Speaker 2 (00:02.38)
Welcome to the Physician Family Financial Advisors Podcast, where physician moms and dads, like you, can turn today's worries about taxes and investing into all the money you need for retirement and college. I'm Ben Utley.
I'm Nate Renneke. Today we're answering the questions, why do physicians get big surprise tax bills? So Ben, I didn't say why do physicians pay a ton in taxes? Cause we know that is kind of inevitable. The problem that we hear all the time is they get an unexpected bill and they're kind of caught in a bad situation and they have to play catch up all year. And it's just a terrible feeling. Is that kind of what you-
Maybe I need to fire my CPA. didn't get me enough tax breaks.
Exactly. It's either breaks or withholdings or whatever it is. And we kind of see the same stories happen over and over again, depending on where you're at.
every April, just about this time of year.
Speaker 1 (00:59.954)
Uh-huh. Yeah. So let's start with why young physicians might see a big bill. Sort of the same story. Either they did it right or something familiar happens to them. Can you say what happens to young physicians?
Yeah. So last year, you know, the young physician, you went to, you went to work, you got your quote unquote real job. You started in July or August, you started making the real bucks and then, you know, you get your, your tax bill in March or April and you're like, holy cow, what just happened? You know, I could, this is like as much as I made before I became a physician last year, that's my tax bill. This is crazy. Right? So it's the shock and awe of meeting the IRS face to face for the first time.
And a lot of times the question is like, why did this happen? You know, I, had withholding taken out of my paycheck last year, you know, like why am getting lit up with this big tax bill? And what you realize is that the withholding assumes a it's withheld throughout the course of the entire year. And B those withholding tables are kind of made for ordinary people. And it gets a little weirder when you get up into the higher income tax brackets and higher earnings. So,
merely having taxes withheld from your paycheck throughout the course of the year is not adequate when you have a big pay bump like physicians typically have in their first year or when they when they have had a job change and things like that have changed when there's been a major upheaval so a big tax bill comes due and this is something I perennially see with new attendings and even new attendings who have become clients
that I have said, Hey, you're going to get a huge tax bill. They're always shocked and surprised by how big the tax bill is. And it just knocks them back. mean, you know, there you are, you're just beginning to pay your student loans. You might have a mortgage. You might have a baby on the way. you know, you're struggling to kind of get your feet underneath you and your practice. And all of sudden along comes this five figure tax bill and it just knocks you backwards. So yeah, very, very surprising.
Speaker 1 (03:10.07)
Yeah, something that I've noticed or it's kind of thing that people don't understand is that in the in that first half the year, you know up until June The withholdings on your paycheck are based on a on a salary as if you continue to make that amount The first half the year throughout the whole year. Yeah, so that's a big issue. If you're nervous about this you can get what's called a tax projection
And you might do that the day you get your attending position. It's going to cost you a few hundred dollars. But the reason this is important isn't because you can't come back from that tax bill. But what I see is that it really scares new physicians in their second year from investing money or getting on track with everything else because they're so terrified they're going to have to save up for this tax bill year after year.
Right. And so if you're not planning correctly, you'll kind of scare yourself into bad decisions for years to come.
Right. And you know, as we're talking about this, I was thinking about the first six months of a physician's attending career. And you know, typically you can't get into a 401k plan or a 403b plan for somewhere between three months and a year. So in that first six months of making six figures, they're not going to have access to a 401k or a 403b that's going to help keep that tax bill at bay. They're not going to be able to contribute to
like a cash balance plan or something like that. So they're, fully exposed and you know, some of the, some of the residency programs or training programs may or may not allow a person to contribute and they're not able to contribute very much during the final six months of their training. I think, you know, missing out on tax breaks that they don't, they literally don't have a chance to get to is, a, is a big part of, of why young physicians get lit up.
Speaker 2 (05:00.226)
And I kind of think that segues into our second point about why physicians have surprised tax bills.
Yeah, yeah. So after these these young physicians kind of repair their their finances from these big bills, they're finally getting into investing some of their money. And they're a mid career physician now making good money for years. So they kind of got the taxing figured out. Then usually they get hit with a different kind of bill. And what is that usually?
Capital gains taxes, capital gains tax bills. So capital gains tax for listeners that are just kind of coming up to speed on this, in the US we pay two kinds of taxes on income. We pay ordinary income tax and the rates on that goes up into the 30s at the federal level, it goes up into the low teens at the state level.
And then we have a parallel tax system for the taxation of capital gains. so a capital gain is when you buy something for a hundred dollars and you sell it for a hundred and fifty dollars, you have $50 worth of capital gain. And that capital gain could be a short-term gain or a long-term gain. So if you held that security or that property for over a year, it's a long-term gain and it gets favorable tax treatment, which means the most it's going to be taxed at is 23.8 instead of in the thirties.
If it is a short-term gain where basically you flipped a property or you flipped a stock or a mutual fund and you have a gain in it, then that's going to be taxed as ordinary income up in the 30s. So that's what capital gains are.
Speaker 1 (06:33.058)
Mm-hmm Yeah, and sometimes you would assume that you're not gonna have any gains if the market is down Can you talk about excessive gains? Even if them if we're in a down year
Right, particularly in mutual funds, traditional open-end mutual funds, as mutual funds go along, they accrue gains. And every now and then they will pay out those gains and they can pay out those accrued gains whether or not you have appreciation in the security. So for example, if you buy a mutual fund that has accrued gains and you can hold it for as little as a month's time.
and it pays out those capital gains distributions in your hands. It doesn't matter whether you have a small gain in it or a loss in it, you're still gonna be holding that security when the capital gains distribution is paid and you're gonna get hit really hard. In fact, we saw, I believe it was last year, year before last, Vanguard in their target date funds made a move, they reshuffled their funds and a whole lot of people got hit with capital gains distributions in...
their taxable accounts. So they probably shouldn't have been holding these securities in a taxable account in the first place. But yeah, there was actually a class action lawsuit about it. And it was kind of a big kerfuffle because Vanguard investors are not accustomed to seeing that kind of problem. But yeah, in mutual funds, you see that. Also, we see capital gains come out of churn. So for example, if you have someone who's managing your account, they kind of have a hot hand.
and they're trading securities in and out, and there's some gains in there, they're going to recognize those gains as short-term gains, and you're going to pay those as ordinary income when April comes. And there's no warning of this. It's not like they're going to call your CPA and say, hey, there's gains coming. They're not likely to call you. It's going to get reported to you on form 1099, and you're going to get that form in February when it's too late to do anything about it.
Speaker 1 (08:29.372)
That one hurts. That's a big hit.
does. So do you want to hear what we can do about that?
Yeah, what can we do about this? This sounds kinda scary.
Yeah, it is kind of scary. so first off, if you're managing your own account, buy securities that you could kind of hold forever. Okay. And if you're managing your own account, you want to lean toward exchange traded funds because exchange traded funds don't have this phenomenon where you're basically paying taxes on somebody else's gains. Okay. If you are hiring someone to manage your money for you,
you wanna have a conversation with them and dig down to find out what they know about taxes, what they know about capital gains taxes and how to avoid them. Are they willing to do tax loss harvesting in your account? Are they familiar with tax coordination strategies? What are they doing with it? And if they're trading, then that's a really bad sign. If they're trading frequently and like one minute you own something, you look at a statement a couple of months later and you don't own it anymore, that's a bad sign. I think...
Speaker 2 (09:26.67)
you watching your strategy or watching the person who's watching your strategy is a big key to avoiding those surprise gains in April.
Yeah, this is really a big drag on the performance. So taxes are huge, especially for physicians. So that can really span across, you know, mid-career physicians all the way to late career physicians. But what is kind of unique to established physicians who own their own practice? Like what surprises are people seeing if they own their own business?
Yeah, so this is interesting. people who own their own business, particularly physicians who own like ambulatory surgery centers, or they own medical office buildings, a lot of times I see physicians borrowing to buy these properties. And so, you know, maybe they'll buy a $5 billion building. They put $500,000 down between them as a group. And let's say that this year they decide, okay, we're just not going to take as much money out of the business. We're going to pay down this debt.
In fact, we're going to aggressively pay it down. We're going to pay ourselves a minimal salary and take minimal distributions. And the rest of this, we're going to pay down the debt with. see this on a pretty regular basis because most physicians are debt averse. So they aggressively pay down the debt. And when it comes tax time, they get this huge tax bill and they're like, wait a minute, wait a minute. I barely took any money out of my business last year. How can I be paying all these taxes? Well, it's not how much money you take out of your business. It's how much money your business earns.
So the money that you earned inside your practice, even though you used it to pay off debt is still taxable to you. And that's what we call phantom income. It's not a bad thing. It's just one of those things that if you're not prepared for it, you will get lit up in April. There's just, there's just no way around it other than to kind of keep the debt in place and pay yourself out, just your regular earnings. But yeah, if you aggressively pay down debt inside your medical practice,
Speaker 2 (11:23.49)
then you need to be prepared because you are going to have a tax bill for every dollar that you earned even if you don't have the dollars to pay the tax bill.
And much like the first example we gave this is something that even if you still want to pay down the debt what you need to do here is Save to pay your taxes. I mean sometimes you just have to be prepared. You can't always Side step the bill you just need to be prepared to pay pay the money and in those cases I don't see people kind of shaken by the tax bill if they're prepared. Yeah, sometimes you can avoid it like with the ETFs, but other times just be
Be ready and be prepared and you'll be good.
Yeah, throughout the course of year, can set aside some money in cash reserves. when April comes, you know, it'd be something that's liquid, something else like FDIC insured, not an investment. And that way, when you show up in April, you've got the money in hand and you don't, you don't have to go bagging.
So keeping your taxes in check is a moving target and it's something you have to review every year. As we learn about the new strategies, you'll hear about them here on the podcast.
Speaker 2 (12:28.76)
Great. Thank you for listening to the Physician Family Financial Advisors podcast. Are you getting all the tax breaks you really deserve? To find out, get your copy of the Overtaxed Doctors Retirement Investing Checklist, available today at physicianfamily.com slash go.
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