Question: I feel like I’m paying more in tax than most of the other doctors I know. What am I doing wrong?

Answer: As a general rule, paying more in tax is a good thing because it means you are making more money. While earning more does result in a higher tax bill, it also generally results in having more money even after paying taxes. Remember that only a relatively small portion of your earnings is taxed at your marginal tax rate (tax bracket), so being bumped into a higher bracket does not result in all of your earnings being taxed at that new higher rate.

Almost all doctors think they pay too much in tax and most of them are right. However, the way to significantly lower taxes is not to find some tricky, hard-to-find deduction or hire the right person to prepare your taxes. The main way is to live your financial life differently: save more, get married, have children, buy a house, start a business, give to charity, hold your investments longer, etc. There are three tax deductions that generally outpace the others for physicians. If you would like to pay less in tax, be aware of all of these and maximize them as much as possible.

#1: Tax-Deferred Retirement Accounts

The first deduction is using tax-deferred retirement accounts. These come in a wide variety of flavors including 401(k), 403(b), 457(b), 401(a), defined benefit/cash balance plans, solo 401(k), SIMPLE IRA, SEP-IRA, and even traditional IRA. All of them work similarly. Any money contributed into the plan by you or your employer this year is money deducted from your income before your tax bill is calculated on the remaining income. For example, if you earn $300,000 and put $20,000 into your 401(k), you will only pay tax on $280,000. If you are single with no other significant deductions, that $20,000 contribution will reduce your federal tax bill by $7,500 (and potentially your state tax bill as well). Imagine that you could put $50,000 or even $100,000 into tax-deferred retirement accounts. You could reduce your tax burden by tens of thousands of dollars this year, plus you would be in much better shape for retirement. The up-front tax deduction is not the only way a tax-deferred retirement contribution saves you tax money. That money also grows in a tax-protected way, meaning you do not have to pay any taxes on dividends or capital gains as you invest in the account between contribution and withdrawal. At withdrawal, all of the money in the account is taxed at ordinary income rates, but you use it to “fill the tax brackets” as you go. For most doctors, they will get a tax deduction of 24–37 percent on contributions and then pay 10–22 percent on withdrawals as they fill the various lower tax brackets with that income. That’s a winning combination. Maxing out your retirement accounts also provides significant asset protection and facilitates your estate planning.

#2: Health Care Expenses

The second large deduction for physicians is health care expenses. I’m not talking about the medical and dental expenses itemized deduction on Schedule A. Since that is subject to a floor of 7.5 percent of income, few doctors will ever be able to claim that. I’m talking about paying for all of your health care expenses with pre-tax dollars. If you are an independent contractor or partner, you can deduct the entire cost of your health insurance premiums. This is a more favorable, above-the-line deduction that you currently take on Schedule 1 of Form 1040, right next to the self-employed retirement plan contributions. You get to buy your health insurance with pre-tax dollars. If you’re in the highest federal tax bracket and spend $1,500 a month on health insurance for your family, that deduction is worth $6,660 to you in saved federal taxes alone. But wait, there’s more! If your only health insurance plan is a High Deductible Health Plan (HDHP), you can also contribute $3,650 ($7,300 for a family) to a Health Savings Account (HSA). That money can then be used to pay your deductibles, co-pays, or uncovered expenses with pre-tax money. That knocks another $2,701 off your tax bill. If you don’t spend it all, you can roll it over to the next year and even invest it for decades until you spend it in retirement. It grows tax-protected, just like your 401(k), and as long as it is spent on health care (including Medicare premiums), it comes out completely tax-free.

If you are an employee, you don’t get a tax break on health insurance premiums paid. You’re probably not paying the whole premium, though, and your employer is able to buy your health insurance for you using pre-tax dollars, presumably saving enough in taxes to give you a raise!

#3: Standard Deduction

The final large deduction that physicians should know about is the standard deduction. That’s right, the one you get just for having a pulse. For 2022, the standard deduction is $12,950 or $25,900 married filing jointly (MFJ). You don’t have to do a thing to get it. So, if you are married and make $300,000, you don’t pay taxes on the last $25,900 of that income, saving you $6,216 in taxes. It’s possible you have enough itemized deductions to save even more. The three main itemized deductions are state income and property taxes up to $10,000 total, charitable contributions, and mortgage interest. If the three of those add up to more than $12,950 ($25,900 MFJ), you can save even more. Imagine that you were married and earned $500,000, paid $10,000 in state income taxes, donated $50,000 to charity, and paid another $40,000 in mortgage interest. That is $100,000 worth of itemized deductions. You just knocked $100,000 off your taxable income and $35,000 off your tax bill. Are you going to come out ahead financially paying state income taxes, giving lots of money away, and buying a fancy house? Of course not. But if you’re going to do those things anyway, you might as well get a tax break for it.

Physicians are high earners with great potential to build wealth. Understanding how the tax system works will facilitate that process.

Dr. Dahle blogs at https://www.whitecoatinvestor.com and is a best-selling author and podcaster. He is not a licensed financial adviser, accountant, or attorney and recommends you consult with your own advisers prior to acting on any information you read here.