Financial Rule #2 - Pay Less Tax

Your biggest expense as a physician will be paying taxes. Financially, you should try to minimize your taxes paid.

I often think about physician finances in an inverse way. Instead of focusing on your specialty and income or compounding returns on investments, I think it’s good to think about what pitfalls could ruin your path to financial independence.

The first rule was about the cost of a separation. The second most costly mistake is paying more taxes than you ought to.

Now, I am not advocating tax avoidance - that’s a crime. This is not about setting up off-shore accounts to hide your money from the government. Instead, what I advocate is that you have a responsibility to make sure you do pay your taxes, but not anymore than required.

This is not a political view. Whether you’re conservative or liberal, how much tax each individual should pay is a decision that society makes through elections and legislation. You will find that even people who are vocal and advocate higher taxes, regardless of their wealth, will not pay more taxes than required. Bill Gates, who has paid more taxes than anyone, says he should pay more taxes but won’t pay more unless required. As he should, it’s not his responsibility to give the government extra money.

Tax-Deferral

In Canada, the highest marginal tax rates are over 50%. For every dollar earned after a certain threshold, the government takes half. That is a lot of your hard earned money. If you were a new attending making $300,000 CAD gross, your tax bill (approx $150,000) your first year out will be double your resident’s salary.

Fortunately, there are strategies to reduce your taxation, or at least to defer it.

Registered Retirement Savings Plan (RRSP)

RRSPs are one way that you can reduce your tax bill. Introduced in 1957, RRSPs are a way to promote savings for retirement by reducing your taxable income. Contribution limits are calculated at 18% of your previous year’s reported income, and deductions can be carried forward. Investments in RRSPs can grow tax free, and are only taxed at the time of withdrawal.

For a great detailed analysis, check out Loonie Doctor’s take on RRSPs. There are also programs like the Home Buyers’ Plan that you can use with RRSPs.

If you’re American, these retirement saving accounts are known as 401(k), 457(b), 401(a), etc.

Medical Professional Corporation

The other big method of tax-deferral that Canadian doctors have at their disposal is incorporation. Setting up a medical corporation is essentially creating a separate legal entity that operates as a business. Your corp will have assets, debts, revenues, expenses. The main reason to incorporate is for better tax rates and to defer paying more taxes upfront. Remember, the government will always get their taxes owed, but legally you have ways to defer paying them until a later date.

The Resident Doctors of BC has a simple guide on the basics of incorporation.

Again taking our new attending who makes $300,000 a year - if she doesn’t need that much money for personal expenses, she can take out only what she needs from her corporation and save the rest for investments. For example, if she chooses to live like a resident and get by on $60,000 of expenses, she can use the remaining $240,000 to invest. The $240,000 is also taxed at a business rate, which is much lower than the personal marginal rates.

Pros of incorporating: Effective tax-deferral strategy, lower business tax rates, ability to regulate personal cash flow

Cons of incorporation: Added complexity to your finances, overhead costs (accountants, lawyers), not ideal if you need money now and can’t have retained earnings

Proper Bookkeeping - Find a Good Accountant

Whether you’re incorporated or not, as physicians your services are a business, and you need to make sure you keep track of your expenses. Buying medical equipment, paying for exams and association fees, home-office expenses, transportation costs, conferences, staff meals, etc. The list goes on and on.

You need to make sure you account for all your costs, so you deduct the expenses from your taxable income.

Be organized. Have a system to keep track of things.

I make sure I expense all the snacks and coffees I get for my medical students and residents. A well-nourished and caffeinated team works faster and creates more revenue for me. Definitely an expense that you shouldn’t cheap out on.

Giving to Charity

Even though I’m a strong believer of not paying a single cent in taxes than required, I am also a strong believer that as high-income earners, we have a duty to give back to society. I would much rather give $100 to a charity than $50 to the government.

Fortunately, the Canadian government also recognized the merit of charitable donations and gives us tax credits.

Work Less

This may seem counter-intuitive at first- how can I become more financially independent if I work less?

Due to progressive tax rates, the more you earn the more you will by taxed. Eventually you will reach a point where you will get diminishing returns.

Doctors aren’t often lacking in money, but they are often short on time. We spend our twenties in school, taking on debt, learning and surviving residency. Add in a growing family and increasing clinical duties, there never seems to be enough time. Eventually, what you’ll find most valuable is autonomy in your schedule.

After a certain point, it doesn’t make sense to do more overnight call. Spending time with your spouse and kids will be more important than the money you will make. It certainly will help with rule #1 - don’t get a divorce - if you have more time to help out at home. Similarly, if you’re burnt out working 80 hour weeks, it will do you no good for your long-term wealth if you end up hanging up the stethoscope in a few years.