With 2022 coming to an end, tax planning will become more important than any time this year. While some may wait until the new year to come to think about their taxes, they may miss out on credits, benefits, and strategies that ultimately aid their financial picture for the current year, if they take action right away.
Medical professionals who work hard for their income don’t want any surprises when tax season rolls around. The best way to avoid that is to strategize now. Here are three strategies to consider that may lower your taxable income and ensure lower income tax obligations.
1. Track and Bunch of Itemized Deductions
While not every medical professional can benefit from itemizing, due to a relatively high standard deduction,1 some may benefit from itemizing expenses that are deductible on your income taxes.
Itemizing one’s tax deductions means keeping track of each individual eligible deduction rather than taking the standard deduction for one’s taxes. Depending on the various sources of a doctor’s income and expenses, they may find the benefits of itemizing far outweigh the standard deduction each year. The drawback is that it comes with additional work to keep track of every deduction the individual is entitled to. However, this work can pay off handsomely if your itemized deductions exceed your standard deduction allowed by the IRS.
A further strategy to consider might be to bunch itemized deductions. This involves taking the standard deduction every other year, and concentrating spending on deductible expenses in alternating years to maximize your deductions over time, for example. To maximize this, one would concentrate expenses they may make purchases for the current year and the year in advance, to create additional deductions. A skilled tax professional can help you navigate whether this strategy might work well for you.
2. Harvest or Offset Capital Gains and Losses
Capital gains and losses directly affect a taxpayer’s total taxable income, although they use a different tax bracket.2Still, income and capital gains are taxed progressively, meaning that any capital gains increase an individual’s total taxable income instead of being taxed completely separately.
Because of this, it may be wise to strategize when and how many capital gains to harvest each year. A sound strategy could be to harvest gains on years when taxable income is lower. For example, a year when itemized deductions are bunched could dovetail with a capital gains harvest, selling appreciated stocks when your tax liability will be lower and then reinvesting that money into another investment.
Capital losses lower an individual’s total taxable income, making them a powerful tool for smoothing out tax brackets. Thus, if you have stocks that have gone down, you might consider talking with your tax or investment advisor about selling them, locking in the losses, and reinvesting that money into another investment you believe will appreciate.
Additionally, if one has net capital losses for a year, you might be able to use them to offset capital gains and even some ordinary income until the capital losses are exhausted.3 This can be a powerful strategy to reduce taxes on successful investments and smooth out tax brackets.
3. Max Out Tax-Advantaged Retirement Accounts
Another strategy for tax planning is to ensure that tax-advantaged retirement accounts are contributed to, up to the maximum limits. For many, this will look like maxing out a 401(k) to lower one’s taxable income for that year. This enables the taxpayer to hold onto more money during their working years, and invest it into other assets. This strategy works well, in tandem with the others, to significantly lower one’s taxable income.
Regardless of your financial situation, these strategies work best when paired with a Certified Public Accountant (CPA), wealth manager, or financial advisor. These professionals will understand the strategies listed here, as well as the specific rules for your specific situation.