption of $11.7 million for 2021.1 Managing through the annual gift tax exclusion can involve a complex set of tax rules and regulations. Before adjusting your strategy, consider working with a professional who is familiar with the rules and regulations.

Tax-Loss Harvesting

Tax-loss harvesting refers to the practice of taking capital losses (you sell securities worth less than what you first paid for them) to help offset the capital gains you may have recognized. Keep in mind that the return and principal value of securities will fluctuate as market conditions change and past performance is no guarantee of future returns. While this doesn’t get rid of your losses, it can be an approach to manage your tax liability.

Up to $3,000 of capital losses in excess of capital gains can be deducted annually, and any remaining capital losses above that can be carried forward to, potentially, offset capital gains next year.2 But remember, tax rules are constantly changing, and there is no guarantee that the treatment of capital gains and losses will remain the same in the coming years.

By taking losses this year and carrying over the excess losses into the next, you can potentially offset some (or maybe all) of your capital gains next year. Before moving ahead with a trade, it’s important to understand the role each investment plays in your portfolio.

If you’re looking into this strategy, familiarize yourself with the IRS’s “wash-sale rule.” This rule indicates that investors can’t claim a loss on a security if you buy the same or a “substantially identical” security within 30 days before or after the sale. Watch this PharmD FP video The Wash-Sale Rule to learn more. 

With these strategies in mind, there are things you may be able to do now to address both your current tax obligation and those you may be required to address further down the road.

Be aware of Shadow Taxes

Shadow taxes are not a term you will find while you peruse the IRS website. I refer to the type of taxes that individuals  pay that are not as common or well known, as shadow taxes. These are the type of taxes that can creep up on you and cause compounding tax liability on your return. If not managed properly, they could cause a snowball affect of taxation that might negatively effect other income sources on your tax return.

Net Investment Income Tax (NIIT)

Net investment income is as it sounds. It's investment income that is earned throughout the year. Common examples of net investment income are interest, dividends, capital gains, rental and royalty income, non-qualified annuities, and passive activity income. The net investment income tax (NIIT) is a 3.8% additional tax rate that is imposed on all net investment income earned, IF your modified adjusted gross income is over a specific threshold. You can see those thresholds below.

Filing Status
Threshold Amount
Married Filing Jointly$250,000
Married Filing Separately$125,000
Head of Household$200,000
Qualified widow(er) $250,000

So, if you find yourself with net investment income and you will exceed the threshold amount allowed given your filing status, you may end up owing an additional 3.8% in taxes on that net investment income.

Short Term Capital Gains

You are probably aware that capital gain tax is more favorable and less punitive (from a tax standpoint) than earned income. When you are taxed at capital gain rates, you currently enjoy tax rates of 0%, 15%, or 20%. But it's important to note that these rates only apply to long-term capital gains. These long-term capital gain rates only apply to capital assets that you buy and hold for OVER 1 year and then sell. If you buy a stock on June 1st of 2020 and then sell it for a profit on June 2nd 2021, you will be taxed at those long-term capital gain rates.

However, any capital asset sold for a profit that was held for one year or less will be taxed as short term capital gains. These rates are the same as ordinary income tax rates. Meaning that the tax benefit of profiting off of the sale of a capital asset (like a stock) goes away unless you hold that asset for over a year. Selling a fast appreciating capital asset before the 1 year holding period has been met, could unwillingly force you to pay ordinary income tax on that appreciated asset. To make matters worse, it might ultimately lift you into a higher marginal tax rate. 

Short Term Capital Gains

Bottom Line

Tax planning is paramount to true financial wellbeing. Understanding where your tax liabilities are and how they can be minimized should be a priority for every pharmacist. Once you let tax opportunities go, they most likely will be gone forever. That is real money out of your pocket. So as you progress throughout the year, keep and eye on your tax situation. Do your best to anticipate tax opportunities that you can take advantage of. Taxes will never go away, but you can minimize that pain by doing everything in your power to avoid it as much as possible.

Derek Delaney is a Minnesota (Minneapolis / Rochester area)  Fee-Only financial advisor serving clients across the country. PharmD Financial Planning provides professionals and families with financial planning and investment management with a focus on tax-efficient retirement planning.

As a fee-only, fiduciary, and independent financial advisor, Derek Delaney is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.

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