Year End Tax Planning: The Good Ole' Days of 2010.
Do you ever pine for the nostalgic days when life was simpler and there were no worries? Oh, if we could just go back. We not only survived but thrived without cell phones, smart phones, personal computers, internet, play stations, DVDs, or texting. Everyone was poor, and we were always outside playing or inside reading or actually interacting with each other, or moving the TV antenna hoping to receive a third channel. No one knew any better. Now we're not happy with only 99 channels and satellite radio to choose from.
But be careful what you wish for. You may think taxes to be high now, but believe it or not, taxes in 2010 are among the lowest in the last century, with the largest tax increase in American history to take effect on January 1, 2011 unless Congress intervenes to halt the Bush tax cuts which sunset December 31, 2010. Top marginal federal income tax rates in 1930 were 25%, 1940 81%, 1950 91%, 1960 91%, 1970 71%, 1980 70%, 1990 28%, 2000 39.6%, 2010 35%, 2011 39.6%, and in 2013 40.5%. You don't have to be a rocket scientist or brain surgeon to see a pattern here and predict future trends. With the country on the verge of bankruptcy, and ever increasing federal spending, all political arguments aside, the numbers are simply unsustainable. It's simple math! And all this on the verge of implementing the largest entitlement program in the history of the country – national health care.
Doctors face certain reimbursement cuts and increased taxation as the country comes to terms with its whopping debt. With the United States teetering on the verge of bankruptcy, and a staggering national debt of nearly $14 trillion (and if you don't remember, that's 12 zeros, $14,000,000,000,000), there exists an ever-increasing and always unfulfilled demand for tax revenues. Our federal government is like a newborn baby; an insatiable appetite on one end, and no sense of responsibility on the other. Doctors will take a direct body blow.
It is not just the rich affected by the 2011 tax increases. The 10% bracket increases to 15%, the 28% to 31%, and the 33% to 36%. Do you realize your retirement plan is automatically diminished in value 3 to 4.6% January 1, 2011 when the top marginal rate increases 3 to 4.6 % for the two highest brackets (which is where most doctors fall)?
Furthermore, long term capital gains tax is currently 15%, and will increase to 20% in 2011, and 23.8% in 2012. Dividends are currently taxed at the long term capital gains rate of 15%, and in 2011 will increase to the top marginal rate, which is 39.6% - a 264% increase! Internal Revenue Code Section 529 plans for college saving, open to all taxpayers, regardless of income, will expire in 2011.
Other tax provisions expiring December 31, 2010 include:
- The "marriage penalty", resulting from the fact that the standard deductions for married couples are less than double the single amounts, will return,
- Phasing out of itemized deductions,
- Phasing out of personal exemptions,
- The child tax credit will be cut in half from $1,000 to $500 per child,
- The dependent care credit is reduced from $3,000 to $2,400 of expenditures for one dependent, and from $6,000 to $4,800 for two or more dependents,
- The increased AMT (alternative minimum tax) exemption expires, affecting thousands of doctors across the country,
- For physician business owners, the $250,000 expensing of business equipment will be reduced to $25,000, and the 50% bonus depreciation will expire.
History will look with nostalgia to the good old days of 2010 when taxes were so low. 2010 was the year George Steinbrenner died with a $1.1 billion dollar estate and saved $600 million in estate taxes, and energy tycoon Dan Duncan of Texas died with a 9 billion estate and paid no estate taxes. However, the little guy profits too in 2010. It is not difficult for a doctor to accumulate a $2 million estate and be hit with confiscatory estate taxes, as the estate includes all assets, i.e. home, bank and stock accounts, retirement plans, and insurance payouts at death.
A doctor dying in 2010 with a $2 million dollar estate pays no estate tax, but in 2003 would have paid $490,000 in estate tax ($1 million exemption and a 49% rate). In 2011 the estate tax comes back with a vengeance. That same doctor dying on January 1, 2011 will pay $550,000 estate tax ($1 million exemption, 55% rate). And remember, that is money the doctor has already paid over 50% tax on already during his or her working lifetime, if one includes federal, state, FICA, etc. in the calculus.
What is so special about 2010? The estate tax in 2010 has been repealed, and the last time there was no estate tax was in 1914 – 96 years ago! The current gift tax of 35% has not been this low since 1934. The top marginal income tax rate this year is a mere 35%. If history is any guide, doctors will be paying 50, 60, 70, and even 80% tax rates in the not too distant future. The government may not call it taxes, but rather license, registration or other various fees; surcharges, FICA, FUTA, Worker's Comp., assessments, duties, or uncapping Social Security income ceilings. Now that the elections are over, look for a VAT (value added tax) or national sales taxes. Look for tax credits to be phased out, charitable deductions reduced, etc.
There will be a day of reckoning for the unrestrained extravagance of the last decade, and in particular the last three years. "Rich" doctors will not get any breaks, and will disproportionately pay. It doesn't matter that we work 70-90 hours a week, holidays, evenings, weekends, and gave up our youth to pursue medicine. We can't bill for telephone time, get reimbursed for filling out insurance and Worker's Compensation forms, travel time to satellite clinics, charge for paper clips and copies, bill for our time thinking about a patient in the middle of the night or in the shower, or bill by the nanosecond and round up to the nearest hour. Do you think lawyers would tolerate such abuse for even 10 minutes? Medicine is the only profession where a neophyte out of residency, still wet behind the ears, gets paid the same as an experienced clinician with 20 years of practice under his/her belt. What is a doctor to do?
Advanced techniques in reducing or eliminating estate taxes are beyond the scope of this article, but suffice it to say that the estate tax is considered a "voluntary" tax among estate planning attorneys, and the overwhelming percentage of doctors who pay estate tax can completely eliminate it through judicious mainstream planning techniques that are conservative and safe and will withstand IRS or court challenges. If your attorney or advisor recommends an offshore account, run as fast as you can!
Is there anything a doctor can do now before year's end or beyond?
- Plan your death in 2010 (just kidding). Beware the hidden "estate tax" in 2010. There is no basis increase on assets passed on with some exceptions, which means potential significant capital gains tax liability for doctors dying in 2010.
- Consider Roth conversion of qualified retirement plans. For the first time in 2010, individuals can convert funds in qualified plans or traditional IRAs to Roth IRAs, and are given the opportunity to include the converted income all in 2010, or split evenly between 2011 and 2012 (bad choice, as income tax rates will be higher then). This is a highly technical area to which an entire article can be devoted, but given the right conditions, huge income, and even estate tax savings can be accomplished.
- Increase income in 2010 before December 31.
- Push expenses into 2011 when tax rates are higher, and more tax can be saved.
- Pay as much capital gains as possible in 2010 when rates (long term gains) are only 15%. Combine this with a Roth conversion by selling equities from funds outside the retirement plan with a low basis to pay the income taxes and you win big, by paying lower capital gain and income taxes, and eliminating some estate taxes!
- Harvest capital losses up to $3,000 by matching with capital gains. Harvest capital gains against any capital loss carryovers
- Contribute to 529 plans for college education. One can prefund the plan with 5 years of contributions gift tax free.
- Postpone charitable contributions until 2011.
- If you own a clinic, delay equipment purchases until 2011 or take depreciation rather than expensing in 2010. You need to consider whether it's more advantageous to take a full deduction in 2010 or to spread the deduction out over future years with higher tax rates.
- For Health Savings Accounts, purchase non-prescription drugs in 2010, as they are not eligible for reimbursement after December 31, 2010.
- Pay for energy efficient improvements to your home in 2010, as the residential energy credit up to $1500 expires December 31, 2010.
- Take advantage of the Opportunity Tax Credit which is available for the first four years of higher education. This expires December 31, 2010.
There is a high likelihood that Congress will tinker with the tax laws over the next several months. It remains to be seen whether Congress will act during the lame duck session after the wave election or wait until the newly elected senators and representatives are sworn in in January. Remember, if Congress does nothing (does that ever happen?) by year's end, the Bush tax cuts will sunset December 31, 2010. This article may well be out of date by the time it is published, so consult with your professional advisor.
Physicians face ethical issues as well as financial issues as 2010 closes. This current tax uncertainty and cataclysmic change set to occur midnight December 31, 2010 has the potential to generate some interesting colloquyes in the ICU at 11:45 PM December 31, when one is considering withdrawing life support. Do we pull the plug on granny before or after midnight? It may mean the difference between the heirs receiving nothing versus several hundred thousand dollars inheritance, or whether the family farm can be passed on. I can envision stat consults for the estate planning attorney in the ICU for the unfortunate patient on the throes of death but expected to either die before midnight or survive beyond midnight. Radically different legal language is required to plan for transfer of assets depending if death is before or after midnight. I can envision oral or holographic (written in one's own hand) wills created just in the nick of time. What a legal morass. Should a request by the agent for the durable power of attorney for health care be honored if ulterior motives are suspected? The author is not suggesting this should even be a factor in the discussion, but human nature being what it is, undoubtedly such situations will arise somewhere in the country. And to think I'm covering neurosurgery call over New Years! Oh, I'm getting a headache. May the sun never set December 31, 2010!