Written by Josh Lantz, CRPC®/ Chief Investment Officer, Financial Advisor
As a financial advisory firm, we talk to hundreds of doctor households each year and see their tax returns. On occasion, we spot issues with their taxes. As you prepare for filing your taxes, we thought you’d want to know the common tax missteps we see with doctors.
#1: Backdoor Roth IRAs
Without a doubt the number one place we see issues with tax returns is on doctor’s Roth IRA contributions via the backdoor Roth conversion strategy.
As a refresher the backdoor Roth conversion strategy is for those earning over the income limits who wish to get money into a Roth IRA. The advantage of a Roth IRA is money goes in after-taxes, grows without taxation, and is withdrawn in retirement tax-free. It acts as a hedge against tax increases. You can think of it as tax-insurance.
If your income is above the threshold, you will fund a non-deductible IRA up to the contribution limit. In 2024 the contribution limit was $7,000 ($8,000 if age 50+). From there, you perform a Roth conversion which converts the funds out of the non-deductible IRA into a Roth IRA.
Here’s where the issues happen. You must tell your tax accountant, or the software if you DIY, that you funded your Roth IRA via the backdoor Roth conversion strategy. That way the tax filer knows to code the contributions into the IRA as non-deductible. They do this by filing IRS form 8606. This is the step that is often overlooked.
Without completing the IRS form 8606 properly, you’ll be taxed on your Roth IRA contributions. If you are married and were taxed for two $7,000 dollar contributions, you would have another $14,000 dollars of taxable income as a couple. Assuming an estimated marginal total tax rate of 40% (state + Federal) you would pay an extra $5,600 dollars of taxes due to this mistake. It adds up even more if this is missed several years in a row.
I’ve also seen tax accountants miss the IRS form 8606, so it’s important to double check they accounted for your Roth IRA contributions properly by asking them. The reason tax accountants can get confused is the custodian (e.g. Schwab) will mail out 1099R tax forms demonstrating funds were withdrawn from your IRAs. If they don’t know you used the backdoor Roth conversion strategy, they might mistakenly think those distributions are taxable.
If you believe this may have happened to you, know that you can sometimes amend previous tax returns to rectify the situation and possibly get a tax refund.
#2: Overcontribute
We see doctors overcontribute to retirement plans and other benefits through work. In general, if you overcontribute to something, you can fix the situation assuming you deal with it in a timely manner.
Let’s say you overcontribute to your 401k or 403b plan at work. The contribution limit was $23,000 ($30,500 if > age 50) in 2024. If you contribute an amount higher than that, you can do what’s called an “excess removal” to remove the excess contributions that exceed the limit. You must do this prior to your tax deadlines. The money that was contributed in excess will be taxed as ordinary income. Talk with your HR or your retirement plan custodian for their process to perform an excess removal.
It is most common to overcontribute to a retirement plan in the years where you change jobs. If you changed jobs in 2024, please review your total contributions. For example, a doctor younger than age 50 worked at job #1 who had a 401k and contributed $15,000 dollars and then later changed to job #2 where they contributed $10,000 dollars, the aggregate balances could not exceed $23,000 dollars (or $30,500 > age 50) in 2024. Therefore, they overcontributed by $2,000 dollars in that example and would need to do an excess removal.
Other common examples are overcontributing to HSA plans. The individual HSA limit was $4,150 and the family limit was $8,300 in 2024. Something unique about HSA contribution limits is they include both employer and employee contributions. Therefore, if you contributed $8,300 dollars and your employer contributed $1,500 dollars, you need to do an excess removal of $1,500 dollars prior to your tax filing date.
#3: Don’t provide all tax documents
These days many tax documents are often delivered to you either via the regular mail or email. They are often sent in February. Generally, doctors will forward these forms to their tax accountant. However, we’ve seen doctors miss forms. Without these forms, you or your tax accountant may file your taxes incorrectly. This could cost you thousands in taxes and may increase your audit risk.
Common forms include:
HSA forms
Mortgage interest 1098 forms
Back door Roth IRA 1099R forms
Brokerage 1099 consolidated forms
Many others
It’s important that you check all of your accounts online under “statements” to discover if you have any tax forms.
If you did a back door Roth IRA, you will receive a 1099R. If you have a brokerage account, you’ll receive a 1099 consolidated form for each account number with activity in it. There can be other forms for other account types.
If you need to access or download your forms on Schwab, you can do that here. At the top click “Accounts” followed by a sub header called “Statements & Tax Forms”. Then click on “Tax Forms” and then select the appropriate date range. Schwab aims to have these forms available in mid-to-late February.
If you’re having any trouble logging into Schwab, please reach out to us at info@mdfinancialadvisors.com. We’re happy to help you get set up.
It’s crucial to find all your tax documents. For example, if you miss a mortgage interest statement with $20,000 of mortgage interest it might cost you $6,000 to $8,000 dollars depending on your tax bracket.
#4 – Error with Cost basis
When you invest in a taxable account in your brokerage, you are subject to ongoing taxation. One way you’re taxed is on capital gains. A capital gain is the difference between what you paid for an investment and what you sold it for.
Example: you buy $10,000 of XYZ mutual fund and you sell it 12 months later for $14,000 dollars. In this instance, your realized gain is $4,000 dollars. The IRS and your state of residence tax you on this gain. Assuming it has been held for 12 months, you qualify for long term capital gains rates which are much lower than ordinary income tax rates.
A doctor with income in the top federal tax bracket would pay 20% + net investment income tax (NIIT) of 3.8%. Therefore, their long-term capital gains rate federally would be 23.8% multiplied by their gain.
Back to our example, you would multiply 23.8% by $4,000 dollars creating a tax bill of $952 dollars. This excludes state taxes, which can make this amount even more. Now imagine for a second your capital gains are not reported properly. Maybe there’s an error on your tax statements.
What you paid for your investment is tracked by something called your cost basis. The cost basis is what helps determine your total gain. Cost basis can also be adjusted for things like dividends, stock splits, etc, but that won’t matter for the purpose of this article. Let’s assume your cost basis (what you paid) is reported as $0 dollars. Therefore, your taxable gain would be $14,000 dollars instead of the $4,000 dollars from above. That would mean your tax bill is 23.8% x $14,000 dollars or $3,332 dollars. That’s $2,380 dollars higher due to the error.
Most of the time your tax accountant will catch this type of error, but not always. If you have any questions about your cost basis in your brokerage accounts, please reach out to us and we can get you more detailed reports.
The most common situation in which this occurs is when you transfer money from one custodian to the next. Sometimes the cost basis does not transfer over properly. If your cost basis is zero, there’s a good chance there’s an error and it needs to be reviewed.
Wrapping up
Above are four very common tax missteps we see doctors make. Make sure to review your situation to see if any of these apply to 2024 or previous years. If you find something that doesn’t look correct, always feel free to reach out to us with questions. You or a tax accountant can always consider a tax return amendment for up to three previous years if needed.
Josh Lantz, CRPC®/ Chief Investment Officer, Financial Advisor With over a decade of financial planning experience, Josh has worked on more than 500 doctors’ financial plans. “It’s very hard to find a doctor’s situation I haven’t seen before,” says Josh. This is only a snapshot of the expertise Josh brings to MD Financial. He can be reached at Josh@mdfinancialadvisors.com.