The COVID-19 pandemic has sent the world in a tailspin and it has directly impacted many of us in our pocketbooks. A majority of my locum tenens clients have seen their income drop dramatically (sometimes ceasing all together), while others — depending on their specialty — have seen their incomes increase. Although your income may have dipped this year, there is a silver lining in this gloomy cloud in terms of tax planning.
Changes to estimated tax payment due dates
Before we jump into some of the tax planning strategies available to locum tenens with lower income, let’s go over the important changes to 2019 tax return and 2020 quarterly estimated tax payment due dates.
- The original federal income tax filing due date has been automatically extended to July 15, 2020 for individuals and C-corps. You can still request an extension on or before July 15, 2020 to extend your individual and C-corp tax returns to October 15, 2020. Partnership and S-corp tax returns are still due by September 15, 2020 if you extended them.
- The extension rules stated above need to be examined for each state you work in because they may differ from the federal.
- Contributions to your HSA and retirement accounts (IRA, Roth, SEP, Solo 401k, etc.) have also been extended to July 15, 2020. If you extend your personal return, you can still wait to make contributions to your SEP or Solo 401k by your extended filing due date (HSA and IRAs need to be made by the July 15 deadline).
- 1st and 2nd quarter quarterly estimates have been extended to July 15, 2020 (3rd quarter is still due September 15, 2020 and 4th quarter due January 15, 2021)
Ok, now that we have the deadlines out of the way, let’s discuss three ways to structure your 2020 for additional tax savings.
1. Roth IRA conversions
If you know you will be in a lower tax bracket because your income is down substantially, you may want to consider converting a Traditional IRA/SEP/401k to a Roth. The conversion will be taxable for 2020 but, at a lower tax bracket, meaning you can take advantage of paying less tax now then you would have at retirement time. Taking advantage of the difference in recognizing the tax in 2020 versus at retirement age is called tax arbitrage.
It’s also important to mention that the contributions in a Roth will grow tax-free and be distributed tax-free once you hit retirement age (plus, there are no required minimum distributions as in a traditional IRA!). With the stock market down, you could take advantage of the growth that will occur in the coming years.
2. Adjust your payroll salary and withholdings
If your income has gone down substantially, make sure to adjust your payroll earnings and withholdings proportionately in order to account for the overall lower income. If you normally earn $400K through your S-corp and split your earnings between W-2 (let’s say you set your salary at $180K) and distributions ($220K), but your income goes down to $300K during 2020, you will want to lower your salary to reflect the reduced number of hours you are working.
It is important to reevaluate your salary every couple of years but more importantly during huge income fluctuations. This will help you put more money into your pocket now instead of giving the government a tax-free loan and waiting for a refund on your 2020 tax return.
3. Tax-loss harvesting
Tax-loss harvesting is a strategy that allows investors to minimize capital gains tax on their investments. The theory is to sell investments at a loss to offset any gains within your portfolio. For example, if you have $10K of capital gains from Stock A but Stock B is currently a loss of $15K and doesn’t look to recover or continue to be a good investment, you can sell Stock B to eliminate the gain on Stock A and still deduct $3K loss on your tax return (you are limited to $3K capital loss a year on your tax return but any loss left over is carried forward to the next year). Not only have you eliminated your capital gains tax but you have also lowered your taxable income by $3K.
Just be careful with wash-sales. The IRS does not allow you to sell Stock A and then buy Stock A back within 30 days. If you do, your loss will not be allowed. The best thing to do is to find a similar investment within the same industry (or mutual fund/ETF) to Stock A to fill in the void Stock A left.
It seems hard to believe that there is a silver lining with this pandemic. The strategies above are just a glimpse into the multitude of tax planning strategies out there for locum tenens docs. If you would like more information about these and other strategies to lower your tax liability, please check out my book Advanced Tax Planning for Medical Professionals: A Concise Guide to Tax Reduction Strategies or contact us at Cerebral Tax Advisors if you would like one-on-one assistance building your tax plan.